Office of Auditor General: Measurable objectives: briefing, Review of Audit Tariff, Noting of request for retention of surplus f

STANDING COMMITTEE ON AUDITOR GENERAL
22 May 2007
OFFICE OF AUDITOR GENERAL: MEASURABLE OBJECTIVES: BRIEFING, REVIEW OF AUDIT TARIFF, NOTING OF REQUEST FOR RETENTION OF SURPLUS FUNDS

Chairperson: Ms B Hogan (ANC)

Documents handed out
Primary Focus Areas: measurable objectives and medium-term output targets
Auditor-General: Proposed internal rates for 2007
Response to the opinion expressed by the Independent Regulatory Board for Auditors
Auditor-General Rates Research Project: Terms of Reference
Auditor-General Rates: Research costs

Executive Summary: Auditor General Audit Tariff 2007/08
Annexure 4: capability maturity model
Annexure 5: black economic empowerment criteria
Annexure 6: Audit quality criteria
Annexure 7: Reputation index
Copy letter 14 May 2007 to Director General treasury together with Annexure “A”
Balance sheet as at 31 March 2004
Executive summary: Surplus Retention 2003/04

SUMMARY
The Auditor General attended the meeting in order to discuss three matters.

The rates applied for audit work from 2009/08 needed to be reviewed as the Auditor General presently outsourced around 20% of its work to private firms, due to lack of internal resources. There was currently a disparity in the Auditor General and private rates, as commented upon by the Independent Regulatory Board, and it was proposed that research be carried out to evaluate the rate basis used in South Africa and internationally, to make a proposal on fair rates. A base line increase of 4% on the old rates was applicable for the 2006/07 year. Members discussed the need to have specific terms of reference for the project, the need to establish best practices both in South Africa and internationally, and clarified that no field visits were intended. The Committee believed that the final terms of reference should be clarified by the Institute of Chartered Accountants and the Auditor General, who would jointly be undertaking the project.

IT was noted that the Auditor General had written to National Treasury requesting permission to retain a surplus of R36.3 million that had arisen in the financial year ended March 2004. Members commented that this matter seemed long delayed. National Treasury had given an indication, informally, that it was likely to approve the retention but a formal response was awaited.

A document on measurable objectives in the Office of the Auditor General was tabled, and the Auditor General explained that this document was allied to the performance outcomes and costings of the office. The primary focus areas were quality of auditing, cost of auditing to government, timeliness of audit reports, auditing of performance information, to be phased in, and international audits. Further objectives related to employment equity, black economic empowerment, leadership, reputation, learning and growth, retention of staff, operational excellence, and financial performance, measured by efficiency gains and debt collection. Members raised questions of clarity under these headings. They believed it would be useful for the Committee to be able to visit the Auditor General’s office to gain a better idea of the work undertaken and had been invited to one workshop on 25 May. The Committee expressed concern over the high debt, particularly resulting from municipalities failing to pay audit fees on time, and requested an age analysis of the debts. They requested more information under leadership information and believed there was a need for investigation into whether sufficient numbers of accountants were produced by the universities and the profession.

MINUTES
Auditor General Rates: Research project briefing and discussion
The Chairperson tabled documents giving the background to the Rates Research Project.

These documents indicated that the audit tariff for 2006/07 had already been set, using a 4% increase on the previous tariff. However, the Auditor General had noted that the audit tariff for 2007/08 needed to be addressed. Currently the Auditor General (AG) outsourced around 20% of its work, due to insufficient internal resources. The Auditor General had two different rate structures. The internal rates were used for work performed by the AG’s own staff, and the external rates were used by private firms to bill the AG. The Public Sector Commission of the South African Institute of Chartered Accountants (SAICA) had expressed concern that the AG’s rates were discounted compared to private firms, and that there was insufficient profit margin allowed on the external rates, particularly given the effect of recent changes to the recoverable hours allowed for audits. The Independent Regulatory Board for Auditors (IRBA) had questioned the basis of calculation of the rates, particularly in regard to the mark-up factor, the increases in the mark-up over the last three years and the increase in head count and “bracket-creep” of skilled staff earning in the upper pay range. The responses of the AG were tabled. It was suggested that research must be carried out to evaluate the basis used to determine the internal and external rates, so that there could be recommendation on a model for determining future AG rates, which would be fair both to the AG and to the contracted firms. The purpose, objectives of research, research team, comparative countries, research methodology and proposed time lines were set out. It was noted that the research project was estimated at R50 000, to be funded in equal proportions by the AG and SAICA.

Discussion
Dr G Woods (NDC) noted that the documents must be read in context and that the proposal related to the future tariffs.

Mr Terence Nombembe, Auditor General (AG), confirmed that the tariffs for 2006/07 were set already, and the base-line 4% increase had been adopted by the Office of the Auditor General (OAG). This discussion document and proposal was the starting point for 2007/08 tariffs. The Auditor General was required to charge for all auditing work performed. There were two aspects with regard to charges. The first part related to charges by own staff, and the second to the tariffs charged to the Auditor General by any external sub contracted, auditing firms. These tariffs must be calculated at rates that would enable these firms to stay in business. Mr Nombembe felt that there was a need to commission a research project to establish a tariff fee-basis for audits in South Africa by South African firms. Such tariff fees needed to be evaluated against the tariff fees operative in other countries. The terms of reference must take recovery of costs into account and would therefore include staff salaries, and should be incorporated in the budget for 2008/2009.

Dr Woods felt that there was a need to set clear terms of reference, especially in view of the global village, and he felt that what needed to be established was whether the rates were reasonable when measured against the profit margin for the large auditing firms. In addition consideration should be given to how the firms were conforming to transformation. He noted that some offices had totally different approaches to outsourcing, and it must be established how they calculated their rates. In the circumstances he wondered how useful a comparison would be, especially as the private firms could not be expected to reach the same profit margins.

Mr Nombembe replied that the object was not to complicate but rather to clarify the background to the budget. If the tariffs were out of line with each other this would disadvantage work in other jurisdictions. In commissioning work OAG had never tried to make distinctions between firms. The perception was that the rates being paid to auditing firms in South Africa were not in line with comparable payments to auditing firms in other jurisdictions and there was a need to find a way of agreement. This exercise would assist the Auditor General to be able to commission and pay for work along realistic lines. It would also encourage transformation, as association with the Office of the Auditor General would enable all firms to have the opportunity to work together in a once-off situation. In the circumstances he requested that the terms of reference be as broad as possible.

Mr J Stephens (DA) agreed with the basic assumption but reminded Members of the global nature of work. Audit firms had international connections and these must be taken into account when determining fees. Other countries may do things differently. The Committee needed to take note of other best practices in order to allow the Office of the Auditor General and private sub contracted firms to establish tariff fees that conformed to international best practice. The only question was how to establish a structure that allowed for good research to be undertaken expeditiously, rather than following circuitous routes, and to write up the research before July 2007.

Mr E Trent (DA) wished clarification as to whether R50 000.00 was sufficient to do research and also perhaps visit other countries.

Mr Nombembe replied that this figure assumed that there would be no field visits. He added that it was of prime importance for the AG always to establish the contracted company’s or individual’s integrity, especially if it was intended that they should be working internationally. The overriding intention of this research was not into the firms, but into establishing a fair basis for charges.

The Chairperson summarised that the Committee needed to consider the desirability of conducting the research and then the costing of it. She believed that this could be left to the nominated individuals from SAICA (Mr Patrick Maranya) and the AG (Mr Jan van Schalkwyk), who would simultaneously discuss the question of the allocation of R50 000.00. Terms of reference must be focused on in deciding the best basis for the research. The objectives was to establish with IRBA a reasonable increase. The whole process must be transparent and set out the system used to calculate the impact of the variants.

Mr Nombembe pointed out that it was not intended to deal with bracket creep in the composition of the audit tariffs, as this could be managed by his office. The real issue was the method of calculation of tariff fees, which would take into account the real costs-recovery, but this could be undertaken via the terms of reference. With regard to break-even systems the costs of all elements of running the OAG had to be taken into account, and these had constantly to be adjusted to ensure that input costs were allocated before any estimates could be made of fee structures for work to be undertaken.

The Chairperson asked whether there could be transparency in the mark up sector of the fees.

Mr Nombembe said that this would be reflected in the costs of the audit.

The Chairperson wished to know whether the fees were set per hour.

Mr Nombembe replied that this was so.
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The Chairperson asked for clarity whether this was the way that the Office of the Auditor General could contain costs and establish a break-even position. She asked if by extending the profit margin element there might be a higher wage bill. She asked guidance on the position in other countries, whether there was a formula and to what extent this might be applicable.

The Chairperson asked if the R50 000.00 budgeted for the research was from the Office of the Auditor General, and whether the South African Institute of Chartered Accountants (SAICA), if undertaking a joint investigation, would be contributing a matching sum.

Mr Nombembe replied in the affirmative and added that initially the South African Institute of Chartered Accountants (SAICA) had wished to do the research and had undertaken to split the costs incurred in equal proportions. He suggested that the matter be left at this stage and that if the costs of the research exceeded R50 000.00 this would be managed between the two bodies at a later stage.

Mr E Trent stated that there was a perception in South Africa that professional fees were unlimited and hence he favoured the research being done.

The Chairperson wished to know whether the 4% increase for 2006/07 still needed to be approved, as she believed this had been discussed already.

Mr Nombembe confirmed that it did not. The reason behind this meeting was specifically to focus on the proposed research project for the 2007/08 fees.

Dr G Woods whether the external auditors would accept the 4% increase.

Mr Nombembe replied that it was unclear

The Chairperson felt that it would be helpful to have SAICA’s comments and arguments and any other outside guidance, and suggested that the proposal be approved.

Discussion on application for surplus retention
The Chairperson noted that a letter had been written to the Director General, National Treasury, by the Auditor General on 14 May requesting permission to retain the surplus of R36.3 million as reflected in the annual statements for year ended March 2004. The Office of Auditor General had made a deficit and was not in a position to transfer the net surplus. There had been a delay in submitting the application, and reasons were outlined in the letter. She asked the reasons for delays.

Mr Nombembe stated that both parties were to blame for delays as it had not been easy to get correspondence backwards and forwards. National Treasury had indicated, informally, that it was likely to approve the retention. Mr Nombembe had addressed another letter to the Director General of the National Treasury regarding the request but as yet there was no reply. The reserve as reflected in the balance sheet would lead to useful debate.

The Chairperson commented that this long delay was not consistent with good corporate governance, and that she hoped that this extended period of correspondence would not recur, and that the parties would keep in touch for the purposes of compliance with the provisions of the Public Audit.

Dr Woods pointed out that this was the first time in a number of years that the Office of the Auditor General had had an operating surplus, so that this fact might have given cause for concern, but he understood the considerations around retaining this surplus which may previously have all gone into working capital.

Mr Nombembe said that he would not have expressed it in this way. He was happy to retain the surplus if the principles set for other years could be applied also to this year.

Dr Woods said that he was happy to take it this way.

Measurable Objectives in the Office of the Auditor General
The Chairperson indicated that the relevant documents were the annexures 4 to 7, on the capability maturity model, black economic empowerment criteria, audit quality criteria, and reputation index, as well as the table of measurable objectives. She asked the AG to give an indication of the purpose of the document.

Mr Nombembe stated that it would be difficult to address the question of costs in a manner that would be understandable to non-accountants. The purpose of the exercise was to ensure that the office became more efficient, and so it was necessary to set some indicators by which efficiency could be measured, and to set a suitable basis for measurement.

The Chairperson queried the figures given in the final column of the targets.

Mr Nombembe explained that projected efficiency ratios had included the figure of 35% to cover the situation where work had been outsourced to private audit firms but where some elements of the work done by the AG itself were charged in. This 35% was intended as a reasonable “cushion”. This figure was influenced by the number of vacancies in his office, and if these could be reduced then more of the work could be undertaken by his office.

Mr Trent (DA) said that he could not understand this approach.

Dr Woods said that there should be only one definition of efficiency and that although there might be other considerations the end result must be clear to the Committee.

Mr Nombembe said that other considerations would include compliance with government policies, and the 35% audit efficiency ratios were set to try to enable the AG to do work efficiently.

The Chairperson asked him to identify another area.

Mr Nombembe referred to the auditing of performance information set out under paragraph 1.4. He said that he could ask Mr Jan van Schalkwyk to clarify this aspect. Some elements in this table were operational and the next two to three years should show up further clarity.

The Chairperson wanted to know what effect deadlines and similar restrictions would have.

Mr D M Gumede (ANC) wished to know whether there was reference to Public Finance Management Act (PFMA) and similar legislation.

Mr Trent asked what impact performance in terms of PFMA would have on these figures.

The Chairperson wished to know how international auditing impacted upon these objectives

Mr Nombembe replied that the impact of international auditing would show in about three years and that what was important now needed to be measurable.

Dr Woods was of the opinion that, in the case of performance auditing, these measurable objectives might fall away if the relevant checks were in place.

Mr Nombembe pointed out that even if it were done, performance could still be increasing the effect that Government was putting into spending money, and thus the objectives would not fall away. He added that service delivery was and would remain a prime interest of Government and that operational information was not required for the evaluation.

Dr Woods pointed out that performance infrastructure was a cost and needed to be carefully defined.

The Chairperson pointed out that what was important was the integrity of the system. Service delivery was required, but there was also reliance on other types of information. Therefore, if this system was to be relied upon, she would like to see that there were the checks that would ensure that the system had integrity.

Mr Nombembe agreed that the facts were complementary. There was a need to confirm that the system had integrity and that this was the auditing system that could provide delivery.

The Chairperson commented that then the Committee was following an approach similar to US Congressional Budgetary Committee.

Mr Trent said that there was a simple basis: to get value for every cent spent.

Mr Nombembe replied that the norm in international auditing was to ensure justification of every cent spent upon the process.

Mr Trent suggested that this sounded as if a special report would be called for if matters were not considered correct.

Mr Nombembe stated that it was an accepted part of international auditing that lack of compliance could result in special reports. The important task was to ensure that the Government spent wisely in all areas.

Mr Trent drew attention to provision for bad debts, at 8%, in the budget. He felt that for government departments and entities this was quite a high amount.

Mr Nombembe replied that this figure was intended to be all-inclusive.

The Chairperson then turned to the question of the implementation of Employment Equity, under Paragraph 2.

Mr Nombembe explained that the figure of 5% was based on historical facts obtained from the United Nations and World Health Organisation. There was a shortage of auditing personnel, and anything further that that would be too onerous and impractical for the Auditor General.

The Chairperson then raised the Black Economic Empowerment focus area, listed under paragraph 3.

Mr Nombembe stated that until there was an established strategy for the Broad Based Black Economic Empowerment (BBBEE) legislation there was a need to comply 100% with the provisions of black economic empowerment as previously stated, so that management would have to enforce the issue. An existing table of BEE had been approved by EXCO, and needed final confirmation.

Dr Woods then raised the leadership outcomes listed under paragraph 4, which referred to “desired culture and current culture” He remarked jocularly that this seemed to be a sociologist’s nightmare.

Mr Nombembe explained that that the culture index, which was evaluated annually, took care of this aspect.

The Chairperson was unhappy with the levels of leadership measurement

Mr Nombembe explained that these had been established in the light of the specialities of the profession. The 2006/07 targets had been established and the Office of the AG was moving towards targets for 2008/09.

The Chairperson stated that there were two differing approaches, that of the stakeholders and that of leadership, and that the culture index was a critical element and identified leadership. She believed that more management information was required.

Mr Trent then asked whether in measuring the same policies would be used every year in order to achieve conformity

Mr Nombembe undertook to provide further information.

The Chairperson then addressed the question of learning and growth, listed under Paragraph 6. She stated that although previous annual reports had provided very useful information around training programmes this report did not provide information about learner skill development.

Mr Nombembe stated that this was correct, but OAG had taken a conscious decision not to deal with this particular aspect. All categories were regarded as valuable.

Mr Trent remarked that what was important was the output, not the intake, of approved candidates and there should be a delineation between intake and the result of training.

Mr Nombembe stated that this was difficult with auditing professionals. He however saw the merit in the suggestion.

The Chairperson then remarked that there was a distinction to be made between what was the minimum necessary training and what was supplementary. It was clear that more appropriate training was required as the pool of prospective and actual auditing professionals had diminished. She asked what qualifications would define “an qualified audit professional”

Mr Nombembe stated that an qualified audit professional held a certificate as a CA or CFA

The Chairperson asked whether there was not an acceptable “middle ground” of another qualification.

Mr Nombembe stated that current legislation precluded any such middle ground.

The Chairperson stated that it was necessary to know the shortfall of audit professionals in the office.

Mr Stephens asked what were the common problems encountered through lack of a team of fully qualified audit professionals.

Dr Woods asked whether having a team of fully qualified professionals might not be too expensive and noted that the Committee required the figures to ascertain what the position might be. It was clear that, whatever the case, there must be a policy of growing and retaining professional staff. He asked what was the ideal mix between qualified staff and staff-in-training.

The Chairperson noted that this required a fully operational HR function.

Mr D Gumede (ANC) then asked whether there was any indication of how many qualified audit professionals were produced by the universities annually.

Mr Nombembe stated that according to SAICA statistics there was an annual shortfall of 5% of requirements, and because of this there was a scramble among those requiring audit professionals to obtain them.

The Chairperson then pointed out that there were not enough audit professionals. The rigorous provisions of the new companies legislation meant that the smaller audit firms were closing and going out of business, as in future only businesses with an annual turnover of R20 million would require to be audited. Without approved financial statements, of which balance sheets were an integral part, smaller firms would find it very difficult to obtain financing.

Mr Trent observed that this would impact upon government.

The Chairperson remarked that potentially it could pose a huge problem.

Mr T Mahlaba (ANC) noted that, although not strictly speaking the function of this Committee, it should endeavour to ascertain what effect the shortage of skills would have, and ensure that less skilled auditing professionals must be used wherever possible.

Mr Nombembe reminded the Committee that legislation demanded certain qualifications before persons could be regarded as skilled auditing professionals, and that there was no way to depart from this. However, this problem needed to be dealt with in the system so that the country was not ill prepared. It would be useful to try to get some projection of how many chartered accountants were required in future, and at what stage the current students were in their training courses.

The Chairperson stated that there clearly needed to be provision made in the budget for skills development.

Mr M Johnson asked whether it was not possible to get potential audit professionals interested in the work now so that they developed a passion for it.

Mr Nombembe said that this was a valuable approach, but unfortunately the confidentiality aspects precluded untrained individuals being allowed in the office. He added that potential audit professionals must show skills in English and Maths.

Mr Trent wished to know whether the 12% retention calculation was based on historical fact.

Mr Nombembe stated that this was the standard financial services industry calculation on professional staff, although it might be somewhere between 18% and 20% globally.

Mr Trent asked whether there was a difference between the remuneration of audit professionals in the Office of the Auditor General and in private practice.

Mr Nombembe stated that the remuneration levels were the same.

The Chairperson could not understand paragraph 8 on operational excellence and asked for clarity.

Mr Nombembe stated that the purpose of this was to demonstrate that governance principles were exemplary in the Public Service. He conceded that perhaps these could have been phrased in clearer English. Essentially it was related to Risk Analysis and the Office needed to achieve the right level of maturity of business processes so there was a need for the Auditor General to evaluate itself.

Dr Woods queried paragraph 9 relating to efficiency gains. He felt that the budget should be an all embracing master plan for the Office of the Auditor general.

Mr Nombembe conceded that Dr Woods was correct in his observation, but stated that with the current system there needed to be a break-even point and that this should be borne in mind because the Office of the Auditor General is competing with private auditing firms.

Dr Woods remarked that there seemed to be a budget within a budget.

Mr Nombembe conceded that this might be so, but stated that the additional percentages could be seen as a reserve fund from which to pay items such as bonuses. The OAG was trying to reduce the annual movement of people by looking at the total costs of auditing. By this means the sum of R30 to R50 million might be retained.

The Chairperson then addressed paragraph 9 on debt collecting, which impinged upon the operations of OAG. Some national and provincial government departments had been tardy in paying audit fees but the problem was particularly distressing among municipalities, some of which were long outstanding with their payments. Many attempts were being made to redress the situation but in the meantime the non payment was having an adverse effect upon the cash flow of the OAG for without the necessary funds it could not pay the auditing firms that had been sub contracted. There was then a knock-on effect. The MEC of KwaZulu Natal had ruled that Councillors were not entitled to increases in their remuneration unless their municipalities could prove that the audit fees had been paid.

Mr Trent stated that perhaps the solution lay in training the municipalities to make provision for their audit fees in their own budgets. However, one had to consider whether this training might push up the budgets and be counter productive.

Dr Woods pointed out that the relevant legislation required payment of the audit fees within thirty days of presentation of the invoice.

Mr Nombembe conceded that part of the problem might lie in the fact that some of the audit fees presented to municipalities were for multiple year audits. In some cases OAG had been unable to audit Municipalities each year because they had not fulfilled the obligations to be audit ready.

The Chairperson pointed out that these audits were performed in line with the Municipal Finance Management Act (MFMA) and municipal managers should be aware of the requirement and the effect of non compliance, which was that Provincial MECs had the right to step in and take over the administration, and in fact that they must intervene before the National Treasury became involved.

Mr Mahlaba requested that the Committee be given an age analysis of indebted Municipalities

Mr Nombembe confirmed that it could be done and that the appropriate steps were being considered.

Dr Woods asked whether it had been contemplated that the Committee members should spend some time in the OAG in order to get a better orientation.

The Chairperson was in favour of this and suggested that it would be useful also to include the offices of the Provincial Auditor Generals.

Mr Trent enquired whether such visits might not impinge upon the impartiality of the Auditor General. He also asked whether it might not be possible to bring in observers from the Municipalities.

The Chairperson was of the opinion that there was no danger of impinging on the impartiality if Committee Members attended, but that municipalities could not be included.

The Chairperson advised that permission had been granted for them to attend a workshop with the AG on 25 May. She hoped that the Members would be brought up to date with the issues of corporate governance and the independence of the Office of the Auditor General, as Members needed to be fully au fait with the auditing process, whilst not hindering the impartiality of either the AG or the Committee.

The meeting was adjourned.