Municipal audit outcomes: Briefing by the Office of the Auditor-General

Meeting report

Introduction
The Chairperson asked the Auditor General’s Office (AGO) to address some of the concerns that had been raised by the local municipalities with regard to audit processes. They had complained that the AGO’s staff changed frequently and that junior officials were deployed to do audits. The reporting format was often changed. Staff had difficulty interpreting the audit reports as they did not understand the terms used, and in some cases municipalities had celebrated having an unqualified audit before realising that this was not a clean audit. They did, however, appreciate the visibility of the AGO and found them readily available for consultation and meetings.

Mr J Steenhuizen (DA) apologised for raising the issue while guests of the Committee were present, but was frustrated that the Committee had not received a report on regulations from the Department, and asked if any reasons or apologies for this had been given by the Department.

Mr Nkosi Mandela (ANC) responded that he had spoken the Acting Director General, who had advised that it was not concluded, but would be soon.
Mr Steenhuizen said that he would have expected at least a memorandum explaining the delay. Practical problems were being caused because these regulations were not in place. He requested that the Committee express their dissatisfaction that they had not been briefed on this, commenting that he was tired of reading in the newspaper information that the Committee should be getting from the Department.

The Chairperson agreed that the behaviour was not professional. The Department had been briefed on the lateness of the regulations and there was still a delay. It was put on record that the Committee expected the Department to come and explain.

She invited the Auditor General’s Office to make the presentation.

Briefing by the Office of the Auditor-General on municipal audit outcomes
Mr Paul Serote, Corporate Executive of the Office of the Auditor General, began by responding to the issues raised by the Chairperson.

He said that what the Committee had not heard concerned the disputes over the outcomes of the audit process. He had confidence in the audit process and the quality of the reports, and the criticisms raised by the municipalities seemed like a complaint or an excuse. He was aware that there had been complaints about the AG’s office changing of staff, using junior staff, and also using contractors.  He wanted to respond to these criticisms and explain why he felt so strongly about the issue.

The AGO’s processes and procedures were extremely well structured and efficient. The office not only subscribed to international standards of auditing, but also to additional private sector standards, which translated into a practical methodology used for the office. The standard of auditing being provided was one of the best in the world. This was signified by the fact that for 12 years, the office had played a significant role in contributing to the UN audit system. This was why accusations that the Office was producing audits of poor quality were so frustrating.

The engagement manager was usually the person responsible for the audit, and had the responsibility of ensuring that when an audit was planned the staff had a mix of varying skills and competency levels. There was a three-year traineeship being run, beyond which there were a variety of management levels, going right up to Mr Serote himself, who in certain instances got involved in some of the larger audits.  The staff had a mix of levels, but the minimum entry requirement was a BComm or a BComm with Honours in accounting or auditing, so even the trainees were graduates and competent to perform their roles. In addition, it was rare to find trainees, particularly the first years, engage with Directors or HODs. The AG’s office maintained that it was very important that professionals be developed, but under no circumstances were they deliberately sending people who did not have the ability to deliver.

The reports of the formats being changed regularly were in the domain of National Treasury and the Accounting Standards Board, but Mr Serote commented briefly that for practical reasons there may be amendments made.   However his understanding was that they were very limited.  In addition there was a Chief Financial Officer (CFO) Forum, where developments could be discussed at a practical level so that everyone was kept up to date. It was the role of the provincial accountant general to ensure this process ran smoothly.

With regard to the terms of language used, if a CFO did not understand what a qualified opinion was then they should be the ones explaining why they did not understand. These were basic accounting terms and they had not changed in a long time. The AGO produced documents clarifying basic terms and answering questions such as what does an audit do, what is a clean audit, and how does one achieve a clean audit.  So the tools were there. Staff could also easily look up terms they did not understand.

Mr Serote moved on to give an overview and context to the presentation. He was presenting the results of the June 2011 financial statements.   At the time, they had been engaged with the process of auditing the next year of local government. This was significant, as a lot had changed since then - some municipalities had turned the corner in addressing issues that had been raised, particularly in the area of procurement. Some of the councils had made changes to their policies to make practical interpretation on the ground a little easier. For example, many municipalities had had difficulty with determining under which circumstances to employ the regulation that dealt with emergency procurement.  AGO had struggled with impressing upon the staff of the municipalities what constituted an emergency.  Some of the councils had taken this to heart and implemented basic steps to help junior staff recognise these issues.

North West Province had had probably one of the highest rates of non-submissions. They had engaged a process a few months previously which had involved employing a firm to coordinate the submissions of the 16 firms deployed on the ground to produce a set of financial statements. As a result, the province had now submitted all the financial statements, although the substance of them was yet to go through an audit process. In some municipalities, AGO was getting financial statements for two years or even three, and would have to address this backlog.

In the last couple of years, AGO had come to appreciate that it was not enough to be presenting only the findings of an audit, but should also dig deeper and ask what gave rise to these findings, and what municipalities should do to sustain good practices. They were therefore focusing efforts on identifying key focus areas which were impediments to a clean audit, such as behavioural factors. Five focus areas had been identified: the supply-chain management, human resources, information systems, service delivery and the quality and credibility of information.

Supply-chain management and procurement were predictable problem areas. At the time of the audit it was still an issue and there had been very little improvement.  From a basic compliance level, the level of understanding and awareness had been seriously elevated in terms of knowing the legislation and regulations.  The problem that remained was the supply-chain management and the project management elements of procurement. The emergency and sole-supplier regulations were examples of this. These were very specific circumstances where it was permissible to sidestep normal processes, but problems with interpretation of the regulations meant that this often did not work in a practical sense. On the contract management side, if a multi-year contract came to an end, local municipalities often did not become aware of it in time to go through the necessary procurement process. This resulted in non-compliance, because the municipality would automatically be renewing the old contract while the procurement process went on. There was progress in this regard, but it was slow. While councils had adjusted policy to help on the ground in some respects, this had not been done on the contract management side.

With regard to human resources, in previous years there had been problems with filling vacancies. In many instances there were improvements in terms of CFO’s, municipal managers and city managers being appointed. During this review period, that situation should have improved markedly. The role that the EMPACs had taken upon themselves, mainly after the training that they had undergone, had started to show some impacts in terms of accountability for credible information moving from the municipalities to council.

The one area where there was just no improvement was information systems.  Information systems did not refer to the accounting system, but to the network of systems that made a municipality work. These basic operating systems allowed municipalities to work, and were linked to the reporting systems that produced financial statements. AGO was picking up basic issues such as incorrect access controls, which suggested a lack of consistency between the authorised and legal responsibilities delegated to those in the system. Many municipalities had no disaster management and recovery plan. It was good practice to make sure that at the end of every day, information was backed up but this was not happening.  If a disaster happened, the constitutional responsibility of a municipality to deliver would remain intact, and this needed to be borne in mind in terms of looking at information technology (IT).

All of these aspects, or the audit of performance information, as it was referred to at AGO, ultimately impacted on service delivery.  Predetermined objectives were identified, and performance information was provided to identify whether these had been delivered. This was ultimately the reason that the municipality existed - to provide a service.  Municipalities had Integrated Development Plans (IDPs), and there was a close relationship between the IDP and the budget. The relationship to service delivery was reported to the National Treasury every quarter. The audit took the IDP and the budget and put them in an operational context, but this was either not being well understood or not being taken seriously.

AGO was trying to promote the mentality that projects should be assessed monthly to see what had been spent and what had been delivered. The mentality was currently that financial statements should be prepared because it was required by law and by the Treasury, but financial statements should be done because they were a key tool of management, to understand how projects were progressing.  A good understanding of why financial statements were done was crucial at an individual level. If this basic discipline was in place on an ongoing basis, then compliance should be automatic. There had been problems with the basic operational budgets of projects running out, but if basic questions had been asked continually, then this should have been picked up on well in advance.

The quality and credibility of the information being presented was still a big issue. Financial statements were often being completed purely for compliance, and the AGO was then required to spend the audit period not only auditing, but also fixing the financial statements.  In some senses, this made them the end consultants of the financial management process. One of the negative repercussions of this was that the Council had made decisions, and at the end of the year these were being amended. This highlighted the need for the Council to hold municipalities accountable, and also indicated the poor quality of financial personnel in the municipalities. This had been measured and reported on, and in the general report, all of the issues covered in the presentation were dealt with in detail for any of the provinces and municipalities.

The extensive use of consultants was an issue which was often misunderstood. The AGO did not want to do away with consultants, as they did have a role to play but should be used responsibly.  When a CFO substituted the value that they were being paid, to a consultant, it was not correct. The percentage of consultants and the audit outcome had both been measured, and it was hoped that this information would assist the Council in managing CFOs.  Consultants should be used to capacitate and assist with specific tasks.  They should also transfer their skills to permanent staff.  A consultancy that performed its duty in such a way that the same work had to be outsourced again the next year was not fulfilling its proper function.  

If consultants were needed to do financial statements, it should be asked why the CFOs were not doing it themselves. While consultants did get financial statements done, they were not creating the solid foundations on which good financial management was based. Simple things like filing invoices for transactions were the basis of the system, and consultants did not resolve these core weaknesses.

These issues were related to the questions AGO were asking. What were the types of behavioural indicators that would get to the heart of the problem? In which instances were their messages not being taken seriously?  Incidences of this were unacceptably high.  The AGO was repeatedly making recommendations, which were not being translated into action.  Key problems were the lack of consequences for poor performance and the lack of skills of finance officials in key portfolio areas. These had been measured and the responses were not positive. 

The AGO had engaged with local government and with different MECs to discuss the way forward, and had observed that there was a lot of support for local government in terms of oversight. All these structures of support needed to do more to coordinate and integrate so that everyone was operating from consistent information, and were all moving forward at the same pace. In the North West province, for example, three or four committees had been visiting in the same month, along with other support structures. These efforts needed to be integrated.  

Mr Serote turned to the status of key focus areas for oversight and governance structures. Supply chain management (SCM) showed no improvement.  Auditees with incidents of uncompetitive or unfair procurement processes had increased to 65%, and the awarding of contracts to employees and councillors or other state officials had increased to 46% of auditees.

Some improvement had been seen in the area of predetermined objectives.  Auditees with PDO findings had decreased from 84% to 71%.  Minimal improvement had been seen in Human Resources (HR). Consultants used due to lack of necessary technical expertise, had gone from 86% to 91%, but prolonged acting positions were only 23% and vacant key positions 30%.

IT controls showed minimal improvement: 75% of auditees still had poorly designed IT controls, while 20% were still implementing controls. There was no improvement in the rate of material errors or omissions in annual financial statements (AFS) submitted for audit - this had increased from 85% to 91%.

Over a period of three years, the progress towards a clean audit had stagnated.  Some municipalities were producing clean audits, which was commendable, but for the past two years only 5% of reports had been financially unqualified with no findings, and 45% had been financially unqualified with findings. These financial statements had been subjected to material correction, which gave hope that they could achieve clean audits, but at the same time the municipalities had to address the problems with their financial statements.

Non-submissions had shown a worrying spike, with 13% not yet audited. The Northern Cape in particular was lagging behind. Outstanding audits would usually come in dribs and drabs throughout the year, but this raised concerns about the true state of the financial statements and the risk of intentional non-submission.

Both the North West province and the Northern Cape’s audits were seriously concerning.  The North West province had no clean audits, two financially unqualified with findings, two qualified, five adverse and fifteen outstanding audits.  The Northern Cape also had no clean audits, eight financially unqualified with findings, five qualified audits, nine outstanding audits and ten adverse audits.

Kwa-Zulu Natal was a beacon of hope, even though it had so many municipalities.  The majority (77%), were financially unqualified with findings, and if these could be converted to clean audits, that would really change the picture. This contrasted starkly with the Free State, where 76% of the audits were qualified, adverse, disclaimed or outstanding.  Gauteng had 60% unqualified with findings, and 40% qualified, which was disappointing, given their much better position in terms of resources.

There were 22 auditees (7%) with no findings on compliance with laws and regulations. Of the remaining 278,  263 had unauthorised, irregular or fruitless and wasteful expenditure; 231 had submitted financial statements requiring material adjustments; 211 had problems with procurement and contract management; 137 had problems with expenditure management; 130 with strategic planning and performance management; 120 with findings in their audit committees; 116 with other annual financial statement, performance report and annual report findings; and 57 with other areas of non-compliance.

Audit committees were there for the sake of compliance, but no one communicated with them. This was improving a great deal, but was still not at an automatic level.  Audit committees had a role to play in terms of governance.  They were meant to raise issues way before the Auditor General (AG) was even aware of it, and were accountable for the functioning of the internal audit. This engagement and communication flow should be happening on auto pilot, as it would cause the other issues to decrease significantly.

The consequence of non-compliance would always be irregular expenditure, which amounted to R10bn in 2010-11. This was a significant increase from R4.7bn in 2009-10. There was R3,3bn that the AG did not have a view on, because documentation for it had never been submitted.  R1,6bn had been identified by the municipalities, but  R5.1bn had been identified during the audit. If there had been a functioning internal control system, then this extra R5.1bn would have been identified before it came to the audit. The controls were there to ensure that service was delivered and that in the course of delivering that service, the transactions were within budget and were complying with the legislation. Here a service may have been delivered, but was delivered with issues of non-compliance. The legislation and regulations had not been followed, and none of the internal bodies had picked it up. This was an issue that really needed to be addressed.

Unauthorised expenditure had come down from R6.3bn in 2009-2010, to R4.3bn in 2010-11. There were two risks with those numbers: whether the budget had been correct in the first place, or whether there had been wastage in the transactions. Two of the main areas that contributed were overspending of votes or main divisions within the votes.

In terms of fiscal health and funding concerns, there was a critical need for municipalities to be robust, sustainable and a going concern. When it came to the preparation of an Integrated Development Plan (IDP), those preparing the plan should know the municipality better than anyone else.  But reports often did not even have a consistent estimate of the number of people in the municipality. This was crucial as it impacted on how much money the municipality required for infrastructure development.

In 2010-11, an extraordinary 91% of consultants were hired because of a lack of necessary technical expertise, rather than because of vacancies. This was a serious concern, as had already been discussed. The resultant reduction of material misstatements was estimated to be 19%, and the transfer of skills 47%, although this was a rough estimate.

In terms of leadership, 33% had been labelled as ‘good’, while 35% required intervention.  Intervention was required in 43% of cases for financial and performance management, and 35% of governance. The Auditor General’s office emphasised that mayors and councillors needed to take ownership of key controls. A lack of consequences for non-adherence was reinforcing the fact that modified audit opinions had become the norm.  Instability at Municipal Manager/CFO levels impacted on implementation of action plans and reforms. There was, however, opportunity for the implementation of reforms related to skills and minimum competencies.
The Chairperson thanked the AG for the presentation, which was more detailed and informative than previous presentations. She invited discussion on the presentation. Mr Serote was not able to respond to all the questions due to time constraints.

Mr P Smith (IFP) said it was refreshing to see such a good presentation. The AGO seemed to suggest that irregularities were a technocratic problem caused by a lack of understanding of regulations. Mr Smith suspected that it was a deliberate strategy to give tenders to friends or family. It was not necessarily ignorance but deliberate use of loopholes. He asked for the AGO’s opinion on that, as perhaps they completely disagreed.

Mr Smith appreciated the emphasis during the presentation on repercussions for poor performance. Those who did not perform should not get performance bonuses, but the Department never did anything about it. If a person was paid a performance bonus without performing, would that constitute irregular expenditure and could it be reclaimed?  He was pleased that this was being highlighted, as this was an important matter.

Ms M Segale-Diswai (ANC) also asked if there was performance evaluation of people at the top who were getting bonuses.

Mr Smith commented that it was often said that there was no link between financial statements and delivery, or that some Municipalities had clean audits but did not deliver. The presentation suggested that there was a direct link - could there be such a scenario?

Mr Steenhuizen suggested that it was possible for a municipality to achieve a clean audit while not performing with regard to service delivery.  Not enough assessment around value for money and service delivery was taking place. Was this going to be factored into future audits?

Mr Serote responded that it was fair to question the link between clean audits and service delivery and the AGO could do more to emphasise those performance issues. This would be taken back to the standards commission. The AGO did report on it – Mr Serote read an extract from a report on this issue – but it was not emphasised and more could be done to emphasise it.

Mr Smith compared the statistics for unauthorised expenditure and irregular expenditure. Almost half of the unauthorised expenditure was identified by the local municipalities, whereas when it came to irregular expenditure they identified only R1,6bn of a total R10bn. He asked why there was a discrepancy in the proportions they were picking up.

Mr Smith noted that the North West was a catastrophe of local government, and asked if they had terrible provincial government as well. The provincial government of KwaZulu Natal was very good, suggesting that this was why they were performing so well in terms of audits. Could the AGO give its opinion on this?  

Mr Smith asked if there were no repercussions, could the AGO suggest some?

Mr Steenhuizen said that the AG himself had been very clear about consequences and lack thereof, and the impact that this was having around the country.  But the AG’s office was not responsible for providing consequences. He had asked the AG what consequences he intended, and the AG had responded that that was the role of politicians. The Committee could cross-question the team from the AG’s office but would not get an answer about the way forward. It rested with the Committee and the political team. There was a need to implement the consequences or the situation would repeat itself next year.

Mr Smith clarified that he had meant to ask for advice for the Committee to take up. He knew it was not the AGO’s responsibility, but the Department was doing nothing, so if the AGO could arm the Committee with information, they could take on the Department.  He also noted that the AGO did have the option of ordering performance contracts.

Mr Serote responded that there were many municipal managers with unsigned or insufficient performance contracts, and there needed to be a serious attempt to rectify this. If bonuses were withheld due to poor performance and the contract was found to be faulty, then the municipality opened itself up to legal action.

Ms Segale-Diswai asked why the staff working full time could pick up only a small proportion of the irregularities, while the auditors, working only once a year with limited time, discovered far more. This suggested that there was a skills shortage. Did the AG have any recommendations to rectify this?

Mr Serote agreed that the transfer of skills was extremely important but it was difficult to achieve in the current environment, in which such a large proportion of the workforce were only in acting positions. Permanent staff were not being made available to receive the transfer of skills. The AGO itself had struggled with staff not turning up for meetings. But efforts were being made.  For example, the chairpersons of the Audit Committees had been invited to join in the quarterly meetings. The quarterly process brought to light a lot of the things that were not being done, but that should be done. If the quarterly basis was performed and adhered to, municipalities would be able to tell by halfway in the year whether they were at a risk of receiving a qualified audit. Once the standard of financial reports being received was higher and the Office did not have to spend time assessing the credibility of financial information, there would be more time to deal with other issues.

Ms I Ditshetelo (UCDP) said that during local government week there had been a lot of outcry concerning consultants. One of the presenters had complained that they were being discouraged from using consultants while the AG was using consultants himself. Was the AG using consultants?

Mr Serote confirmed that the AGO was using consultants. There were two realities that necessitated this. The first was that the AGO faced an immense workload and the capacity needed to deal with it was spread thoughout the industry. They had therefore established effective and transparent mechanisms to bring capacity in from the private sector. These companies were bound by a strict code of conduct, and could not audit companies or institutions that they had worked for. The process of appointing auditing firms was a long one with many checks in place. The second consideration was the contribution that was being made to the sector and the profession. Emerging firms had been identified and were being assisted by the process.

Ms Ditshetelo asked if the AGO could help with the problem of vacant key positions. If the standard of auditing was among the best, why was it that there were such serious financial problems?  Did the AGO do monitoring or anything that could help sort out the problem?

Mr Serote responded that the AGO had identified three main causes: a lack of skills, lack of consequences and messages from the AGO not being taken seriously by the chain of command. Now something needed to be done.

Ms Ditshetelo was particularly concerned about the North West province, as she was from there. There were 16 firms working there, and yet they had more outstanding audits than clean audits. Were the 16 firms there just to rescue the present situation, or were they doing skills training so that the situation did not recur?

Ms Ditshetelo asked the presenter to explain the R3.3bn of irregular expenditure.

Mr Serote explained that they had identified R3.3bn worth of transactions for which there was no documentation.

Ms Ditshetelo asked what could be done about baling out the municipalities, particularly the North West and the Northern Cape.

Mr Steenhuizen said that the scariest slide had been the one dealing with consultant use -- 91% of consultants were used because existing personnel lacked the technical expertise. So while there was a desire to limit the use of consultants, there were people in positions who could not do the job. This was why the Committee became agitated about improvements in implementing regulations around the use of consultants. Without them, the municipalities would flounder.

Mr Steenhuizen asked if there was a figure on the audit fees owed by the municipalities, and what methods were employed to recover them.

Mr Serote was not sure of the number, but it was not more than R400m. Local government was the biggest contributor to that number. Many municipalities had not been able to pay for quite a few years.

Mr G Boinamo (DA) said that the Office of Auditor General was doing good work, revealing the work of municipalities. But it was not helpful if this was revealed and then there were no consequences for poor performance and the vicious circle continued year after year. He asked if the Auditor General made recommendations for the removal of underperforming people before more damage was done. There were shocking results from the provinces. The taxpayers’ money was just going down the drain. Although the AG did not have capacity to remove people from their offices themselves, they could make recommendations.

Mr Serote felt it was correct that as an Office they did not have the powers to remove office bearers. However, the reports tended to make it easy to assess whether somebody was performing or not. The reports listed what needed to be achieved, what had been achieved and who achieved it. So the detail was there, which made it easier for the Council to hold CFOs accountable. The Council would also be able to reflect on its own impact, and whether it was able to respond.

Ms C Mosimane (COPE) applauded the AGO for going out and doing this analysis. She asked if the CFO Forums and Audit Steering Committee could come up with a guiding document to overcome the problems being encountered by municipalities. Could they also look at disciplinary processes and see how best to overcome problems in whole municipal sector?

Mr Serote responded that the presence of the CFO forums and Steering Committees showed that the tools for support were in place and a lot of effort was being made. Assessment of key controls needed to happen quarterly to encourage processes that were indicative of sound financial management. This was something that municipalities should be doing themselves and AGO was trying to ensure that this practice was institutionalised.

Mr Nkosi Mandela (ANC) said that as substantial amounts of funds were being lost, was enough being done to fight corruption. Officials were often just dismissed without investigation and prosecution.  Funds were never retrieved. Was this enough?

Mr Serote responded that the minute there were councillors benefiting from the municipality, it was unlawful. The information was available as to where they had identified the transaction and the councillor, so everything was there for this to be taken further by the relevant authorities.

The Chairperson suggested that information should be translated into other languages and distributed to the municipalities, because people on the ground did not understand the terms and assumed corruption when it was not always justified. Communication was really essential.

Mr Serote responded that for many years the AGO had attempted to simplify their message in order to make it more accessible to the public. This had improved over the last two years and a lot of interest had been created in audit reports. Radio had been used as a very effective means of communication in a number of languages. Through this a lot of people were engaging with the reports. 

The Chairperson asked whose fault it was that the Treasury allowed deviations in case of emergency to Departments and other institutions. What constituted an emergency? For example, the recording devices in Parliament had stopped working and replacements had not been budgeted for. Recording was essential to the functioning of Parliament – did this constitute an emergency? 

He asked how much consultants charged and how much of a difference they made on the quality of financial statements.

The estimated cost of consultants was at least R259 million. The immediate objective of the contract awarded in the North West, for example, was to do financial statements. This had been done, but he was not sure if there was a plan in place for a transfer of skills. He emphasised that the important thing was to instil habits of basic discipline so as to establish a system with credibility of internal control. This was something that could not necessarily come from consultants.

The Chairperson commented that it was the Committee’s duty to ensure that financial management went hand in hand with service delivery.

Mr Smith suggested that if consequences for wrongdoing were a central issue, then the Committee should engage all the relevant stakeholders in a national workshop on the problem. The National Treasury, the Auditor General’s office, the local municipalities, the Department and the Committee were some of the people who could contribute to the discussion. Guidelines or regulations could then be developed with a view to eventually impacting legislation.

The Chairperson agreed that this would be a productive enterprise.
She thanked everyone for attending and closed the meeting.