Office of the Auditor-General: Annual Report 2007/8

Meeting report

Office of the Auditor General (OAG): Annual Report 2007/8 presentation
Mr Terence Nombembe, Auditor General, noted that the bulk of the presentation would be focusing on those areas which had, last year, been identified as needing further strengthening. The business of the OAG was to audit government, and it had a responsibility to create good infrastructure. It must also ensure that the public was properly informed and that public confidence would be enhanced. The Office of the Auditor General (OAG) was focusing on keeping stakeholders aware of the results of the audit. There were two main audit cycles – one for institutions bound by the Public Finance Management Act (PFMA) and another for those bound by the Municipal Finance Management Act (MFMA). The OAG was actively engaging with those working with the figures in the departments, and was also having engagement with the MECs of finance in the field of local government. There had been a workshop held a couple of months ago, and this had shown encouraging results. It was hoped to extend this also to provincial levels. 

The Chairperson asked if it was envisaged that there would be the equivalent of Standing Committee on Public Accounts (SCOPA) at provincial level.

Mr Nombembe responded that only Gauteng had this to date, but there were signs that provincial governments were moving in the right direction.

He added that the engagement with local municipalities was also bringing further insight into the realities these were facing in trying to transform. The process had begun in Limpopo and was moving to other provinces. The motivation and commitment were high, and there were improvements in psychological and technical levels. There was further improvement in planning, which in turn assisted the OAG. This was more fully explained on page 7 of the Annual Report. Mr Nombembe noted that this also had an impact on the training of staff, and the reporting would become more relevant, and improve the environment in which government was working.

Mr Nombembe also spoke about transformation of the profession. New smaller firms were emerging, and by tapping into their capacity the OAG was able to complete its work. He explained that a percentage of government work would always be contracted out to audit firms, and this had gone far to empower black professionals in the accounting profession. The OAG should sustain this and take it to the next level. It was hoped that by improving their own capabilities, they would in turn enhance their own training capacity, so that more qualified and experienced people were available in the pool for the AG to attract to work for it. He was pleased that the OAG was playing a positive role in transformation.

Mr Nombembe mentioned the recommendations coming out of the ad hoc committee that, last year, had conducted hearings on the Chapter 9 institutions. Although this report had not been formally tabled in the House, the OAG had already started to act on some of the recommendations.

Mr Nombembe stated that the OAG was also involved internationally. The OAG participated in the Association of Auditors in Africa and the International Body of Auditor Generals, and South Africa would be taking the Chair of the latter organisation in October. Strategies were being developed, working in language groups of English, French and Arabic, on the continent. OAG participated in and also tapped into the research efforts and creation of standards, which built professionalism whilst tapping into work already done elsewhere. The OAG would be hosting an Assembly in October, in Pretoria. 

Mr Nombembe noted that there had been an important review into how the audit business was conducted. There had to be sufficient capacity and resources in the office. The structure had been considered, and a new Head of Audit position had been created that would champion the work of strategy development and coordinate what was happening internationally and apply it in the South African context. More attention was focused on the streamlining of audit support and ensuring that tools being used were making the work simpler and more effective. Support services included the creation of the post of Chief Operations Officer, who, together with the Head of Audit, was driving the activities on the business side. The Chief Financial Officer’s post was critical, and an appointment had been made, and the OAG hoped to continue to get unqualified audit reports.

Mr Kimi Makwetu, Deputy Auditor General, added that the appointment of the Corporate Executives was regarded as a significant achievement, as they provided leadership to all the business leaders in the provinces. They were supported by business executives, and the staff complement at these levels was stable.

Mr Makwetu said that last year the OAG had had to pay particular attention to the stabilisation of its financial management. Attention had been paid to this and by the end of the financial year he hoped that the situation would have been fully stabilised.

Mr Makwetu turned to the challenges faced, as set out in the business plan. The OAG had not filled all the vacancies, with most having occurred, during this financial year, at supervisory and management levels. Supervision was still not at optimum levels, and attention was being paid to this field. The quality of the reports would depend on the level of supervision. Constraints in filling vacancies included the fact that many people did not respond to advertisements because they had tended to specialise in other fields. Deloitte had then approached the OAG, asking whether it would be willing to work with Deloitte in its talent management strategy, which involved finding qualified professionals working in other countries, such as India. Deloitte enquired whether the OAG was willing to bring over people to work in South Africa. The advantage to the OAG would be in delivery of audits, having more qualified internal staff, which meant that the supervision could happen at internal levels, relieving of pressure where distances posed a challenge, or there was a need for managerial staff, competitive rates, and minimal risk.  There had been agreement in principle, but the details were still to be finalised, and officials from the AG would be going to assist in screening of candidates. The proposal was being done on a phased approach, starting from October.

Mr Makwetu said that the technical and delivery levels were also receiving focus. Because the OAG spent a lot of resources on training of accountants, it could also hope to promote from within the office. Although in the past staff left for better remuneration, a recent study had shown that the AG’s managerial level salaries were in line with the market.

Mr Makwetu then turned to the financial statements. The revenue for 2008 had been R1.1 billion, as compared to R893 million in the previous year. This figure included work done by the OAG as well as the work contracted out and done for it by the private audit firms. OAG did not earn a profit margin on the contracted-out work, which in the last year had accounted for about R400 million of the income. If the OAG was to continue to fund its own work, its profit margins would need to grow. International work accounted for about R21 million revenue. It was being done by a small team based overseas, assisted by other staff sent over on six-week assignments. Most of the work was done for the United Nations' agencies. The exposure gained was more important than the profit margins for this work. Overall, there was a deficit of R8.3 million, as compared with a deficit of R1.8 million in the 2006/07 year. This deficit was caused by the high provision for debtors in the income statement – some of which could be recovered, but the OAG was erring on the side of caution. Most of this debt was owed by municipalities. When identifying the gaps in leadership, it was decided that all risks must be examined in depth, and this had led to a “clean-up” of the balance sheet, which produced another R3.9 million of matters that were not billed, advances that were not recovered from staff who had left, and similar discrepancies. None was a large figure on its own, but added up. When there was a change over of the system, some balances were not carried over correctly, and these had multiplied over the years. Irrecoverable debtors had also now been written off.

Mr Makwetu said that it was important to see this in context. In future, the balance sheets would not have any outstanding challenges. In the future there was also budgeting for variable staff performance bonuses, which had not been budgeted for in the past years although they had been paid.
 
Mr Makwetu then tabled a comparison of performance against budget (see attached presentation) and spoke specifically to some items. He noted that for “own hours” the amount of R700 million was budgeted, but there was a variance of R53.3 million. He explained that when budgeting for this, the OAG had assumed a 5% vacancy level, but it had been higher in reality, meaning that there were not as many people to undertake the “own hours” work. In addition, the OAG gave special leave to those who were still studying. The budget had also assumed that 20% of work would be contracted out, but the final percentage had been higher. He noted that although this meant the profit margins would be lower, it did also mean that the OAG could ensure that its work was done by the prescribed deadlines. It was policy to meet these deadlines through all available means. On the other hand, he noted that there had also been better recovery of the costs.

Ms Hogan intervened to say that the income statement in the Annual Report, at page 82, showed a figure of R417 million, as compared to the figure in the presentation of R423 million.

Mr Makwetu responded that the figures in the Annual Report were correct, as they were the final figures, whereas those included in the table he was showing were initial management figures that he had used to demonstrate trends rather than the final figures.

Mr Makwetu mentioned that the OAG had previously discussed the funding model with the Committee, including the vacancies, and the capping of the tariff for outsourced work. Implementation of the funding model recommendations would move the OAG to a sustainable position, as it would allow billing at a consistent rate.

Mr Makwetu added that the audit of the OAG was done by BDO Spencer and had been unqualified, both in respect of the financial information and the performance information. None of the errors mentioned in the Schedule was material, and none required any alteration to the financial statements. The key priority of the OAG was to achieve clean audit reports, and great emphasis was placed on maintaining current levels. The underlying processes of governance must also be strong in all the business units, to ensure that disciplines were maintained in respect of investigating asset registers, checking authorisations of leave, giving and checking advances, clearing debtors regularly and so on. In addition, the processes must be clear, verified and tested, so that anyone stepping into a new environment would immediately be able to deal with it.

Mr Makwetu briefly described the environment in which the financial statements were produced, and he paid particular tribute to the management team. All processes in place, whatever they were concerned with, must be able to be tested and verified and clear, so that a new person stepping into that new environment would be able to deal with them. The internal control environment must be strong, and disciplines must be maintained.

Mr Makwetu then tabled a schedule of actual performance against targets. On quality of auditing, 10% had been adjudged as poor (compared to the target of 0%) but the units were identified, leadership was found to be the major challenge, and remedial actions had been taken. Cost of auditing had achieved a 25% efficiency ratio, which took into account the variations in the own and contracted work. Not all timelines were met as there were some backlogs with the MFMA institutions, and some extensions were given to cover the period of the strikes in 2007, but 70% were audited on time. All of the outstanding audits would be completed by the end of August. He reiterated that meetings with MECs had shown positive results. Performance audit processes were defined clearly, and international audits were well within the 5% self-imposed cap. OAG achieved full compliance with Black Economic Empowerment (BEE) criteria. Leadership was not as effective as it could be, but some proposals had been put on the table. There had been a dip in the reputation index, which was judged from an independent study, largely due to unhappiness from the internal staff. The matters, largely relating to contracts, had been investigated and improved. The OAG exceeded its minimum requirements of 20 qualified professionals, and the figures for the different categories of professionals were set out. The projected staff turnover was 12% but the actual had been 20%, mostly at lower levels. Operational excellence was improving at level 2 but still fell short at level 3. 

Mr Makwetu noted the efficiency gains. Debt collection from national departments was at 10 days average, at 34 days at provincial and 111 days at municipal level. He noted that the funding bottleneck had been addressed. There would be ongoing challenges in capacity, because less people were entering the profession in South Africa. The OAG needed to safeguard its position but the private audit firms would remain a key stakeholder. It needed to focus on growth and retention of key stills, and sustainable development and growth of key processes.

Discussion
Mr E Trent (DA) wondered if the funding model would be discussed separately, as he said that quite a number of his questions hinged on it.

The Chairperson noted that the Committee had already discussed this, but that Mr Trent had been unable to attend that meeting. She suggested that the questions should nonetheless be raised.

The Chairperson congratulated OAG on the clean audit, saying that there had been much praise for the way in which the AG had turned around a potentially difficult situation. The Annual Report showed increased professionalism, and the reports were considerably easier to read. The OAG was one of the founding pillars of democracy, and she was enormously encouraged by its innovation and its work with this Committee.

Mr Trent added that the ad hoc Committee investigating the Chapter 9 institutions had also commented on how well this office was performing.

Mr Trent asked how many of the late audits resulted from information being submitted late to the OAG.

Mr Makwetu confirmed that this was a factor. He said that during the PFMA process, some departments had submitted their documents, but then had to withdraw them and re-submit, causing delays. The OAG was aware that many of the departments were struggling.

Mr Nombembe noted also that if the timelines fell by 10% this would be an indication of a problem>

The Chairperson noted that MFMA reports had been a problem. She noted that table 9 on page 43 of the Annual Report showed that 48% of the total submitted were finalised by due date.

Mr Makwetu noted that the tracking was done on 28 February, the date on which there should be sign-off. By that date, only 48% of reports were signed off. However, last year the deadlines for PFMA had been extended, and that caused a spill-over because provinces would finish the PFMA process before attending to the MFMA process. OAG had calculated that if the strike had not intervened it would have achieved 79% compliance.

Adv J Stephens (DA) commented that the way in which the figures were presented in fact seemed to put the OAG in a poor light. He felt it would be more informative to know how many reports were completed within two months of having received the documentation. The non-performance shown in these tables could have resulted from non-performance by the auditees.

The Chairperson suggested that additional columns be added to show how many auditees had handed in on time, and how long it took from date of receipt to date of sign-off. She was impressed to see the increase in sign-off and asked whether Mr Nombembe was happy with the performance.

Mr Nombembe said that he was happy with the submissions. He noted that the information requested by the Chairperson did appear in the Annual Report, but he could certainly let the Committee have it directly as well. He noted that most municipalities had now submitted their statements for 2006/07. However, he noted also that even if they had all submitted on time, there would not in fact have been sufficient capacity in the audit profession as a whole (meaning both the OAG and the firms it contracted to) to complete all audits by the set date, but by August that backlog would have been cleared and the OAG would move from a clean state into the 2007/8 financial year audits. 

Mr Trent asked if there were penalty clauses for late sign-off applied against auditors contracted by the OAG.

Mr Makwetu responded that there had been one or two problems, especially when information was not forthcoming from the auditees.

Mr M Johnson (ANC) noted that one of the challenges had been lack of capacity in the OAG’s own office. He also noted its developmental role in contracting out work. However, he saw this as a contradiction, and asked how the amount of work being contracted out was affecting the capacity challenges, and the financial deficit.

Mr Makwetu responded that it was necessary to look at the model. Because of the PFMA and MFMA delivery times, there were two peak periods in the year, but outside of those times the office was not called on to deliver many reports. This was unlike the audit firms, who would deal with a number of variable year ends. It was a question of finding the balance between hiring permanent staff, who then might not be used to full capacity outside of the peak times, or contracting out as necessary. When a province asked for work to be done, a decision must be made on whether to send out the OAG staff, or outsource to a firm in the area. If less was outsourced, this would improve the OAG’s profit margins, but the legislative requirement to deliver on time must be met. There was a certain formula that OAG used in terms of the speed of the work, and it would also try to apply fairness across the profession. When it outsourced, it effectively would bill the auditee according to what the OAG had been billed by the client, and would not take a percentage.

The Chairperson noted from the Annual Report that the extra work was going less to the large audit firms than to the smaller and medium sized firms.

Mr Makwetu said that the decisions were made predominantly according to availability. Many of the larger firms did not have a presence in all provinces, or in smaller towns, and the OAG would rather give work to locally-based firms.

Mr Trent said that in theory the AG should be recovering all costs, and in theory there should not be a deficit if all costs were covered. If there was full recovery of the cost of outsourced work from the auditee, he did not understand how this would affect the position.

Mr Makwetu explained that there had been a diagnosis of the funding model. The 44% that was contracted out was limited by a capping of 4%, which meant that in truth there was not a full recovery, in the sense that the administrative costs of processing invoices and the like were not recovered. Granting of study leave and would also affect the numbers.

Mr Johnson noted that there were still references to the “PAC” in the Annual Report and he gently reminded the OAG that this should be the “APC”.

Mr Johnson referred to page 57, and said that he would like further explanation of the link between success in retaining staff, and staff morale.

Mr Makwetu said that the results of the survey had shown that most of the unhappiness was expressed by internal staff. The OAG then instituted further investigations, which revealed that most of the concerns were around employment, including growth and development. Staff at the OAG tended not to gain experience across a wide range of different company audits, but on the other hand they knew, when entering employment, that they might be restricted to one government department. They would have limited exposure to variety but substantial exposure to content such as financial management, governance and similar issues. They would also receive extensive training. There had also been unhappiness around contracts. OAG also focused on achieving the April deadline for salary increases actually being paid to staff. Staff morale was improving and senior management would interact more at a personal level with staff.

Mr Trent recalled that fixed term contracts were to be changed, and he asked if that had assisted retention.

Mr Makwetu said that previously there had been rigid interpretations, and some five-year contracts were expressly non-renewable. Now OAG had eight to ten-year renewable contracts, with renewal dependent on achievement of certain stated deliverables, which created more certainty.

The Chairperson asked if the staff turnover tended to be regionally-based, and whether there had been patterns in certain provinces.

Mr Makwetu said that no analysis had been done. Some people might be attracted to other provincial departments – such as to Chief Financial Officer posts. Previously those completing articles would have had to compete for jobs, but now they were being identified in advance and considered eligible for promotion without having to apply. 

The Chairperson asked what the industry average was for staff turnover.

Mr Nombembe replied that the financial services sector average was 16%, but the accounting profession average was in the mid 20% range. 

The Chairperson noted that, despite the competition it faced the OAG’s vacancy rate was then below industry average.

Mr Makwetu said that in past years part of the branding for accounting firms had been to profile their graduates overseas. This led to many graduates automatically heading overseas to find jobs, leading to shortages in South Africa, especially at consulting level.

Mr Trent noted that the positive to the AG losing staff to provincial departments would be to improve the skills in those departments.

Mr Trent asked what the process was with the international audits, and whether they were subject to capping.

Mr Nombembe said that the OAG would invoice and be paid in US dollars, to ensure full recovery.

Mr Makwetu added that the finances were controlled from South Africa and fees were paid into a separate account. A small office was maintained overseas, but OAG would draw its own staff from a pool in South Africa to go on six to eight week contract audits. The audit fees were agreed up front, and would include recovery of the full costs of accommodation, travel and so forth. The staff would continue to receive their monthly salaries from the South African payroll, but their daily allowance would be paid in US dollars. The fee to the OAG was paid in US dollars so that the foreign exchange risks were covered.

The Chairperson asked if the current financial model was sustainable, and whether the next budget would be premised on the change of the funding model, which hopefully National Treasury would accept, or whether there would still be deterioration to March 2009. She asked if this was because of delay from National Treasury, whether the 4% cap would still apply, and whether the results were anticipated to deteriorate in the coming year.

Mr Makwetu replied that the current model would run over to the next financial year. The cap would remain at 4%. Therefore it was anticipated that the results could continue to deteriorate, if recovery of costs and other initiatives were left out of the calculations. The longer the current financial model was run, the worse the situation would become. The quantum of the amounts subject to capping was moving higher each year.

The Chairperson asked to what extent non-timeous payment by Municipalities was an issue.

Mr Makwetu noted that this was quite a significant factor. In some cases the OAG was told that they did not really have a budget to pay the auditing fees.

The Chairperson appreciated the environment in which the OAG operated, but said that the Committee should be able to rely on the budgets, and she noted that already OAG was predicting a larger increase than budgeted in respect of contracted-out work. She asked why OAG had not been able to anticipate this better.

Mr Makwetu said that an incorrect assumption was made on the vacancy rate, and the lack of staff meant that more work had to be contracted-out.

The Chairperson said that at the time of tabling the budget, the OAG had been embarking on a very ambitious and aggressive recruitment campaign. She asked what the difficulties had been and what had been achieved.

Mr Makwetu said that the OAG had engaged with service providers throughout the provinces. Positions were advertised, but at managerial level, many of the vacancies had been filled by the OAG’s own staff being promoted. The “external” candidates, having predominantly worked in the private sector, would have required extensive re-training which was not viable. The promotion of the internal staff was more effective, but had then resulted in a bottleneck and more vacancies at lower levels. Therefore the marketing campaign, although not incorrect, had not succeeded practically in filling the vacancies.

Mr Trent was concerned that trade and other receivables had increased in the balance sheet by R67 million in the last financial year. These included amounts where collection might be “dependent on the assistance of government”. He asked if this was a question of timing, or of not being able to recover at all. He noted that the time for collection had increased. Government departments could not be sued, but he would like assurance that the money was not to be written off as bad debt.

The Chairperson noted that this question arose every year and there seemed to be no progress on the issue.

Mr Trent also noted provision for writing off some receivables, and he asked why this would be so.

Mr Makwetu referred members to pages 111 and 112 on the Annual Report. In the case of national departments, it was likely that processes were at fault, and they would probably pay with time. However, there was certainly a challenge with local government. Provincial departments not paying tended to be based in North West, Northern Cape and Eastern Cape. Limpopo had now improved, following more active interventions adopted by the MECs.

Mr Nombembe added that in the Northern Cape the MEC seemed to be willing to receive details of the payment status, which would give him a better indication of how municipalities were performing, whether they were failing to pay generally, and whether there was a need for the next level of government to chip in. This had been successfully applied in Free State. Eastern Cape used to assist with an annual top-up, but the changes in MECs had led to a change in approach, and possibly there was not full comprehension of the problem.

Mr Trent found the research into perceptions very encouraging. However, he asked for more details on the business unit culture unit mentioned on page 57 of the Annual Report. He asked why the statistics showed such wide diversity over two years.

The Chairperson also asked how the culture index was measured.

Mr Makwetu noted that this must be seen in context. In Mpumalanga, there was proactive engagement with leaders once a new business executive was brought into the unit, and that improved morale.

Mr Trent asked what the "average of 1%" overall improvement meant. The individual figures seemed to indicate otherwise. He asked whether perhaps responses given in the first year were incomplete, or whether the second year’s responses were based on a better understanding.

Mr Makwetu noted that these individual figures spoke to internal perceptions, which had since been identified and dealt with; most were around fixed contracts and job security.

Mr Nombembe added that broadly speaking he was satisfied with the numbers and with what was informing the directional trends. These numbers resulted from a statistical analysis that took into account different trends and aspects, which would be unbundled through further interventions.

Mr Trent mentioned that he was interested in hearing the OAG’s remarks on three aspects of the report of the Ad Hoc Committee.

The Chairperson noted that this report had not been tabled in Parliament, and that the questions could not properly be answered until then. However, Mr Trent and the AG could perhaps discuss these matters outside the meeting.

Mr Trent noted that the OAG was intending to install generators, and commented that it would be hugely costly if the staff were unable to work for days because computers were not working.

The Chairperson said that the Committee looked forward to receiving the budget and strategic plan. In addition, she was aware that the OAG had wanted to effect certain amendments to the Public Audit Act, and although these would not be finalised in this Parliament’s term, it would be useful to discuss the proposals and give a hand-over report to the new Committee. In addition, it would be useful to have a report reflecting on the corporate governance framework and a final report to the House.

The meeting was adjourned.