Learning Unit 7: Increased Accountability and Transparency

Learning Unit 7: Increased Accountability and Transparency

Lecture 14: Auditors, Audits, etc

Auditor Definition

  • Definition of an auditor not specified, but is central to the process of audit, governance, and accountability in companies.

Regulatory Framework

  • The appointment, duties, and matters concerning the company secretary, auditors, and audit committees (AC) are regulated under Chapter 3 of the Companies Act.
  • Primarily applicable to public companies and state-owned companies (SOCs), with certain private companies also included.

Core Requirements for Public Companies and SOCs

  • Enhanced accountability and transparency under Chapter 3 of the Co Act stipulates:
    • Must appoint an independent auditor.
    • Must appoint an audit committee (AC).
    • Must appoint a company secretary (CS).
    • Maintain a register of secretaries and auditors.

Financial Statements and Stakeholder Protections

  • Independent oversight of financial statements is crucial for protecting stakeholders against unreliable data, which may include inaccuracies, unfairness, or misleading information.
  • Companies must indicate whether their financial statements have been audited or independently reviewed.
  • Not all companies are mandated to have audited financial statements:
    • Public companies and SOCs must have their Annual Financial Statements (AFS) audited.
    • Companies with a PI score of 350+ must have AFS audited; scores of 100-350 can use internally compiled AFS.
    • Review according to International Review Standards Audit if scoring is higher than 100.

Auditor Appointment Protocols

  • Public companies, SOCs, and certain private companies are required to appoint an auditor:
    • Upon incorporation and annually at the AGM (Annual General Meeting).
    • Retiring auditor can be reappointed automatically unless certain conditions apply:
    • Not qualified anymore.
    • Not willing to accept appointment.
    • Required to cease serving under Section 92.
    • The audit committee objects to reappointment.
    • An intended resolution to appoint another auditor exists.

Independence and Qualification of Auditors

  • The auditor (individual or firm) must:
    • Be registered with the Independent Regulatory Board for Auditors (IRBA).
    • Be determined independent by the audit committee.
    • Not fall under prohibited categories within the previous five years:
    • Director, company secretary, or prescribed officer of the company.
    • Employee or consultant involved with the company's financial records for more than one year.

Resignation and Vacancies of Auditors

  • Protocols for auditor resignation or vacancy should be followed:
    • Give a notice of resignation.
    • Board can remove the auditor from office.
    • Casual vacancy means the Board must appoint a new auditor within 40 business days post-resignation:
    • Propose a new name to the Audit Committee (AC) within 15 business days.
    • AC has 5 days to reply; if no reply, the Board appoints the auditor.

Auditor Rights and Functions

  • The auditor holds significant rights:
    • Access to all accounting records.
    • Right to inquire with directors/prescribed officers for performance of duties.
    • Access to financial statements of subsidiaries as a holding company's auditor.
    • Attend general meetings of shareholders and receive communications regarding these meetings.
    • To voice concerns at general meetings regarding auditor-related duties.

Responsibilities Regarding Auditor Resignation and Vacancies

  • Effective on filing of resignation notice.
  • New auditor to be appointed within 40 business days if the company had one auditor only.
  • Board proposes a new auditor to the AC within 15 business days; if there’s no objection from AC within 5 days, appointment can proceed.

Audit Committee (AC) Role

  • The AC is vital for:
    1. Ensuring integrity of financial controls and reporting.
    2. Managing financial risk.
  • All public companies and SOCs must appoint an AC.
  • Other companies may appoint an AC where provisions apply to MOIs.
  • King IV recommends all companies should also have an AC.
  • AC appointments must occur at every AGM.

Composition of the Audit Committee

  • Comprises at least 3 members, all directors and non-executive independent directors.
  • Members must not engage in daily company management nor be involved in activities that could compromise integrity or impartiality.
  • Non-compliance with section 94 may lead to an incorrectly constituted AC, lacking proper authority to conduct its functions.

Nomination Committee's Role

  • Since AC members are board directors, the nomination committee plays a crucial role in identifying skilled candidates for the AC.
  • Shareholders can appoint any individual deemed fit to the AC.
  • AC may have advisors and invite knowledgeable individuals to meetings, but voting rights are restricted toCriteria compliant members.

Shareholders' Consideration in AC Composition

  • Although the Act does not address shareholder participation, King IV suggests careful scrutiny of shareholder membership to the AC considering potential impacts on independence. The assessment should focus on public perception of independence.

Duties of the Audit Committee

  • Key functions include:
    • Nominating independent auditors.
    • Determine audit fees and terms of engagement.
    • Ensure compliance with Co Act and applicable legislation in auditor appointment.
    • Pre-approve contracts for non-audit services by the auditor.

Audit Committee Reporting Requirements

  • AC must report in AFS:
    • How the AC performed its designated functions.
    • Evaluating auditor independence and commenting on financial statements and internal controls.
    • Address complaints relating to accounting practices.
    • Submit findings regarding accounting policies and practices to the board.

Additional Functions of the Audit Committee

  • Beyond legislative duties, AC also:
    • Oversee financial risks, internal financial controls, fraud, IT risks associated with financial reporting.
    • Ensure a combined assurance model for coordinated assurance.
    • Oversee internal audit and external audit processes, alongside integrated reporting.
    • Evaluate resources concerning finance function.
    • Engage in risk management processes and oversee external auditing practices.

Recommendations for External Auditor Appointment

  • One key function of the AC is to recommend external auditor appointments to shareholders and oversee the external audit process.
  • Global mandates call for independence assessments and considerations regarding audit firm replacements.

Statutory Committee Aspects of the Audit Committee

  • As established by the Act, the AC operates as a statutory committee bearing sole responsibility for its decisions on auditor engagement while remaining accountable to the board for other matters.
  • AC must report on functions performed, independence assessments of auditors, and specific comments on financial statements and internal controls to shareholders through AFS.

Auditor Independence Considerations

  • King IV identifies the importance of auditor independence, incorporating disclosure of tenure in auditor reports.
  • Additional significant audit matters must be disclosed to inform stakeholders.

Enhanced Audit Committee Report Criteria

  • Essential disclosures in AC reports should include:
    • A statement affirming auditor independence.
    • Policy and controls concerning non-audit services.
    • Tenure of the audit firm, critical in cases of mergers or acquisitions, including predecessor firms.
    • Rotation of designated external audit partners and changes in management during the auditor's tenure that could mitigate familiarity risks.

Audit Quality and Effectiveness Indicators

  • In the AC report, the quality of audits, chief audit executive efficiency, and internal financial controls effectiveness should be outlined, particularly relating to any material weaknesses that can impact financial integrity.

Appointment and Role of the Company Secretary (CS)

  • Public companies and SOCs must appoint a CS:
    • Must be a permanent resident of South Africa.
    • Appointment can be made by the board or by the holders through ordinary resolutions.
    • CS must exhibit adequate experience and knowledge as evaluated by directors.
    • In case of a vacancy, a replacement must be found within 60 business days.

Duties of the Company Secretary

  • Responsibilities include:
    • Guiding directors on duties and legal compliance.
    • Reporting to the board regarding legal failures.
    • Certifying AFS conforming to the Co Act requirements.
    • Ensuring proper recording of meeting minutes.
    • Sending copies of AFS to entitled persons.

Evolving Role of the Company Secretary

  • The role of the CS has grown in recent years from mere record-keeping to a pivotal function in guiding board operations and governance.
  • The CS is tasked with ensuring that board members receive comprehensive information to enhance decision-making without overwhelming them.

Reporting Structure of the Company Secretary

  • The CS, or any corporate governance professional, reports on statutory responsibilities to the governing body through the chair and administrative matters to the designated executive management member.

Disqualification, Removal, and Resignation of Company Secretary

  • Disqualification aligns with grounds for director disqualification.
  • A board resolution can remove the CS, with a right for the CS to have remarks included in company financial statements if removed.
  • Resignation requires at least one month's written notice unless otherwise approved by the board.

Overview of Internal Audit Function

  • This function ensures a review of internal control systems.
  • It operates under board oversight and aims to provide a risk-based assurance approach rather than mere compliance evaluation.

Accountability and Objectivity of Internal Audit

  • Internal audit must be independent from management and provide impartial assurance on risks.
  • The Chief Audit Executive should be informed of strategy and performance via engagements with senior management.

Risk Management and Audit Function Interrelation

  • Directors are responsible for internal controls and can rely on the internal audit department’s evaluations to feed into comprehensive risk management plans.
  • Board members should understand the risks facing the company to facilitate informed oversight and direction on the internal audit's focus.