This article highlights some of the key challenges in the auditing profession as well as some of the international developments that are taking place to address these challenges. The focus on COVID-19 should not divert attention from audit reform discussions that were aimed at enhancing audit quality as this could hamper the progress that was steadily building in this regard.
Before the outbreak of the COVID-19 pandemic in South Africa, the audit profession was in discussions on audit reforms to improve audit quality and to make sure that the profession remains fit for purpose. Audit reforms refer to those laws and regulations that will have an impact on areas of audit regulation such as corporate governance related to auditors, the structure of audit firms, auditor selection, auditor independence, reporting by audit firms, auditor oversight and competition within the audit market. In his February 2020 Budget Speech, Minister Tito Mboweni indicated that National Treasury will appoint an independent panel of experts to review practices in the audit profession and that legislation that will strengthen the Independent Regulatory Board of Auditors (IRBA) is planned. This independent panel has not yet been formed. We will be guided by National Treasury in this regard.
The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework. Audit plays a crucial role in the economy by creating order in the financial markets as stakeholders can form views about the audited entities based on trustworthy financial results. In this time of enormous and unprecedented economic upheaval in particular, users of financial reports need comfort that the financial information that they are receiving can be relied upon.
Challenges in the profession
The auditing profession has in recent years experienced many challenges. Some of the key challenges are discussed in greater detail below.
Audit failures
The corporate failures experienced in South Africa and abroad have called into question the role and effectiveness of the external audit. In South Africa, accounting scandals have occurred at companies like Steinhoff and Tongaat Hulett where the executives are purported to have conducted themselves unethically to hike profits and deceive the markets. The auditors did not detect these fraudulent activities, which has resulted in scrutiny of the audit profession by shareholders and the general public.
It must be noted that the International Standards of Auditing (ISAs), with which auditors are required to comply, do not place a requirement on the auditor to detect fraud. The ISAs require that: ‘An auditor conducting an audit in accordance with ISAs is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.’ The audits may therefore not necessarily be ‘failed audits’ in terms of the ISAs. Where negligence has occurred and it has been demonstrated that the auditor(s) did not comply with the ISAS, disciplinary processes have been implemented. Shareholders and the public are, however, calling for a reform in this regard as it is perceived that an audit is ineffective if it is not designed to detect fraud.
Declining audit quality
The IRBA’s Public Inspections Report 2019 published on 17 March 2020 indicated that the 2019 results of positive inspection outcomes declined compared to 2018. The IRBA also indicated that the frequency of findings in South Africa remained higher compared to other jurisdictions. These results further strengthen the need for audit reform as they suggest that the profession, under the current rules and regulations, is not self-correcting.
The lack of competition in the audit market
In South Africa, more than 90% of the Top 40 listed companies are audited by the Big Four firms (Deloitte, EY, KPMG and PwC). Currently, only banks are required to appoint joint auditors to perform the audit engagements, subject to the conditions contained in the Banks Act 94 of 1990 and directives issued by the South African Reserve Bank (SARB). Even where joint audits are performed for banks in the Top 40 listed companies, all of these are performed by Big Four firms. The exception in this regard is MTN Group Limited (this is the only other company in the Top 40 listed companies where a joint audit is performed, in this case a voluntary joint audit). SNG Grant
Thornton is one of the joint auditors in this engagement.
While a number of small- and medium-sized firms may want to play in the listed entities space, there are several deterrents to entry, including increased costs (for example investments in technology and staff), intense scrutiny by regulatory authorities such as the Johannesburg Securities Exchange (JSE) and the IRBA, and the existing relationships that some of the audit committees may have with the auditors. The latter may be partly because the Big Four firms have invested heavily in audit technologies to enable them to perform audits of large multinational companies whose operations may be complex, and this may give audit committees comfort in the firms’ ability to perform the audits. To illustrate this, an audit committee report for 2019 of one of the Top 40 listed entities on the
JSE, contained the following statement:
‘As a listed entity, we believe that the auditing services of an international “Big 4” auditing firm, with the necessary experience and expertise, is required to ensure that our financial results are reasonable and comply with IFRS. Furthermore, our growing business and ever-changing accounting standards make it imperative to appoint an auditing firm that has exposure to international best practice and knowledge.’
Such a statement points towards a preference for the appointment of one of the Big Four firms. The reasons expressed in the statement are an obstacle for small- and medium-sized audit firms to competing for listed company audits. One of the questions around audit reform is what the possible solutions to solve this concern are.
International developments
Talks of audit reform are not only happening in South Africa. The United Kingdom (UK) has undertaken a number of studies to research and understand the problems that the audit sector is facing – including the challenges identified above – and how these could be addressed through audit reform. One of these initiatives includes the Statutory audit services market study in the UK conducted by the UK’s Competition and Markets Authority (CMA) and issued in April 2019 (the CMA study).
Other studies conducted in the UK include:
- The Report of the independent review into the quality and effectiveness of audit performed by Sir Donald Brydon issued in December 2019 (the Brydon review). The recommendations are collectively aimed at improving audit and assurance in relation to Public Interest Entities (PIEs) in the UK.
- The Independent Review of the Financial Reporting Council (FRC) performed by John Kingman (the Kingman review, issued in December 2018, to assess the effectiveness of the FRC, which is the audit regulator in the UK. A new regulator, the Audit, Reporting and Governance Authority (ARGA), is in the process of being formed.
- The Department of Business, Energy and Industrial Strategy (BEIS) select committee published the Future of Audit report (the BEIS report) in March 2019 to examine how all of the reviews would complement each other, given the links between the quality of the audit product, its regulation and the health of competition.
SAICA is currently performing an analysis of all the reviews and how they could impact the South African environment. A number of thought leadership articles will be published in this regard, with this article (Part 1) focusing on the CMA’s study and the next article (Part 2) on the Brydon review.
The CMA’s study resulted in the following recommendations in the UK:
- Greater scrutiny and oversight of audit committees to increase their accountability. This is intended to increase the effectiveness of audit committees in ensuring that the selection and oversight of auditors is focused on quality.
- Mandatory joint audits, including at least one non-Big Four firm (referred to as challenger firms), for most large companies to increase the long-run resilience and choice in the market. In an environment where only four firms are performing the largest audits and where the challenger firms are ill-equipped to perform the audits, there is a risk of a market crisis in the event of failure of one of the Big Four. Joint audits are now mandatory to allow for the challenger firms to gradually adapt to the audits of large companies over a period of time and to develop the capacity to perform these audits.
- An operational split between the audit and non-audit practices of the biggest firms.
- A five-year review of the progress by the regulator.
In the table below we provide a comparison of the CMA recommendations as listed above to similar regulations in the South African audit environment, where applicable:
| Greater scrutiny and oversight of audit committees in order to increase their accountability | In South Africa, the activities of the audit committee members are described in the Companies Act 71 of 2008 and the King IV Code of Corporate Governance. Audit committees are not regulated in South Africa. For example, the JSE’s and the IRBA’s powers do not extend to audit committees. Several bodies, including the IRBA, are consulting with National Treasury on comprehensive regulation (which was recommended in the World Bank’s Report on the Observance of Standards and Codes, Accounting and Auditing in South Africa, 2013 (the ROSC report) (comprehensive regulation is referred to as a ‘comprehensive arrangement for supervision of the accountancy profession’ in the ROSC report). This consultation may result in comprehensive regulation of the accounting profession in some form, with one of the assumptions being that all role players in the ‘corporate reporting chain’ should be regulated. This would logically include audit committees and audit committee members.
SAICA continues to engage with the Institute of Directors, the King Committee and the Audit Committee Forum on several topics. |
| Mandatory joint audits, including at least one non-Big Four firm, for most large companies | As mentioned above, banks are the only entities where joint audits are required to be performed in South Africa. Voluntary joint audits may be performed for all other companies although there is no mandatory requirement to do so. MTN Group Limited is the only Top 40 listed company, aside from the banks, where a joint audit engagement is performed.
Secondly, in the case of banking institutions where joint audits are required by the SARB, there is no specification as to which firms should perform the joint audits. The appointed firm in this case would have to satisfy the criteria set out by the Registrar of Banks. The criteria focus on the relevant auditing experience of the firm and the responsible partner in the particular regulated industry, as well as the depth of skilled resources of the audit firm in relation to the complexity and size of the audit of the regulated institution. This may explain why the Big Four firms continue to be the only firms auditing banks in the Top 40 listed companies. This presents the small- and medium-sized firms with a Catch 22 situation: they are not able to obtain experience in the industry and are therefore not able to audit in that industry, thereby not gaining experience … Appointment of the auditors is at the discretion of those charged with governance subject to the requirements of the Companies Act and the IRBA’s Code of Professional Conduct for Registered Auditors with regard to such appointments and independence of the auditors. SAICA recommends that extensive consultation should be undertaken to assess whether mandatory joint audits be a requirement for certain companies and other entities in South Africa, including the viability thereof. Advantages could be that the small- and medium-sized firms could gradually adapt to the audits of large companies over a period of time and could develop the capacity to perform these audits. However, auditors are required to exhibit the necessary competencies before an audit commences, so the purpose of these joint audits should not be to ‘upskill’ these firms as the skills should already exist. |
| An operational split between the audit and non-audit practices of the biggest firms | Section 90(2) of the Companies Act prohibits an auditor from being appointed where certain services were rendered to the same client. This prohibition applies to both the firm and the individual auditor. However, there is no regulation requiring an operational split between the audit and non-audit practices of the firms.
SAICA recommends that extensive consultation should take place in order to analyse the advantages and disadvantages of having the operational split. Furthermore, an impact analysis of section 90(2) of the Companies Act and other regulations introduced by the IRBA should also be made to obtain an understanding of how these provisions have impacted the independence of auditors in South Africa. Any reforms introduced should be directed at enhancing existing laws where they are effective. Existing and new academic research may prove useful in this regard. |
SAICA is not currently advocating for any specific solutions to the proposed reforms, as some may not even be relevant to South Africa. However, SAICA is advocating for the discussions to continue and to be accelerated and for solutions to be comprehensively explored with all the relevant stakeholders, namely South African regulators, the government, accounting institutions, audit committees, users of audit reports and the audit firms. Further research, discussions and consultations can run in parallel with the work that the independent panel referred to in the Budget Speech will be mandated to do.
Conclusion
Given the global interconnectedness of the audit profession and the challenges experienced by the audit profession in South Africa, it is imperative that effective solutions to the South African challenges be devised. SAICA encourages auditors to get involved in the important engagements taking place during this period in order to restore trust in the profession, enhance audit quality, and promote independence and a more competitive audit market. The issue of audit reform is a matter of priority and delaying its urgency during this period could lead to the current crisis in the profession becoming even greater than the one currently being imposed on it by COVID-19.
Notes
1 International Standard on Auditing (ISA) 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with ISAs, paragraph 3.
2 ISA 240, The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements, paragraph 5.
3 Per an informal study conducted by SAICA staff.
4 Northam Platinum Limited Annual Financial Statements, 30 June 2019.
AUTHOR | Thandokuhle Myoli CA(SA) is Project Director: Audit and Assurance at SAICA.
