Appointment of the External Auditor: report, AGSA funding model and induction workshop

Standing Committee on Auditor General

17 September 2009
Chairperson: Advocate M Masutha (ANC)
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Meeting Summary

The Standing Committee firstly considered the recommendation for appointment of an external auditor for the Auditor General South Africa (AGSA), made by the Audit Committee of AGSA. A Member commented that the Audit had not prepared itself fully, as one issue was still outstanding, and questioned the recommendation being made, pointing out that contractors sometimes failed to fulfil their promises. The Audit Committee believed that it had, in describing the audit approach, in adopting its own systems, and undertaking independent reviews, made an informed recommendation. The preferred candidate had met the Audit Committee's requirements to a far greater extent than any other, and in addition already did work for the Auditor-General's Office in Eastern Cape, and was well-recognised. After discussion, the Standing Committee approved the Audit Committee's recommendation to proceed with negotiations for appointment of the preferred candidate as external auditors, on condition that the unfulfilled Independent Regulatory Board for Auditors reviews criterion (as set out in table 1, page 2 of the attached document on  Appointment of External Auditors, was met.

The Auditor General then gave a presentation on its funding model. When it had separated from Government in 1993 it had opted for, and become accustomed to, a self-funding model, whereby it did its work like a commercial audit firm, and collected fees in cash from government departments, the auditees. However, the Office had capped its fees and not increased them in line with the levels of pay of the new professional staff that it had recruited. This had resulted in a serious and growing deficit. Secondly, because of the shortage of skills and its high vacancy levels, OAG had also had to engage external audit firms, which it did at no extra margin to itself, so that the more that the work was contracted out, the less it could earn to accrue a surplus to allow it to pay its overheads. Therefore there were two issues to resolve: firstly to fill the vacancies and to make less use of unplanned contract work; and secondly to revise margins so that fees reflected the actual costs of employing professional and other staff in order to perform the audits. A
new funding model was approved by the previous Committee for implementation on 01 April 2009. Capping was removed and charge out rates were now based on direct salary cost, marked up by an agreed factor. A once-off non-refundable grant of R154 million had been approved to address working capital and capital expenditure requirements, although only R90 million had actually been received from National Treasury. A once-off tariff increase of between 25.9% and 30.9% had been obtained. This had resulted in a budgeted surplus for 2009/10. This would contribute about 91% to the Capex requirement, although expenditure on that would be subject to cash flow availability. The new funding model and arrangements for working capital management were illustrated. Members expressed especial concern about the inability of many municipalities to pay their audit fees, agreed that litigation should be the last resort, but suggested that perhaps any new allocations should be made conditional on payment of all outstanding debt for previous audits. Members agreed that it was vital to protect the integrity and independence of the Auditor-General, that fees should be charged, but that grants from Treasury should not be excluded.

The Committee then completed the presentation on the work of the Auditor General, and how the audit process worked. Full explanations were given of the purpose of the audit, the need to ensure that there was correct governance, the need for checks and balances, and appropriate controls, and the proactive approach to auditing. His understanding was that audit gave guidance. The performance audits were also outlined. It was noted that leadership should be doing its own monitoring, and regular reporting was an imperative. Service delivery, not transgression of prescripts was not an issue in all spheres of government.

Members finally discussed matters to be taken forward from the previous Committee’s legacy report, which had not been received by all Members, and which was in any event incomplete, together with other issues highlighted by the Auditor-General and the Committee during discussions. A time would be fixed for a presentation on the changes proposed to the Public Audit Act. Members were reminded of the upcoming Association of Public Accounts Committees conference from 27 to 30 September.

Meeting report

Appointment of External Auditor: Recommendations of the Audit Committee
The Committee had previously begun to deal with the consideration of appointment of the External Auditor for the Auditor-General of South Africa (AGSA) during its meeting on 19 August 2009.

Mr Peter Mayo, Chairperson of the Audit Committee, Auditor-General of South Africa (AGSA), said that the Audit Committee had completed the work that it believed necessary for it to recommend the appointment of external auditors to the Office of the Auditor-General (OAG). The Audit Committee recommended completing the contracts with the first preferred candidate, who was named. However, some more discussion was needed with this firm on administrative matters. The Audit Committee sought the Committee's approval for completing the contract with this firm, and had made a written submission. Unfortunately, when the Audit Committee had asked for tenders, it had not specifically asked for prices. This firm’s figure was approximately within the range of acceptable prices, but it was still necessary to finalise the price.

The Chairperson asked Mr Mayo to tell the Committee more about that firm and give reasons for its preference.

Mr Mayo said that in his report to the Audit Committee he had said that the overall quality of tenders received had not been impressive.  The tender of the preferred candidate had been the most professional tender received. It was the only submission that had given substantial details as to how the firm would approach the audit. He furthermore noted that the team proposed to undertake the audit was impressive, and met the criteria, as set out in the attached document (Audit Committee: Appointment of External Auditors, table 1, page 2).  This firm was substantially ahead of the candidate firm that was rated second.

Mr M Steele (DA) referred to the 'hurdle criteria' listed in Appendix B on page 5 of the document. This stated that a firm ‘must provide evidence of a satisfactory result on their latest Independent Regulatory Board for Auditors (IRBA) review results for the firm and for the engagement partner'. He said that this firm scored a blank on that 'hurdle criteria’  of review.

Mr Moyo replied that the preferred candidate had indicated that the firm had just completed their review, and that the results would be available at the end of August 2009. He had said in his submission to the Audit Committee that it would be necessary to review those results. If they were negative, the Audit Committee should not continue with appointment of this candidate.

The Chairperson said that the Committee was supposed to make an appointment that day.

Mr Moyo replied that the Audit Committee was asking, at the present time, for the Committee's approval that the Audit Committee carry on the process with the preferred candidate, to try to deal with the terms of the contract.

The Chairperson asked whether there would be a suspensive condition to the contract negotiations.

Mr Moyo replied that it would be made clear that negotiations were being conducted conditional to the review being satisfactory.

Mr N Singh (IFP) asked what would happen if the preferred candidate fared badly on the IRBA review, and if the Committee would then need to meet to consider the second candidate. It was time consuming for both the Audit Committee and the Committee to have to keep reconsidering this matter.

Mr Singh also asked how a firm could compete with the difference in price quoted by the preferred candidate, being a variance of R750 000 (about 60%) from the R2 million. He asked if the Audit Committee had queried that apparent discrepancy.

Mr Moyo replied that it was really not for the Audit Committee to query it. However, he himself had misgivings. He would have expected each contender to ask for a fee higher than R2 million.
The Chairperson asked if the Office of the Auditor-General (OAG) wanted to comment.

Mr Kimi Makwetu, Deputy Auditor-General, replied that Mr Moyo was correct in saying that, in terms of the various cycles and disciplines that constituted the external audit, any quotation that fell 'on the lower side of R1 million' would probably indicate that the firm would be cutting corners in the work, and would be worrying because the OAG needed to obtain a credible outcome from the external audits. However,  the quotation by the preferred candidate fell within the range that was expected.  

Mr Singh said that, having received those comments and explanations, perhaps the recommendation should be accepted, conditional upon the IRBA review being satisfactory.

The Chairperson opined that if it turned out that there were problems, then the Committee should perhaps formally confirm that consideration should then be given to the second candidate, but asked for the views of Mr Moyo, since there might be further nuances.

Mr Moyo said that the audit must start soon. He suggested that if the Audit Committee faced any problems in the contract, perhaps any member of the Audit Committee should be authorised to confer with the Chairperson of the Committee, who could be given the discretion to finalise the matter.

The Chairperson said that he would prefer to examine both options. He suggested that the Committee must satisfy itself on the suitability of both first and second candidates. If the first candidate did not succeed in the review, the Committee should authorise the Audit Committee to proceed to negotiate with the second, without having to refer back to the Committee, which would not cause undue delay. He would also be happy to discuss matters with the Audit Committee.

Mr Steele pointed out that the second candidate did not meet the IRBA test either.

Mr Moyo replied that the second candidate would be satisfactory. It was a network of four or so firms that audited companies listed on the Johannesburg Stock Exchange. However, the Audit Committee was concerned that that network operated from different offices, and had indicated that the audit would be carried out from their Pretoria office. The Audit Committee believed that this would lead to a fee higher than if the audit was done by the Johannesburg office, and would, if contracting with this candidate, insist that the audit must be done by both the Johannesburg and Pretoria offices in order to contain fees.  The IRBA review appeared as a blank, because when making the submission, the network had submitted for its different offices, and had shown only the review result for its Stellenbosch office, which the Audit Committee had disregarded because that office would not be involved in the audit.

The Chairperson said that it seemed that the second candidate presented more cause for reservation than the first. It did not seem that the Audit Committee could not have automatic recourse to the second candidate if the first failed, given the number of contingencies that still needed to be resolved. He was inclined to the view that the first candidate should be accepted, on condition that this firm fulfilled the outstanding requirement. If this was not done, then the Audit Committee should return to the Committee so that it could examine other options.

Dr D George (DA) remarked that one of the other firm’s quotation was unusually low. He asked if that was because Octagon was trying to deal with the criterion that the audit fees from the AGSA should not exceed 10% of its total revenue, as he was not sure whether this firm could deliver a service at such a price.

Mr Moyo said that in regard to this firm, it had been no surprise, but of great concern, to the Audit Committee that its fees were so low, as only one partner in the firm was qualified, and the manager was not a chartered accountant.

The Chairperson said that it was undesirable for anyone to perform work for government at a loss or on charitable grounds, since this would risk compromising the principle of independence.

Mr Singh asked how often the IRBA review was done. 

Ms Jillian Bailey, Head of Audit, AGSA, replied that it was every three years.

Mr Singh asked if the last review of the candidate had been examined, and if so, then the Committee should be satisfied with that.

Mr Moyo said that it was necessary to satisfy the Audit Committee.

The Chairperson agreed that it would be of more benefit to examine something that was more recent, so that consistency could be affirmed. 

The Chairperson asked about the composition of the team of the preferred candidate.

Mr Moyo replied that he did not have all the details with him. However, the preferred candidate had two partners who were chartered accountants, and two qualified managers. The Audit Committee was more comfortable with that team. It was also the only firm that proposed a black person as a partner of the audit team.

Ms J Sosibo (ANC) expressed her concern that the Audit Committee was not fully prepared because of the IRBA matter. She referred to the total scores of 42.5 for the first candidate against 30 for the second. She was concerned that contractors often failed to fulfil their promises with consequent loss of government money. She asked if the Audit Committee would return to the Committee, once they had settled on the preferred candidate.

Mr Moyo responded that he thought these remarks unfair. He said that the Audit Committee had not simply taken the word of the candidates. In his report to the other members of the Audit Committee, he had stipulated that the Audit Committee needed to satisfy itself fully. In terms of the description of their audit approach, their own systems, and the Audit Committee's own independent reviews, the preferred candidate had met the Audit Committee's requirements to a very much greater extent than any other candidate. The difference had been obvious. One of this candidate’s offices, in the Eastern Cape, already did work for the Office of the Auditor-General. It was a recognised firm, and Mr Moyo did not think that the Audit Committee was taking short cuts.

The Chairperson asked about the scoring by another firm whose proposed audit fees at R2.4 million were the highest bid.

Mr Moyo pointed out that under the audit approach, the Audit Committee had not given this firm any points. The firm's submission had given no information on how it would carry out the audit. This was actually two separate firms. The Audit Committee suspected that this fact would be a challenge, although it had not penalised them on this basis. Joint proposals were acceptable.

The Chairperson asked if that could account for a small extra cost, in that there were two separate firms forming a team.

Mr Moyo said that he thought not. In fact, their fee was fairly realistic, but the Audit Committee had rated this quotation third because it lacked a clear audit approach.

The Chairperson asked if it was because the firm had not written up its proposal fully or properly.

Mr Moyo said that the Audit Committee had been unable even to assess the firm's audit approach because this was omitted completely from the proposal.

The Chairperson said that his experience had taught him that some candidates might have a strong curriculum vitae but be poor at marketing themselves. It was important for the interviewer to give him or herself, not the candidate, the benefit of the doubt, otherwise the interviewer would be acting without proper diligence.

The Chairperson noted that it was necessary to make a decision. He proposed that the Committee would endorse the proposal, in view of the urgency, notwithstanding that the IRBA review was still to be resolved. The Audit Committee was granted permission to proceed, on condition that that particular criterion was met.

The proposal was accepted by the Committee.

Funding Model of the Office of the Auditor-General (OAG): Auditor-General (AG) briefing
Mr Terence Nombembe, Auditor-General (AG), gave a background to the funding model. He noted that the OAG had been constantly recording deficits or losses in operations. There were cash flow difficulties that were not improving, because of the inability to collect the cash that was due from auditees, particularly the municipalities. This funding model was premised on two fundamental issues: firstly, the necessity of obtaining a healthy margin or surplus to enable the OAG to operate in a healthy financial state, and secondly to sustain a cash balance to meet obligations from time to time. As part of the exercise, the OAG examined the most appropriate sources of its revenue.

Since separation from government in 1993 the OAG had opted for and become accustomed to a self-funding model. It would do its work like a commercial audit firm, by recording the time spent, issuing an invoice, and collecting fees in cash from government departments (the audited). The alternative would have been to obtain a grant from the government, not to have to worry about following a business process and managing the flow of transactions. This alternative would have presented the choice of seeking funds either from the Ministry of Finance or directly from Parliament.

Mr Nombembe addressed the first issue of the continuous losses or deficits which the OAG was experiencing. On analysis, it was found that the OAG had been continuing to discount its charges to government. The costs that the OAG incurred in its operation were not fully recovered in the charges to auditees. At a certain point the OAG had put a ceiling on how much it could charge for services. That was set at a low level of senior manager, which meant that some of the senior managers were not fully recovering their costs for doing the audit. This also meant that the business executives, who were the leaders of the OAG's various portfolios, were effectively charging less than half the ideal cost for the audit services. There had been some logic to that initially, since when the OAG moved away from government, the level of pay, skills and costs that the OAG incurred for those senior managers was still appropriate for charges at those levels. However, as the professional calibre the staff was raised to a higher level, the fees had not kept pace. At present, there was a four to five year backlog in the erosion of its margins. When this was discovered, it came as a 'huge revelation'.

The Chairperson asked if the OAG had not kept pace with inflation.

Mr Nombembe explained that this situation did not arise through inflation. It was instead the failure to increase prices to match the levels of pay of the new professional staff. Therefore the OAG was incurring personnel costs that far outweighed what it recovered from its charge-out rates (fees) to government departments. The OAG still had a ceiling, in that it was, for instance, charging R800 per hour for the professional staff’s time, rather than charging R1 500 per hour. This had been an arbitrary cap. The OAG had not previous analysed the extent to which this cap had eroded its margins. Having completed the analysis, the OAG determined the cost of that cap and, in its negotiations with National Treasury, had sought to recoup that loss. National Treasury (NT or Treasury) was generous enough to reimburse in the form of a lump sum equivalent to the calculated loss from those margins.

Secondly, the OAG found that another cause of loss was the fact that both its own staff and external audit firms were doing the OAG’s work. The OAG had been losing money because of the shortage of skills and the high vacancy levels, and thus had been obliged to engage external audit firms to do some of the work. Because the pricing formulae for contracted audit firms and the OAG's own staff differed, OAG found itself giving work to firms at no extra margin, effectively just transferring the fees, so that there was no profit to the OAG.  This meant that the more the OAG contracted out to other firms, the more it lost money. If it could use its own staff more, then it would have surplus to enable it to pay its overheads.

Mr Nombembe summarised that this meant there were two issues to resolve: firstly to fill the vacancies and to make less use of unplanned contract work, and secondly to revise margins so that fees reflected the actual costs of employing professional and other staff in order to perform the audits. In short, the OAG stopped the discounting that it had done previously. This came into effect in the financial year beginning April 2009.

Up to the previous financial year, Members would realise that the annual report had reported a deficit that had now been budgeted for because the OAG knew the economics of its business. But that deficit was obviously discounted by some of the cash advance that it had received from Treasury during the course of the previous year.

The Chairperson asked who was responsible ultimately for approving the OAG's fees.

Mr Nombembe replied that the Committee was responsible. It was one of the three direct responsibilities of the Committee according to the Public Audit Act.

The Chairperson expressed the view that the Committee would be remiss in terms of its statutory and constitutional duties if it did not interrogate the OAG on its audit fees, and if it merely concurred with the OAG's previous generosity regarding its fees, which had effectively compromising the OAG's ability to perform its work while remaining self-sufficient.

Mr Nombembe replied that indeed the Committee would be remiss if it allowed the OAG to undercut itself. The OAG had suspected this problem and raised it with the previous Committee, but the full implications had not been realised until OAG had carried out the analysis. The impact was that OAG thought it essential to correct both the vacancy rates and the cash flow problem. With regard to the latter, OAG aimed to collect cash from auditees in 30 days, in accordance with the Public Finance Management Act (PFMA). OAG still had to master the practical implementation of that requirement. There were various reasons that prevented municipalities, in particular those in the Northern Cape, the North West, and the Eastern Cape, from paying their audit fees on time. Municipalities in other provinces appeared to obtain some help from the respective province.  Collecting fees from national and provincial government departments was less of a problem.

Mr Nombembe said that, in conjunction with the previous Committee, the OAG had analysed its options intensely, had compared international benchmarks, and had concluded that its present self-funding model was best for the time being, while noting the importance of achieving correct pricing, managing vacancies and seeking assistance in collecting cash due. The advantage of cash collection was that there was still scope for various forms of support, either through the Committee, or through various ministries, to accelerate the collection and payment into the OAG's bank account, although not all options had been explored yet.

The Chairperson said that the last point could be included in the list of legacy issues for the report. He would request a fuller briefing on international benchmarking and the changes proposed to the OAG’s institutional arrangements. He had heard of the capacity problems of some municipalities in paying their suppliers, and it would be necessary to analyse their problems and find ways to prevent recurrence, as also to ensure that the OAG was properly supported when doing the reports, and that municipalities achieved clean audits.

Mr Singh said that the AG had highlighted the main points, although some details might have been omitted. He asked that the Deputy Auditor-General (DAG) be given the opportunity to skim through the rest of the presentation, and fill in other information in preparation for a fuller discussion.

The Chairperson thought that the specifics could be extracted by Members’ questions.

Professor L Ndabandaba (ANC) asked the AG to suggest what would be the ideal model of funding.

Ms Sosibo wanted to know, in the light of the AG's introduction, how the OAG had managed to pay for its overheads.

Mr J Matshoba (ANC) asked the AG about the idea of the OAG's receiving funding directly from Parliament.

The Chairperson said that he had his own views on the subject. There might be important reasons beyond the financial sustainability of the OAG, but the Committee had to deal with instilling certain values or ethics within certain government institutions. Typically, government institutions received their money from government and then they spent it. However, it was good for them to become accustomed to paying for a service, would value it and insist upon quality service.  

Mr Nombembe replied that there was a specific presentation that Mr Makwetu would present. However, the OAG, having examined other options, believed that the existing self-funding model was ideal. The previous Committee had supported the OAG in continuing with the present model. The OAG had survived the deficits on the strength of its financial reserves accumulated prior to the erosion of its margins, and its increased level of staff professionalism. However, in using these margins it was effectively using money that it had set aside for death, leave, and post-retirement medical aid liabilities, which was why it had approached Treasury to recoup these reserves. He admitted that the difficulties in collecting fees from municipalities were a serious risk to the reserves set aside for liabilities.

The Chairperson said that he would have least suspected the Northern Cape to be a risk for non-payment of audit fees.

Tabling of slide presentation (see attached document)
Mr Makwetu noted that this presentation was an update of the presentation given to the former Committee on 12 June 2008, and outlined the funding model approved by that Committee for implementation on 01 April 2009. Capping had been removed, and charge out rates were now based on direct salary cost marked up by the agreed factor. A once-off non-refundable grant of R154 million had been obtained to address working capital and Capex requirements. R90 million was actually received in January 2009.  A once-off tariff increase of between 25.9% and 30.9% had been obtained. This would allow a 4% budgeted surplus for 2009/10. The 4% surplus would contribute about 91% to the Capex requirement for the 2009-10 financial year. However, expenditure on capital expenditure would be subject to cash flow availability. The new funding model was illustrated on slide 32, and the working capital on slide 33.

Mr Makwetu emphasised that the
AGSA staff complement, in 2008/09, comprised 2 107 audit staff, and 222 support staff.  AGSA had 866 auditees, of which 175 were national government , 209 were provincial government , 334 were local government, 47 were statutory entities and 101 fell into the category of “other”, including trust funds, funds, pension funds and the like. Fees charged to auditees were based on the time spent on audits.

He highlighted the different elements of revenue that were generated. Many members of the staff were responsible for generating what the AGSA called 'own hours revenue'. This had been growing at a pace slower than that of the contract work, which meant that the AGSA was having to outsource more work to private audit firms, with no margin left to itself. The key reason was inability to fill the high vacancy rate (15% for audit staff in 2008/09) within AGSA. It was fortunate that the private sector had been willing to assist AGSA to fulfil its mandate of contributing to the transformation of the audit profession. He reminded Members that there was, however, no mark-up on contract work, so the auditee was charged whatever the contractor charged AGSA. Because AGSA realised this was  undermining its income, it now had a deliberate strategy to reduce its vacancy rate.

AGSA needed to make a surplus of between 4% and 6%. However, due to the inherent limitations of the old funding model, it could only budget for a small surplus for 2008-09. As a result, it had reported recurring deficits for the past few years. After adjusting for the National Treasury grant and performance bonus written back to income, the deficit increased to R58.6 million. If this trend had continued, the effect would eventually have been bankruptcy.

Under the self-funding model, fees were used to offset the funding costs of staff, which amounted to 66% of the OAG's total expenditure. Also funds were required by the AGSA for financing fixed assets and working capital. He reiterated that capping had been a major problem for several years in that it limited income from fees, while the cost to the AGSA of employing professional staff had increased. The number of staff affected by 'capping' had increased quickly as professional standards were raised. The impact of 'capping' was illustrated in detail on slide 17.

Mr Makwetu also highlighted the problem of debtors once again. The situation had not improved since tabling of the Annual Report, in particular with regard to municipalities. AGSA had engaged with the executive leadership of the three provinces concerned, and with the Ministry of Co-operative Governance and Traditional Affairs. The previous Committee had also engaged with that matter. It preferred to do this rather than institute legal proceedings under Section 23 of the Public Audit Act, since AGSA was confident it could make progress in recovery of charges, with the assistance that the Committee had offered.

The Chairperson agreed that legal action should be the last resort.

Mr Makwetu reported that the Minister of Co-operative Governance and Traditional Affairs, Hon S Shiceka, had convened, in the Eastern Cape, a meeting between AGSA, the MEC for Local Government, the MEC for Finance, and the Premier. AGSA stressed that the longer the payment was outstanding, the more it assumed the character of a loan debt extended by the AGSA to its clients, which impacted upon the independence of AGSA. The Executive in Eastern Cape specifically agreed to examine the matter, and to make a submission to the provincial budget committee to ask for extraordinary approval to assist those municipalities in the province at a provincial level. A similar process was undertaken in the Northern Cape and in the North West, with the assistance of the Minister. It was hoped that cash would soon be paid. He was appreciative of the Minister’s proactive approach.

The Chairperson said that a presentation on that project might usefully be included in the Committee's programme, to explore the possible collaborative role of the Committee.

Mr Makwetu noted his remarks. He said that it would not be desirable for the Auditor-General to have to “stand in a queue” with other ministries and entities with fiscal challenges, as it would have implications for the uninterrupted operation of the OAG as an independent audit organisation. The Office of the Accountant General had raised objections to the idea of collecting municipality audit fees from a special fund in the national Department.

The Chairperson asked if constitutional implications had been identified.

Mr Makwetu responded that he did not recall mention of such implications.

Mr Nombembe agreed with Mr Makwetu that there had been no direct constitutional implications around this issue, other than the broad consideration whether any of these options would affect the independence of the OAG to do its job, which was 'a constitutional imperative'. All the debates had been centred around that parameter.

The Chairperson said that he was thinking of the concept of 'fiscal federalism'. Once an equitable share of the nationally collected revenue had passed from national to provincial treasuries, the national one had very little say on the spending. Provincial treasuries, once they received their allocations, examined their mandates and decided on their priorities, which might or might not be completely consistent with national priorities. Hence there was the concept of ring-fencing of conditional grant funds controlled nationally, so such funds could be taken back by the National Treasury if not spent correctly.

Mr Makwetu replied that in the process of evaluating the four options eight considerations were taken into account, informed by research and advice received from other Auditors-General, based on experience and their discussions.

Mr Makwetu continued that it was essential to ensure the OAG's financial viability. If there were to be a combination of charging, collection from the provincial treasuries, and receiving a parliamentary allocation, those constitutional issues would be raised. It would not be a simple solution. If the OAG delivered an auditing service, and billed for it, this would not affect the ability of the OAG to perform the work independently, except if there were regular challenges in collecting the cash. The OAG was confident about the transparency of its costs, as it determined its fees in consultation with the auditees, and submitted its rates to the Committee for approval. The promotion of flexibility in the system was founded on the direct billing process.

Mr Makwetu reiterated that the financial position had been
deteriorating until March 2009. The improvement in the year 2008-09 was due to an unconditional grant of R90 million received from National Treasury, although the full amount required to replace the money that the OAG had drawn from its reserves was calculated at R154 million. It had been agreed with Treasury that monies owed by debtors would not be included, since there was still hope of recovery of those debts. The amount of R90 million, agreed to by the previous Committee, would be discussed further when OAG presented its 2008-2009 Annual Report. In the current financial year it was expected that the cash balance would improve, due to the new funding model introduced in April 2009.

The Chairperson observed that the OAG remained short.

Mr Makwetu replied that the OAG was still surviving. It had experienced difficulties in paying audit firms, but was able to use some of the R90 million to pay them, after the municipal audits had been completed in December and January 2008-2009. When the new funding model, with removal of the cap, had been implemented, auditees had been informed of the consequent increase in fees. At the moment surpluses were just over R100 million. However, the OAG did not work in a straight line environment'. After the PFMA audits, many trainee accountants were sent on study leave, while other staff were busy planning, and would not be earning fees. This was not a sustainable number in the sort term, but he was confident of the longer term future.

The Chairperson said that the Committee might need to revisit the issues, particularly around enforcement of the debt from municipalities. He recalled that the State Liability Act noted that judgment debts must be set aside out of the national revenue, so that if one government department was sued, it was a debt of the whole State. The issue of how to manage State debt at different levels might need more consideration. The co-operative governance provisions of the Constitution clearly stated that litigation between State institutions should be a matter of last resort. He was pleased that the OAG appeared to have adopted that approach. He asked if the idea had been considered that before a new allocation was made, all outstanding debt for previous audits must be prioritised. Creative thinking was required. He deplored the trend of every government department and State organ being expected to be bailed out by National Treasury. Risks to the self-sustainability of entities should be dealt with promptly.

Mr Singh said that he was pleased to note this turnaround strategy and the prospect of improvement. It was the responsibility of the new Parliament to improve matters for the OAG to protect its integrity and independence. The proposed model was a mix. He supported the model which required direct charges to auditees, but said that to be realistic it could additionally look to National Treasury for grants, including the remainder of the R154 million.

Mr Singh asked for an explanation of indirect expenses. He agreed that it was incorrect to give work to the private sector, but not retain an administration fee, which must be distinguished from a commission or discount, because there was a cost to giving out such work, and it would not be out of line with common practice. He accepted the need for outsourcing some work, at busy periods, to private audit firms, but asked for a reduction in dependency on them.

Dr George agreed that the reduction in the number of managers was questionable, and that there was no reason why there should not be a mark up for contract work, bearing in mind the overheads.

Mr Makwetu responded that the OAG had not conducted an exercise on charges for contract work. The OAG always tried to moderate audit costs to government in general. He asked for time to engage with these issues and make a submission.

Mr Nombembe said that Treasury was uncomfortable with the charging of these costs to government, so OAG opted for a direct charge, whereby the OAG participated directly in overseeing the contract work to be charged as part of the audit cost. However, National Treasury was very uncomfortable with the administrative element, and there was a possibility of asking contracted audit firms to absorb the administrative element, since they were not bearing any costs for the benefit that they were receiving.

The Chairperson said that it was important to fill essential vacancies.

Mr Singh noted that the number of support staff had increased by 200, whilst the number of audit staff had been reduced by 233. He asked how that could be reconciled.

Mr Steele also expressed his concern with the apparent projected reduction in staff, noting that at the same time the contract work revenue was projected to decrease.
Mr Makwetu acknowledged that the principle of contract work would remain, but said OAG had been aggressive in recruitment, although it had experienced difficulty in recruiting at the core supervisory level. Many recruits, when fully qualified, were tempted by opportunities outside the OAG. In many cases, they became chief financial officers with other organisations or companies. They were needed to supervise trainee accountants in the OAG. In some cases, the OAG had recalled work outsourced to private audit firms, but at the same time did not want to create an impression that it no longer needed the private sector to assist it when required. The OAG had established a vacancy committee, to ensure that there was proper motivation for all new positions, and ensure that there was no uncontrolled growth in support staff functions, since the core function of the OAG was to deliver audits. In spite of the figures given, it was expected that the number of professional staff would grow. Recruitment was predominantly aimed at auditors.

Mr Singh asked about the OAG's capital expenditure requirements, to distinguish money required for actual work as distinct from office facilities.

Mr Steele commented that accommodation costs, at 4%, seemed to be low.

Mr Makwetu noted that capital expenditure was concerned with the basic facilities used in the OAG to ensure that it could do its work. A big item under capital expenditure was laptop computers, since the audit methodology was electronic. All OAG facilities were rented.

Mr Singh asked for a list of the local government defaulters. Municipalities should include an item in their budgets for audit fees, and it was also necessary to insist that they hire competent, qualified and experienced people to do the work of bookkeeping and accounting, since properly prepared accounts would reduce the workload of the OAG.

Mr Makwetu noted that OAG had available a list of municipalities that had failed to pay their audit fees, but had wanted to acquaint Members with the historical background before formally submitting the list to the Committee prior to presenting the Annual Report. Some municipalities claimed that they did not have enough money for service delivery, and, even though they had budgeted for audit fees, they had redirected the money to other purposes.

The Chairperson suggested requesting that the Department of Cooperative Governance and Traditional Affairs be present on that occasion.

Dr George asked why there had been a cap in the first place. It was totally unacceptable that audit fees were not paid. This indicated a liquidity problem that needed to be addressed. All auditees must budget for their audit fees.

Mr Nombembe said that the present staff of the OAG had inherited capping.  The OAG had continued with it until the OAG had realised that it was eroding margins.

The Chairperson remarked that many criminal statutes still contained maximum fines, often severely out of date, and said that it was critical to keep track of inherited restrictions such as the capping.

Mr Steele noted that the public would perceive large and growing surpluses to be exploitative.

The Chairperson asked what the source of the surplus was. If, for example, the source of the revenue was work for the United Nations, it would be a good surplus to be proud of, and a valuable source of outside revenue.

Mr Makwetu said that at the end of the year, it was established practice, in accordance with the Public Audit Act, for the Committee to discuss what should be done with the surplus, if there was one.

Ms Sosibo asked if the OAG had given the three provinces mentioned a time frame, and if the Treasury would make up the balance of the unconditional grant of R90 million.

Mr Makwetu confirmed that th
e three provinces had been given time frames, but they had not been met. He said that there was a possibility that the OAG could still obtain the balance of its unconditional grant from the Treasury, which at the time had been unable to pay all the funds requested. The OAG, however, had been aware that fiscal constraints might prevent payment of the full amount. It had been thankful at least to have received the R90 million.

Mr Matshoba asked what the OAG meant by 'contract work irrecoverable' on slide 9.

Prof Ndabandaba asked about the effect of irrecoverable contract work.

The Chairperson asked how the OAG covered the costs of such work.

Mr Raj Mahabeer, Chief Financial Officer, AGSA, said that this referred to consultants that the OAG brought into the organisation, on contract, to perform very specific functions, for example, Information and Communications Technology (ICT). However, the cost of contract work that was given to outside audit firms was recoverable, because it was charged directly to auditees.

Mr Makwetu added that the choice of wording was possibly giving cause for concern. He clarified that 'contract work irrecoverable' was an overhead cost.  It was effectively part of the cost of doing business.

The Chairperson said that it was necessary to move away from the kind of pricing that undermined the sustainability of the OAG, and in that light, the capping issue became of even greater urgency for review.

Mr Nombembe said that in the forthcoming presentation of the Annual Report and Strategic Plan, there would be extensive reference to the principles reflected upon in this meeting.

Continuation of Workshop and SCoAG Induction: Day 2: presentation of slides 98 to 135
The Committee then continued with the second day of the Committee Orientation Workshop, following the previous session on 13 August.

Mr Nombembe said that there was a long presentation, but he would highlight the elements of the key auditing principles, the basis on which opinions issued by the AG were indisputable, and how the AG gathered evidence, to give an understanding of how and why the AG could be relied upon when reaching its conclusions. The nature of its work made it unlikely that its decisions could be overturned on appeal or review.

Mr Jan van Schalkwyk, Business Executive: Audit Research and Development, OAG, referred to the AGSA's mandate, which was reflected in some of the definitions. He emphasised the benefits of external auditing in adding credibility to the work of the auditee. Additional information in the AG's audit reports attempted to provide good context to the AG's findings. An audit report really became useful when it pointed towards solutions.

Mr van Schalkwyk defined the different types of audit, in particular, the regulatory audit, the term 'reasonable representation', and the financial audit. It was important to be sure that all the assets of the organization audited were reflected in the assets register, and that all assets in the register were tangible. The emphasis on good governance practices was a feature of public sector auditing. There was also much more emphasis on legislative compliance and value for money. Also there was emphasis on auditing of performance information to ensure that government departments and organisations correctly reported on service delivery. Performance auditing, on the other hand, related to use of assets. There was a big difference. Donor funding was an example of matters subsumed by special audits.

Mr van Schalkwyk noted that credibility was closely related to independence. He said that the nature of audits were post facto, and the OAG did not involve itself in the running of entities. He referred to the International Standards of Auditing (ISA) and the International Standards for Supreme Audit Institutions (ISSAI). He was proud to say that the public sector audit profession and the private sector would be adopting the same set of standards.  Excellent documentation was an essential foundation for an audit. It was not possible to carry out an audit in isolation. There had to be trust at a senior level between auditor and auditee. The OAG never finalised a report without letting management give comment and have the opportunity to address the issue.

Mr Nombembe added that the OAG always emphasised to members of the media that they should not react to leaked reports or rumours. He gave an example of an unfortunate instance where a management letter had been leaked to the media, and even the judge had not understood the audit process and concurred in the publication of the leaked letter. The OAG had taken steps to educate the media accordingly.

Mr Van Schalkwyk said that in the absence of a final file of evidence, one could not proceed to an audit opinion, There were quality check lists throughout the process. He then explained 'emphasis of matter' and 'other matters'. The ideal audit outcome was an unqualified audit opinion with no other matters. An unqualified audit opinion with other matters was a warning that would indicate that although the financial statements were unqualified there were other matters, which, if not fixed, were likely to lead to a qualification in future. An adverse opinion would indicate that the AG disagreed with the management's representation of its financial statements to the extent of confirming that it was not a fair reflection of the financial position. A disclaimer was the worst type of audit and would indicate lack of sufficient audit evidence so that the AG was unable to form an audit opinion.

Mr Nombembe said that the directives for the audit standards would also need the Committee's approval in terms of the Public Audit Act. Possibly the only item not well defined in the presentations was the role that the Committee. However, the more critical item was the approval of the standards by the Committee.

The Chairperson said that the Committee had scheduled visits to the municipalities that were challenged in their ability to pay their audit fees. It was hoped to find one municipality that was successful to serve as an example, and then concentrate on struggling municipalities.  It was hoped that the visit would be preceded by the Department of Co-operative Governance and Traditional Affairs.

Prof Ndabandaba asked for a distinction between mandatory and discretionary audits. Secondly, he asked how the OAG's audit training was received by the media, and if it had borne any fruit.

Ms Sosibo asked how the OAG had explained to the judge about the leakage of the management letter in the case mentioned above.

Mr Nombembe said that mandatory audits had to be performed every year. Audits of performance information were captured in the Public Audit Act and were also performed annually. However, in consideration of the fact that government was not fully ready for this kind of audit, an extended phasing-in period had been adopted, to avoid embarrassment and misunderstanding. Within the next 18 months to two years, the OAG expected to be expressing opinions on all the mandatory audits.

Discretionary audits would fall into the category of performance audits, and were performed when it was determined that this would be in the public interest. They required wide consultation. The criteria for these audits had not been dealt with in the presentation. The OAG had a Special Audit Committee to assess these criteria. This Committee and Standing Committee on Public Accounts (SCOPA) would be among the stakeholders to be consulted. Discretionary audits would be done on a cyclical basis. A topic chosen was the use of consultants by government departments and public entities. Education had also been chosen as a topic for a discretionary audit, subject to Government completing the determination of its priorities in education.

The media houses had found the OAG's presentation most valuable. There were now very few instances where the OAG was misquoted in the media.

In the case where a management letter had been leaked, the respondent had been the Department of Transport, not OAG. Judgment went against the Department and in favour of the media house's right to transparency. Mr Nombembe, however, believed that the judge, through lack of insight into the audit process, had given his verdict on the incorrect premise of a letter that should not have been in the public domain. The OAG sought to find ways of ensuring that a similar situation would not occur again.

The Chairperson said access to information would be a constant area of contest. All legislation needed to be tested from time to time. It was important not to distort issues through ill timed media releases.

Mr Steele welcomed the AG's assurance that discretionary audits would be discussed by the Committee subsequently.

The Chairperson said that there was an unfortunate tendency for public servants to prefer to do nothing than risk violation of prescripts. He asked how the AG handled such challenges.

Mr Nombembe said that the OAG was not supposed to restrict anyone from discharging a job in pursuance of service delivery, but to ensure that everyone acted within the parameters of good governance. There must be checks and balances, and appropriate controls. He emphasised the proactive approach to auditing, with importance given to internal auditing. His understanding was that audit gave guidance. Leadership must do its own monitoring. In this respect regular reporting was an imperative. Any official who remained inert for fear of auditors was not doing his job. Monthly reports from auditees would be appreciated. Service delivery, not transgression of prescripts, was the issue of concern in all spheres of government. Continued weighting of financial performance at only 5% in the personal contracts of financial officers would delay success in achieving an improvement in their efforts.

The Chairperson said that the vexed issue of enforcement should be discussed with the Public Service Commission, and the question was who followed up after SCOPA had done its processes.

Legacy report and legacy issues
Mr Steele said that he had learned that morning of issues discussed by the previous Committee which had not been communicated to the new Committee, such as the previous Committee's legacy report. This specifically related to issues dealing with the Public Audit Act (PAA) and other matters. He asked that this be discussed at the next meeting.

The Chairperson said that he recalled that the OAG had highlighted some institutional issues for review, including legislative arrangements. He was not sure if the Committee needed to consult other structures. He wanted first to assure himself that the Committee had powers to sponsor or pass legislation, and whether the issues would have to be referred to the Finance Committee. It would also need to be determined how to initiate applicable legislation, since this Committee was not related to a government department. Not all committees had legislative powers.

Mr Makwetu said that as far as the legacy report was concerned, his general comment would be limited. He advised highlighting any outstanding matters canvassed with the previous Committee to ensure that the new Committee gave them due consideration. In its first interaction with the new Committee, the OAG had specifically asked that the legacy report be included on the agenda. He recalled that in the January 2009 meeting of the previous Committee, it had discussed a legacy report, and he thought that it would have been handed over to the new Committee.

The Chairperson commented that it was the OAG who appeared to be handing down the institutional memory, and said that the version of the legacy report adopted by the old Committee seemed to be incomplete, without highlighting the issues that were to be handed over to the new Committee. He suggested that the Committee should simply focus on issues needing to be taken further.

Mr Singh said that it was not possible to discard the previous report while extracting outstanding issues, but also that the changing circumstances must be taken into account. In addition, the Committee could identify new and relevant issues.

Mr Singh asked if the Auditor-General could comment on a response by Hon Chabane, Minister for Performance Monitoring and Evaluation, on the role of the AG, which appeared to be contradictory.

Mr Nombembe responded that journalists had approached the issue incorrectly. In essence, Mr Van Schalkwyk was saying that there had been five years of piloting audits of performance information before expressing an opinion, as distinct from a report.  The Minister in the Presidency had reflected correctly on that article in The Sunday Times. The aim of audits of performance information, like financial audits, was to increase the credibility of information on government. The article had been misleading.

The Chairperson said that it would be necessary to revisit the issue of oversight. All issues needing to be taken forward should be accommodated in the Committee’s programme. He noted that a summarised legacy report was made available at the first meeting of the new Committee.

Dr George said that the DA was not represented at the first meeting because it had not received any invitation or notification on account of an administrative lapse.

The Chairperson said that he could easily arrange to make the report available. He suggested that this matter be taken up later.

Mr Nombembe commented on that certain governance issues, such as possible amendments to the Public Audit Act, the governance framework for the AG, including the internal structures, as well as the role of the Committee itself, needed the Committee's attention.

The Chairperson asked if the amendments had yet been drafted.

Mr Nombembe said that all the possible amendments had been identified, now that the PAA had been in use for some time, that would be useful to minimise confusion. The governance unit of the OAG would be able to give a list to the Committee. His Office had commented on the legislation when it was still in Bill form, to the relevant structures in Parliament.

The Chairperson therefore proposed that those proposed amendments should be circulated, and that the Committee programme make provision for a presentation on them.  made available in the Committee's programme for presentations on those proposed amendments to be made.

The Chairperson reminded Members of the upcoming Association of Public Accounts Committees conference, to be held from 27 to 30 September 2009, at the Cape Town International Convention Centre.

The meeting was adjourned.

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