11 minute read
AUDIT COMMITTEE
by kwedamedia
AN ANALYSIS OF AUDIT COMMITTEE DISCLOSURE PRACTICES IN SOUTH AFRICAN METROPOLITAN MUNICIPALITIES
It is common knowledge that South African municipalities are struggling to deliver basic services in accordance with the constitutional mandate.
Metropolitan municipalities are situated in densely populated areas of South Africa in accordance with section 2 of the Municipal Structures Act 117 of 1998 (RSA 1998).
The lack of service delivery by metropolitan municipalities therefore affects many stakeholders. According to Martin (2021), as many as 909 protests activities occurred between August 2020 and January 2021, expressing the public’s dissatisfaction with poor service delivery by municipalities.
The problems of South African municipalities are also evident from the Auditor-General of South Africa (AGSA) reports (AGSA 2019a:6).
Governance is critical in ensuring that public funds are spent appropriately and that services are delivered successfully (Motubatse, Ngwakwe & Sebola 2017:91, The International Federation of Accountants (IFAC) and the Chartered Institute of Public Finance and Accountancy (CIPFA) defined “public sector governance” as the plans that are formulated to ensure that the organisation achieves its objectives and communicates the objectives to stakeholders (IFAC & CIPFA 2014:8).
The audit committee has been found to be an important governance structure (Marx 2009:31; Brennan & Kirwan 2015:466). The South African local government sector agrees that the establishment of audit committees is important and requires municipalities to establish audit committees in accordance with the Municipal Finance Management Act 56 of 2003 (MFMA) (RSA 2003).
According to Manamela (2020:21), public funds are used in the best interest of the public when appropriate governance structures are in place. Public sector audit committees also promote accountability and transparency on both financial reporting and compliance (Letsoalo & Motubatse 2019:136).
A key requirement for good governance is accountability. Accountability requires the governing body, or those charged with governance, to provide explanations for its actions to stakeholders and provide stakeholders the opportunity to express an opinion on its governing ability (Thornhill 2015:77). Shbeilat (2014:542) claimed that the audit committee is a vital role player in accountability.
Effective accountability results not only in the effective management of public resources, but also in improved governance and satisfactory delivery of basic services (Van Niekerk & DaltonBrits 2016:118). More stakeholders are looking to the audit committee to ensure transparency and accountability. The audit committee can hold management accountable for the management of public funds when reviewing the financial reports prepared by management (Bananuka, Nkundabanyanga, Nalukenge & Kaawaase 2018:139).
Municipal audit committees also advise municipal management on public funds management, to ensure that sufficient funds are available to meet the needs of the community and the mandate as set out by the Integrated Development Plan (IDP) and Service Delivery and Budget Implementation Plan [SDBIP] (PSACF 2018:3).
The audit committee is an independent external committee which provides feedback on the stance of the municipality’s operations to the municipal management before the Annual Financial Statements are submitted to the AGSA for the annual external audit.
Another important aspect of governance is disclosure (Bagwandeen 2010:17). Sufficient disclosure of the audit committee activities allows stakeholders to determine the audit committee’s effect on the performance of the organisation (Coetzee & Msiza 2018:91). Marx (2009:35) explained that for stakeholders to have assurance in the audit committee’s operations, detailed reporting on these operations is required. Moloi (2015:67) agreed that disclosure of additional, voluntary information will render the audit committee reports more useful, as the users will gain an understanding of the activities of the audit committee.
Adequate disclosure concerning the audit committee’s operations may influence the organisation’s financial- and reporting framework, as companies with good corporate governance practices are more likely to obtain a clean audit opinion (Sun 2019:542). Similarly, Manamela (2020:112) found that South African central government departments with more detailed audit committee disclosures were more likely to obtain a clean audit opinion.
This denotes that the reported financial information contained fewer misstatements, in cases where audit committee disclosures were more detailed. There are, therefore, benefits to comprehensive disclosure concerning the operations of the audit committee.
The AGSA reports are often headline news because it reveals the deterioration of the South African municipalities. An important disclosure report that is often not focused on, is the audit committee reports. The audit committee is an independent external committee which provides feedback on the stance of the municipality’s operations.
The audit committee provide feedback to the municipal management before the Annual Financial Statements are submitted to the AGSA for the annual external audit. It is therefore worthwhile to see what concerns the audit committee had prior to the audit of the AGSA and whether these matters were addressed or remained and were subsequently reported on by the AGSA.
Disclosure requirements of audit committees
Municipal audit committees are required to disclose matters as contained in MFMA section 121(3) (j) and MFMA Circular 65. These legislative requirements are, however, not detailed. MFMA section 121(3) (j) only requires audit committees to include its recommendations in the annual reports (RSA 2003).
When audit committees do not disclose areas of concern in the municipalityandthe efficacyofthefinance function, it raises the questiononwhether audit committees are hesitant to share their concerns with stakeholders due to the politicalenvironment theyoperateinand perhapsfearbeing removedshouldthey share their concerns.
MFMA Circular 65 states that audit committees should disclose their functions and attendance of meetings, council resolutions and implementation thereof, and additional relevant matters that could improve accountability and governance (RSA 2012:8). The last disclosure requirement, namely “relevant comments that could improve governance and accountability”, is open to interpretation.
Differences are likely to occur amongst the disclosures by different municipal audit committees, as no minimum requirements for disclosure on governance and accountability are outlined. Disclosure practices in municipalities vary in nature, as well as in the extent of information disclosed, owing to a lack of legislative guidance on aspects required to be disclosed (Ackermann et al. 2016:49).
The limited legislative guidance on audit committee disclosure practices might therefore be contributing to the lack of accountability in the current municipal environment.
In addition to the aforementioned legislation and guidance that aim to improve governance, South African organisations, including municipalities, can apply the principles and practices contained in the King IV Report on Corporate Governance (King IV), to improve governance. The King IV Code is voluntary for the public sector, that includes municipalities. Part 6.2 of King IV contains the sector supplements for municipalities (IoDSA 2016:79). Municipalities can apply King IV Code to improve municipal governance, as the sector supplements can guide municipalities on how King IV Code must be applied and interpreted, in a municipal context (IoDSA 2016:75).
Principle 8 of King IV Code describes the disclosure requirements for audit committees (IoDSA 2016:55- 56). The King IV Code confirms the important role of the audit committee and recommends specific aspects that the audit committee should disclose (Deloitte 2018:1). Coetzee and Msiza (2018:91) suggested that King IV can provide guidance concerning best practice for audit committees, including the audit committee disclosure. Stakeholder confidence is increased when audit committees implement practices that are referred to as “best practice” (Coetzee & Erasmus 2020:37).
In a similar vein, Chauke (2021:63) asserted that adopting and applying King IV Code will create trust and build stakeholder confidence in municipalities.
Since municipal audit committees have limited legislative guidance on matters to be disclosed, the authors analysed the disclosure practices of the audit committees of the metropolitan municipalities in South Africa. The authors also compared the existing disclosure practices to the King IV Code audit committee disclosure requirements.
Analysis of the audit committee disclosure practices
In terms of MFMA section 121(3) (j) and MFMA Circular 65, audit committees are required to
disclose matters in the annual reports of municipalities. The latest accessible annual reports of the metropolitan municipalities—when this analysis was performed—were those of the 2018/19 financial year (RSA 2020).
The matters disclosed by the audit committees in the “audit committee report” section of the municipal annual reports, were analysed. Short phrases (codes) were then assigned to the different matters disclosed. These codes were grouped to identify overall themes in the disclosure practices of the eight audit committees.
The results of the analysis can be seen in table 1 above.
Due to the lack of legislative guidance on matters to be disclosed by municipal audit committees the disclosure practices vary in nature, as expected. Only one audit committee disclosed areas of concern in the municipality and the efficacy of the finance function. This raises the question on whether audit committees are hesitant to share their concerns with stakeholders due to the political environment they operate in and perhaps fear being removed should they share their concerns.
Only half of the audit committees disclosed their composition which included the name, surname, and qualifications of the members. The appointment of audit committee members often lacked transparency due to the political intentions that often outweigh the financial expertise of members (Coetzee et al. 2021:7).
The non-disclosure of four audit committees therefore may attributed to the fact that members might not have the necessary expertise to serve on the audit committee. Technology has become an integral part of modern society, and it is concerning that only one audit committee disclosed matters concerning technology.
It prompts the enquiry as to whether municipalities have the necessary technology in place or do audit committee members have the knowledge to be able to report on technological matters. Roos (2021:198) confirms the latter and found that municipalities experience challenges in recruiting audit committee members with IT expertise.
Accountability is a concept that the South African public sector is struggling with (Erasmus 2022:1). The audit committee is an independent committee, and it would be of value to get their view on the accountability in South African municipalities. An aspect of accountability that the AGSA frequently addresses is consequence management, or rather the lack thereof.
Only one audit committee addressed consequence management in their disclosure, which is concerning as this is a well-known problem in the South African local government sector. In similar vein, governance is also an important concept in municipalities. Only two audit committees disclosed governance related matters. It is concerning that audit committees do not provide their insight into these crucial matters that the South African local government sector struggles with.
Audit committee disclosure practices compliance with the King IV Code disclosure requirements:
The King IV Code is often referred to as “best practice”. The disclosure practices of the audit committees were therefore compared to the King IV Code disclosure requirements which was used as a checklist. The results can be seen in table 2 above.
The King IV Code contains 12 disclosure requirements applicable to municipal audit committees, as seen in table 2. All 12 disclosure requirements were identified among the audit committee disclosure practices which indicates that municipal audit committees are aware of the King IV Code audit committee disclosure requirements.
As evident from table 2, the concern remains as only one audit committee disclosed their views on the effectiveness of the CFO and finance function. This is of particular concern an amount of R1.26 billion was spent by all South African municipalities on consultant costs, to offer support in preparing the financial statements, during the 2018/19 financial year (AGSA 2019b:2).
This occurred, even though the MFMA’s section 81(1)(e) determines that the CFO is responsible for the financial reporting of a municipality— signifying that the CFO and finance function should have the ability to prepare the financial statements.
Conclusion
South African municipalities are facing governance challenges which is evident by service delivery protests and the reports of the AGSA. The audit committee is an important governance structure and stakeholders can gain insight of the audit committee’s role by analysing the disclosures of the audit committees.
It was found that South African metropolitan municipalities’ audit committees disclosures vary in nature. The identified, non-uniform disclosure practices might render it difficult for stakeholders to gain an understanding of the role that municipal audit committees played during the financial year. Nonuniform disclosure practices could also create challenges to holding audit committees accountable as there is no consistent metric to measure performance.
It is recommended that more detailed legislative guidance on matters to be disclosed in the annual report, be provided to municipal audit committees. Matters disclosed concerning accountability are not King IV Code audit committee disclosure requirements, however, it contributes to the transparency of the audit committee disclosures.
King IV Code audit committee disclosure requirements should be used as the minimum guide for municipal audit committee disclosures, in the annual reports. National Treasury can, furthermore, provide additional disclosure requirements for municipal audit committees.
*Lorraine Derbyshire is now with the University of Cape Town*
