Presentation to the Standing Committee on Public Accounts on the General and Activity Report
26 March 2003
Ladies and Gentlemen
What is the purpose of this session? This is a vital question that in effect sets the tone for this whole presentation. This session is to provide an overview of the overall trends in our audit findings for 2001-02 and an indication of my performance and the performance of my Office. Often audit reports are presented without the necessary context that indicates how common or unique problems are. The General Report on Audit Outcomes in particular provides a framework from which we can evaluate financial management and corporate governance principles amongst departments, provinces and across ministerial portfolios.
This allows for generic problems to be identified and brought to Parliament’s attention accordingly. By reporting on a consistent basis, it is possible to evaluate whether the situation in the public sector is getting better, worse or staying the same. Users of the report will be able to understand the public sector environment from a comprehensive perspective. It is not enough for me to simply point out problems without setting the context. Nor is it enough to simply state findings without any analysis.
Moving on to the reports, I am discussing three different reports that serve different purposes. Let me elaborate:
Firstly there is the General Report on Audit Outcomes
Secondly the Activity Report
And finally
The Annual Report of the of my Office. This report will be presented by the CEO after I have discussed the General Report on Audit Outcomes and the Activity Report.
Another report that is expected to be tabled shortly is the General Report on Audit Outcomes for Local Government. This is separated from the report covering national and provincial spheres of government for the first time. The rationale for doing this was primarily to enable the earlier tabling of the national and provincial report, as the local government financial year-end is 3 months later (i.e. June).
The diagram on page 6 of the activity report shows the distinction between the General Report on Audit Outcomes and the activity report. Basically the General Report on Audit Outcomes highlights and summarises our audit findings resulting from conducting our audits, whereas the activity report is more focused on two areas:
- my performance and therefore the performance of the office.
- key findings relating to certain audit focus areas such as financial management.
In effect the general report on Audit outcomes is outwardly focussed on the audited results of the auditees i.e. focuses on our core business and the activity report looks inwardly at how well I have performed. However I have included information on financial management in the activity report, therefore this distinction is perhaps not absolutely clear. This was due to the financial management information being available earlier and at time when the activity report was being finalised. Over time I anticipate the distinction to become clearer and clearer.
The Annual Report of the Office contains the financial statements of my office for the financial year and a commentary on the financial position. In addition, it contains a review by the CEO of how the office as an entity is progressing. There is some overlap between the activity and the annual report but in a nutshell the activity report is for holding me accountable whereas the annual report is directed more to the operational and governance matters pertaining to my office.
A final way of looking at these different reports is that the General Report on Audit Outcomes is focused on our audit findings whilst the other two reports give an indication of the tools at our disposal to achieve our work and how well we utilise those tools.
I now want to go into the General Report on Audit Outcomes. However, during this session references will also be made to the activity report, so if you could have both reports available this would be helpful.
This report has been set in a similar format to the previous report. This is intentional and allows for the commencement of comparative reporting. The format has evolved through recommendations made by SCOPA, reviews of reports of Auditors-General of other countries, as well as detailed discussion and research with various other stakeholders.
The information in the report is principally derived from the audit reports on the auditees. In addition, some information supporting the analysis of the audit flavours comes from the annual reports of the auditees and from surveys completed by my auditors. Therefore the intention is to bring together only authoritative information to add to the credibility of the document.
The general report has begun to be used by other stakeholders in addition to Parliament and this Committee. We have received enquiries and had discussions with staff from the National Treasury, Statistics South Africa and various interested persons and researchers. In particular, the portfolio summaries are an excellent summary of the activities within a portfolio and this information has not been available previously. To this end, I anticipate and hope that the number of potential users of this report will increase over time.
As our understanding of the underlying causes of audit qualifications becomes clearer, we will demonstrate these relationships through the general report and use it as a vehicle to monitor progress closely.
This will enable further transparency and accountability. So, for example, if there are particular problems with regard to asset management then the annual reporting requirements of the auditees should identify the action plans in place to rectify the situation and indicate how the departments have performed against such plans.
I think at this stage it will assist the Committee to consider the audit process and understand how the audit opinion is arrived at. Paragraph 1.2.1 on page 3 of the general report gives the background on auditing standards. When we conduct an audit we are assessing the auditee against a set of principles that are in line with the auditing standards set by the International Auditing Community as adopted by the South African Auditing Standards Board. These standards are called the South African Auditing Standards. Therefore the opinion I express on the auditees is aligned with the standards of the international community and can be evaluated accordingly.
This type of standardised approach enables potential benchmarking with other sectors. However, one important distinction between public sector auditees and their private sector counterparts is the lack of a profit motive in the public sector and the importance of compliance with rules, procedures and achievement of outputs and outcomes. Paragraph 1.2.2, page 4 refers to this aspect.
However, the underlying factors of how well an organisation is being run in terms of financial management and corporate governance are consistent. It is these aspects (that is, financial management and corporate governance) that are the focus of my reports.
On page 5 of the general report the intention is to provide the user of the report with a clear understanding of the steps of the audit process. I want to go through this in some detail as it will help provide the necessary understanding of the audit process that gives rise to the audit reports.
If you take the first block, the pre-engagement activities, this is where the primary focus for my audit teams is to match the requirements of the engagement to the skills and competencies of the audit team. This is of paramount importance as the basis of a professional and constructive audit rests with the right blend of experience and qualifications. The annual report of the office states that the most important resource at my disposal is the staff. To this end we are a recognised training organisation and pride ourselves on the continuous learning aspect that forms a pillar of the strategy of the office.
Another important aspect of the pre-engagement activities focuses around the last bullet. If the highest standards of professional behaviour and ethics are not maintained, then my credibility is compromised. We have seen recent cases of one of the biggest accountancy firms suffering ruin solely through the loss of its reputation. It is vital that we are seen not only to maintain the professional standards expected of us, but to exceed them. The two main accountancy/auditing institutions with which we have article schemes, namely the South African Institute of Chartered Accountants and the Association of Chartered Certified Accountants, both have a code of conduct that its members have to adhere to. This further endorses my full commitment to the highest professional standards.
The audit planning is the second block of the diagram on page 5. This is now concerned with the second important aspect of the strategic initiatives of the office, namely process. Audit planning is where the audit team obtains a knowledge of the business through varied internal documentation and consultation with staff. From this the organisation is assessed for the risks that it faces from being able to report accurately and ultimately, performing the functions that it has been created for. Once these risks are identified, an assessment is undertaken to assess what controls management have put in place to ensure that such risks are either prevented or, where this cannot happen, that they are mitigated. This is a critical aspect, since deficiencies in management implementation of sufficient controls to mitigate or prevent risks often lead to onerous and costly audit fees as well as fundamental issues that are taken up in the audit reports.
When the auditors assess that sufficient controls from management are not in place to control the organisation, this leads the auditor to having to check more individual transactions for the required assurance, rather than testing the controls. This in essence provides less valuable audit work and makes it more costly. We are currently in a position where the conclusion not to rely on the controls and systems put in place by management is the norm rather than the exception. Audit flavours to which I will refer later cover such issues as control environment and asset management, which are typical examples of such controls.
Another focus area at the planning stage is to assess the internal audit functions of auditees. This purpose is twofold: firstly, to assess whether reliance can be placed on the auditee to in effect reduce the potential work of the auditor. Secondly, to conclude on whether the requirements of the PFMA, which calls for an effective internal audit function, are being met.
As you can see, the planning phase is critical and the basis for the audit approach is determined via the planning. This is communicated to the management and audit committee of the audited entity and often gives a good indication of where potential problems may occur.
Once the audit planning is completed by the approval of a sufficiently senior and experienced member of staff, the audit execution phase begins. This is where the planning assumptions are tested and audit findings are made. These findings are on an exception basis; that is, where the process is not operating as it should, or an error has occurred that has monetary implications. This depends on whether you are performing tests of controls or tests of balances.
Any audit finding that is sufficiently important will be communicated formally in a report to management. This is represented by the block beneath the execution of the audit and before reporting.
It is important at this stage to understand that when conducting almost 700 audits across all tiers of government and international entities, there is a need to have consistency in our audit process. To this end we have implemented a standardised audit approach that is fully aligned with the standards I referred to earlier. In addition, we have very well established quality assurance processes including independent reviews undertaken by the Public Accountants’ and Auditors’ Board. The findings of the Public Accountants’ and Auditors’ Board are summarised in the activity report in section 2.3 at the bottom of page 8 and top of page 9. The review of the 2001-02 audits showed that 77% of audits complied with the required standards whereas only 12.5% of audits reviewed for the 2000-01 financial year were deemed adequate.
As indicated in the final paragraph of the quality control report, this improvement is largely due to improved internal processes that have evolved in an environment where quality is non-negotiable.
When considering the above process, it is important to understand that there is constant interaction between the auditor and the auditee. Audit observations and findings are communicated to the management of the auditee. The auditee is allowed to respond to the observations and findings, these responses are then evaluated by the auditor. The auditor makes a judgement of whether matters are material and significant which is then included in the Audit Report. The types of audit reports are shown at the bottom of page 5 of the General Report on Audit Outcomes. Furthermore, if you turn over to page 6, table 1 gives explanations of each type of audit opinion that can be expressed in an audit report. The table also rates the opinions in terms of the level of severity. This should be borne in mind whenever reviewing the audit report.
Starting with the unqualified audit opinion, this is where the auditor will have concluded that no audit findings are required as the financial statements present fairly the state of affairs of the auditee and there is no reason for any other matters to be brought to the attention of the reader of the statements. This is the ideal situation, but as yet very seldom occurs amongst auditees audited by my office. The only two national departments receiving such an opinion for the past financial year were the Departments of Communication and Housing. This is out of 34 votes audited. It must be mentioned that an unqualified audit opinion does not indicate there are no concerns about an auditee. It simply means the financial statements represent the financial position fairly, nothing more; nothing less. There are other dimensions one needs to consider. For example, the performance of the auditee in terms of pre-determined objectives and standards is not included in the audit opinion. The absence of adequate norms and standards does not at this stage enable an audit of the performance information of a national or provincial department to be undertaken. I will also touch upon this issue when I discuss public entities later in my presentation.
The least severe opinion is an unqualified audit opinion, but containing emphasis of matter. This is where the financial statements still present fairly the affairs of the auditee; however, there are matters that need to brought to the attention of the users. These may include non-compliance with statutory requirements, such as the internal audit requirements of the Public Finance Management Act. In terms of the votes audited, 32 of the 34 reports contained emphasis of matter. Wherever there was a qualification on a vote, emphasis of matter was also reported. I will go into more detail as to the types of issues that give rise to emphasis of matter as we go further into the report. But at this stage it would suffice to say that many matters pertained to internal controls and non-compliance with the Public Finance Management Act.
The next opinion, which is referred to as a severe opinion, is the qualified opinion. This is where the financial statements still present fairly the state of affairs of an auditee, except for the matters discussed in the qualification. Therefore, after taking those factors included in the qualification paragraph out of the equation, the rest of the statements present fairly the state of affairs of the auditee. Five of the 34 votes received a qualified audit opinion. All of these also had emphasis of matter reported in their audit reports.
The two most severe opinions that can be expressed on the financial statements of an entity are the adverse opinion and the disclaimer of an opinion. The adverse opinion is expressed where the auditor in effect disagrees that the financial statements present the affairs of the entity fairly.
The adverse opinion is very significant and was expressed on the Department of Water Affairs and Forestry. It was also expressed on a number of other entities, but this will be discussed later.
An audit opinion is disclaimed where the auditor cannot obtain sufficient appropriate audit evidence to be able to express an opinion. The two votes where this was the case, were the Department of Public Works and Statistics South Africa.
The qualifications, including the adverse opinions and disclaimers, accounted for 8 out of the 34 votes or 24% of the votes. This year we also obtained information on national public entities in terms of qualifications. In their case the situation is better, although still not acceptable. Out of 208 public entities there were 16 qualifications, or 8%.
Having provided a high-level overview of the audit opinions by type of entity, I would like to move on to the detailed analysis of the audit findings and whilst doing so, start showing trends. As stated earlier, the general report has now reached a stable format, whereby information can be provided for comparative purposes.
This will give Parliament a picture of whether things are improving, remaining static or actually deteriorating. In this way, individual results that go against trends can be seen in context. Where for example an auditee goes from unqualified to qualified audit opinion, whilst the general trend is in the opposite direction, this may be an indicator that the entity should be singled out for special scrutiny.
If we look at page 7, we can see that we are beginning to get information over a useful period of time. The trend of unqualified reports on the votes and the trading entities has tended to be upwards. However, the most recent period 2001-02 shows a dip from the previous year. This should be read cautiously, as the inclusion in the analysis of the Department of Public Works and the exclusion of the Department of Transport has meant the situation is not as clear cut. If these adjustments are taken into consideration then the situation is quite similar between the two financial years. As you may recall, the Department of Public Works was excluded from the 2000-01 analysis as the audit report was not available at the cut-off point for the general report.
What I find interesting, is that although the unqualified percentages are reaching a plateau, that is not to say that it is simply the same entities receiving the same qualifications year on year. This is a very encouraging factor. If you turn to table 2 on page 8, it should be noted that although the qualifications are similar in number, only 4 departments were included in both years. This shows that qualifications are being lifted whilst new issues are emerging.
The issues that give rise to the qualifications are further analysed in table 4 on page 10. When looking at this table it should be explained that the 38 issues relate to only 16 entities. That is because in some cases, more than one factor gave rise to the qualification.
Taking out the adverse and disclaimer of opinions (columns a and b), we can see that the number of issues giving rise to the "except for" qualifications has fallen from 28 (33 less the 2 disclaimers and 3 adverse issues) to 10 (38 less the 14 adverse and 14 disclaimer issues). Once again, this demonstrates that issues that are raised in audit reports as serious are being addressed by management. Take for instance the debtors issue. Seven instances were reported in 2000-01, whereas only one instance was reported in 2001-02.
Furthermore, if you page forward to table 6 on page 13: of the 10 items under the "except for" qualifications, only 3 are from items reported in the prior year. That means that 7 of the 10 items are new issues that only came to the auditors’ attention for the 2001-02 financial year. Although it is a matter of concern that new issues are causing qualifications, it is further evidence that there is a strong possibility that the negative audit reports and the accountability process are provoking corrective action from the auditees.
Whilst there is room for giving credit, I think it is also important to reflect on some of the problem areas. These can be looked at via the disclaimers and adverse opinions that have significantly risen from only 5 issues in 2000-01 to 28 in 2001-02. However, of the 28 issues mentioned, 11 relate to Public Works, that was not included in the previous year’s analysis. This still leaves an increase from 5 to 17.
In terms of the rise in the adverse opinions the principal issues were noted under the Water Affairs and Forestry Portfolio. All but 3 of the 14 issues were attributed to the department or its 3 trading entities. The other entity that received an adverse opinion was the Government Printing Works that falls under the Minister of Home Affairs. The audit opinion was made more severe than in the previous financial year, when it was a qualified opinion. This, as I stated earlier, is an example of an entity that is perhaps going against the trend. The situation of going from a qualified to an adverse opinion is also relevant to the Department of Water Affairs.
In terms of the disclaimer of audit opinions the vast majority of issues were in respect of Department of Public Works. However, Statistics South Africa went from an unqualified opinion to a disclaimer. The detail is available in tables 5 and 6 on pages 10 through to 14. In addition, Annexure A also analyses the information on qualifications.
In summary, the situation with regard to the adverse and disclaimer of opinions rests with a few portfolios, in particular Water Affairs and Forestry and Public Works. Therefore, based on the arguments I have put forward earlier, they should be subject to particular scrutiny.
Having taken these two portfolios into account in terms of qualifications, the situation firstly appears to be moving in the right direction. And secondly, the old perennial qualifications appear to be diminishing. Whilst new qualifications and challenges lie ahead, I think the impression this analysis provides is that management are addressing concerns raised through the accountability process.
I would like to move on to the emphasis of matter section in paragraph 1.3.3 on page 15. These, as described earlier, are matters considered important enough to be mentioned in the audit report but not warranting qualification of the audit opinion. Therefore they are not as severe as the issues discussed in terms of the qualifications. However, as I stated earlier, they are far more widespread. Of the 33 votes, 31 had emphasis of matter paragraphs.
The analysis of these emphasis of matter paragraphs has more general connotations and is perhaps more indicative of the underlying issues facing government. If you look at table 7 on page 15, the emphasis of matter issues are split into categories. Once again these are issues raised in reports and more than one issue may be included in any report. The categories are split as follows:
- Internal control over accounting and financial systems and processes
- Potential liability or loss to the state
- Departures from financial requirements or other legislation
I would like to discuss the categories and comment on the information regarding trends.
The first category, the internal control over accounting and financial systems and processes, is in my opinion a critical area. When I spoke earlier about the audit approach we follow, I made some salient points about management controls over the organisation and the ability of the auditor to rely on such controls. This area is critical to the overall control of the organisation and ultimately the effective delivery of services or functions.
The subcategories within this section include asset management, the computer environment, as well as employment and related costs. These link to the financial management issues that I reported on in the activity report as well as the audit flavours. I will elaborate on this shortly, after I have briefly reviewed the two other categories under emphasis of matter.
The category of potential liability or loss to the state includes aspects where public funds are either at risk or have been lost. This area is markedly diminishing in its significance. The number of issues raised in 2000-01 was 33, whereas only 11 issues were raised in 2001-02. And of these 11 issues only 4 were related to the previous financial year. This is once again representative of matters being eliminated from the audit reports and therefore shows a positive movement.
The third category represents the departures from financial requirements or other legislation. The vast majority of these findings relate to the Public Finance Management Act. Of these findings a significant number relate directly to the inadequate functioning of the internal audit function. If you turn to page 147-149 of Annexure B you will see the table relating to non-compliance with the PFMA. In a large number of cases this is attributable to the internal audit function.
The internal audit issues, in the general report, only relate to the national departments. However, if we look at the financial management information reported in the activity report in paragraph 3.2.1 on page 11, we can see the situation is also problematic at provincial level. Whilst initiatives are in place, primarily supported by the National Treasury, this appears to be an area for essential improvement. As also stated in the activity report in paragraph 3.2.1 (c), only 30% of national department auditors placed reliance on the work of the internal audit functions.
The internal audit functions are a fundamental management tool for, firstly, the evaluation of risks and secondly, the reporting of the effectiveness of the internal control system in mitigating or preventing such risks. If this function is not carried out effectively, it could leave organisations susceptible to not identifying and/or managing their risks and, as I said earlier, not fulfilling their functions.
The other area that should be mentioned, is unauthorised expenditure. The second table on page 147 of the General Report on Audit Outcomes refers. As you can see, 6 departments were found to have incurred unauthorised expenditure. Four of these cases were simply overspending on voted funds. This represents poor budgetary control and once again represents fundamental weaknesses in the ability of management to control their business.
Overall the departures from financial requirements or other legislation have decreased from 59 issues in 2000-01 to 33 in 2001-02. However, of the 33 issues, only 17 related to the 59 from the prior year. This can be seen in table 7 at the top of page 16. I suggest that this again follows the trend that audit reports and the accountability process are acting as a catalyst for improvement.
Going back to the first category under emphasis of matter on page 15, namely the internal control over accounting and financial systems and processes: I think this is where the trend of improvements is halted. The number of issues actually rose in 2001-02. And although a number of issues reported in 2000-01 were resolved, there were still 45 of the 77 issues recurring. This can be explained through taking one of the categories, namely asset management. If you go to table 9 on page 18 you can see that, unlike other areas, a large number of these items (87%) are recurring from previous periods.
If we look at the underlying causes for the internal control problems, they are multifaceted. That is why I think that this is an area for audit flavours. However, in addition it is also a fundamental feature of financial management. If we can look at the activity report, page 12, paragraphs 3.2.2 through to 3.2.4 on page 13, you can see commentary on fundamental elements of internal control.
Firstly, it appears from paragraph 3.2.2 that not all departments nationally and provincially had adequate internal control policies and procedures. Furthermore, in almost 50% of provinces and almost 40% of national departments, the auditors could not rely on the internal controls.
Another fundamental aspect of internal control is having the appropriate staffing in place. Paragraph 3.2.3 states that a large number of financial components are inadequately staffed. This has fundamental implications for any internal control structure. If the policies and procedures are in place but the staff are not, then this severely compromises management’s ability to control the financial resources.
Finally, paragraph 3.2.4 confirms the problems identified in table 9 of the general report on page 18. In addition, the management processes of debtors, creditors and cash also have some serious shortcomings.
All these factors from the financial management section of the activity report are once again reflected in the emphasis of matter paragraphs within the audit report. I believe where the auditees cannot provide an adequate internal control system to support their organisation, this presents a fundamental obstacle to overall effectiveness.
In my opinion, this is where the audit resources as well as the efforts of the auditees should be focused. I am aware of the Treasury’s financial management improvement programme in this regard. However, I think that the annual reports of departments who have fundamental weaknesses in internal controls should be utilised to reflect the work being carried out and what results are expected, by when, to meet the requirements of an effective internal control system.
Paragraph 3.1 on page 9 of the activity report explains the framework that I will employ for assessing financial management by auditees from 2002-03. The capability model provides a framework to enable the reader of the general report firstly to assess the adequacy of financial management and secondly to monitor progress over time. In addition, comparisons can be made between all types of entities.
The capability model introduces 6 levels for measuring financial management. These are:
- Start-up level [Level 1]
- Development level [Level 2]
- Control level [Level 3]
- Information level [Level 4]
- Managed level [Level 5]
- Optimising level [Level 6]
At this stage government departments are situated at levels 2 and 3. The issues discussed above in terms of the internal control framework prohibit departments from going beyond level 3. An entity that achieves level 3 would enable the auditor to rely on the controls operating within it. This would firstly reduce the audit testing required and secondly assist in focusing the audit resources on more valuable aspects of the auditee’s business. This is reiterating what I have said earlier, namely that testing of controls would provide more valuable audit work.
An important point to note is that the internal control systems may be lacking due to problems with the transversal computerised system such as the Personnel System (PERSAL) or the Financial Accounting System (BAS). Moving back to the General Report on Audit Outcomes: Some of these problems relate to what we call general controls. If you turn to the general report, table 8 on page 17: Some of these general control issues are based on control problems at the State Information Technology Agency (SITA) and not at the auditee. Therefore, these general control issues should be dealt with as a matter of urgency by the National Treasury who has a responsibility for these transversal systems.
Moving on to the audit flavours. The purpose of these was to bring special focus to the areas of:
- Asset management
- Control environment
- Human resource management
- Procurement and
- Capacity
I believe I have addressed the control environment and the asset management in some detail. Looking then at human resource management, I have tried to identify the magnitude of personnel costs and paragraph 1.4.3 on page 20 of the general report sets out the information collated to assess this flavour. Firstly in paragraph (a), it is stated that of the R104 billion that was included in the analysis, R30 billion is made up of personnel costs. If transfer payments are taken out of the R104 billion, then personnel costs would represent about 54% of the remainder. Therefore the significance of personnel costs cannot be under-estimated.
Table 10 on page 21 provides an overview of the personnel costs for the top 10 departments, excluding transfer payments. For the purpose of this information not all annual reports were available.
The next stage of the analysis was to provide an estimate of the amount of expenditure for which senior management are responsible. The purpose of this was merely to provide possible benchmarking information and the results can be viewed in table 11 on page 22. Finally, tables 12 and 13 on page 23 are intended to link human resource management and capacity.
These tables are again for information and are starting to evaluate whether relationships exist between, amongst others, high vacancy rates and/or significant underspending and severe audit reports. This analysis is very basic; however, care was taken only to use information that was available from the annual reports. Therefore it is for the reader to draw conclusions.
Once again the benefit of such analysis will become more apparent as the information is reported over a longer time frame.
I would like to move on to the provincial information in paragraph 1.5 on page 24. As you can see I have summarised the information from all provinces on a high level. The percentage of qualifications of the votes fell from 75% to 46%, which denotes a significant improvement. However, this is still behind the 25% mark of national departments.
In addition, when we further note that 69% of provincial expenditure falls under the Health and Education sectors, the proportion of qualified opinions rises. In summary we can say that a serious problem still exists regarding the departments with the larger budgets. Paragraph 1.5.4 on page 26 gives a brief overview of provincial performance.
Paragraphs 1.5.5 and 1.5.6 on pages 26 to 28 are concerned with transversal performance audits at provincial level on financial management and the audits conducted on the Departments of Housing. The financial management report referred to in this paragraph once again confirms findings already referred to in the activity report under financial management, in that processes, systems and personnel problems are obstacles to effective financial management.
Paragraph 1.6 on page 28 discusses Schedule 2 listed public entities . Once again the issue of late or non-submitted reports to my office by the required deadline as stipulated by the Public Finance Management Act, is discussed under paragraph 1.6.3. In addition, paragraph 1.6.4 states that only 6 of the 15 public entities tabled their annual reports in Parliament by the required time. This compromises accountability.
An area of immense importance and therefore concern is the requirement for public entities to report on their performance. Paragraph 1.6.5 on page 30 touches on some of the concerns from an auditing perspective. Also I note that guidance is anticipated from the National Treasury on reporting on performance. This requirement to report on performance is also a future requirement for national and provincial departments. Essentially the evaluation of whether entities have achieved their predetermined objectives is the next step in the accountability process. My office is currently conducting research on this topic.
I would like to also point out paragraph 1.6.7 on page 32: Non-audit services supplied by auditors. This situation has received a higher profile due to events in the United States. I would like to stress that I have been commenting on this for several years and have continued to stress the need for independence.
That concludes Part 1 of the General Report on Audit Outcomes. Part II consists of the portfolio summaries. This is very good reference material and provides a comprehensive view of entities within the portfolio as well as the value of assets, income and expenditure and the audit opinions. The summaries are more comprehensive than the previous year and should provide the ministers of each portfolio with a chance to benchmark information with other portfolios. The purpose is to act as reference material and it can be used by various stakeholders. I would urge committee members to look at portfolio summaries when preparing for hearings, as it provides a broader perspective.
Finally, I would like to take you through the some of the remaining sections of the activity report.
It is stated in the Constitution that organs of state supporting constitutional democracy, of which I am one, should be, and I quote: "be accountable to the National Assembly and must report on their activities and the performance of their functions at least once a year". The information from page 16 is intended to assist in discharging this responsibility.
In paragraph 5.1.1 on page 16 I firstly set out the basis for the fees we charge. As you can see, the fees are benchmarked against the private sector in order to ensure that reasonable value for money is offered to the auditees. The only revenue other than through the audit fees is received for the small audits where the National Treasury supplied the office with just over R7 million; this represents slightly over 1% of the total income of the office.
With the staff complement of just over 1300 we are expected to audit 693 entities as shown in the table on page 17. To offer a cost-effective and quality service, it means that we have to contract audits out to private firms and also contract in the services of skilled persons. The audits contracted out are still my responsibility in terms of the audit report and therefore guidelines are issued and procedures are in place to ensure that these guidelines are adhered to.
About 20-25% of the audit work is contracted out to the private firms. This provides a further opportunity for measurement of our standards and qualities against those of private firms. This is through, amongst others, the same quality assurance process, that I mentioned earlier, being applied to those audits. In terms of our contribution towards black economic empowerment we have set a target to contract out 40% of the audits to small and medium emerging firms by the year 2004. We have achieved this target already.
In paragraph 5.1.3 there are options for the measure of performance that are used by Auditors-General internationally. For the purpose of the activity report I have focused on the cost per rand of expenditure audited. The first part of the exercise is to ascertain the audit income received from different spheres of entities. The table on page 17 shows the value of audit fees by each entity type. As can be seen, the national and provincial departments contribute just over half of the audit fees.
An important factor for any audit organisation is that no one auditee should be excessively large in terms of its audit income. For the national and provincial departments the fees received from the 5 largest entities represent 34% of the total national and provincial fees received. Please refer to the last paragraph on page 17. Therefore, by generally accepted criteria, no one audit is deemed to have potential undue influence on my office. The five largest departments are listed at the bottom of page 17 and top of page 18. In terms of their percentage of the total audit fees of national departments, the chart at the bottom of page 18 shows the situation.
I have attempted to explain some of the criteria that affect the audit fee as a proportion of the total expenditure of the auditee. These items are listed in bold on page 18. At this stage is it is important to consider these factors when looking at a particular entity against the average. In particular, where an entity exercises good control and financial management as previously discussed, it is inclined to require relatively less audit work to arrive at an opinion.
The table on page 19 shows the proportion of the expenditure to the audit fees for the large departments. Overall the average of 0.20% that means 20 cents out of every R10 000 of expenditure relates to the audit fee. From the preliminary analysis below the table, I have concluded that poor financial management and control is the primary cause of higher proportional audit costs. However, in the penultimate paragraph on page 19 I have put forward reasons where I see improvements occurring. This is thanks to the improved audit methodologies employed by my auditors and improved financial management through the auditing and accountability process, as well as through the advent of legislation such as the Public Finance Management Act.
The proportion over on page 20 for provinces, shows an average of 10 cents out of each R10 000 audited. Although these show significant differences, there are a number of factors that could cause such fluctuations. Firstly, the expenditure figures were based on budgeted amounts and may have given rise to deviations when the actual figures became available. I do not wish to start looking at the difference at this stage, purely because this is the first time this information has been collated. It may prove more valuable once we obtain a second round of information and look more closely at the differences year on year, rather than between sectors. However, on the surface it appears that provincial audits compare favourably with their national counterparts.
The paragraphs below the table on page 20 give information on public entities and municipalities. The situation for these entities was more difficult to evaluate: firstly, they have a different basis of accounting to national and provincial departments and secondly, they are far less homogenous. The graph at the bottom of the page simply provides an early indication but will be followed through with more associated research for this forthcoming round of audits. Overall, the average was an audit fee of 16 cents for every R10 000 that was audited. The international audits are based on a fixed fee that is in US dollars, therefore benchmarking here may be inappropriate due to, amongst others, exchange rate issues.
As the internal management information systems of the office are developed, I envisage that this information will be presented with appropriate target information and explanations of differences. This is merely the first step in establishing the criteria against which I can be held accountable.
Section 6 of the activity report on page 21 investigates the reporting against the requirements of the Public Finance Management Act. The first table provides an overall summary and the second a breakdown of the reasons for late submission. The majority of cases relate to the late submission of documentation by the auditee.
Most of my presentation has been concerned with the audits that provide an opinion on the financial statements. These are often referred to as regularity audits. They constitute the vast majority of the audit fees received and are the cornerstone of our work.
The final section 7 on page 22 onwards provides information on other audit disciplines.