Change who pays the fiddler

South Africa has adopted the co-regulation model for ensuring that the independence of the auditor is not impaired. While the legislative regime in the Auditing Profession Act has primacy; the auditor independence provisions contained in the Companies Act play an important role in complementing the legislative requirements in the Auditing Profession Act relatedto auditor independence. The Independent Regulatory Board for Auditors (IRBA) play the “professional” role in regulating auditor independence through their professional standards andcodes of ethics. This is what I term “professional” regulatory oversight. This public policy from the auditors “self-regulation” of the own behavior. For example, prior to accepting appointment as an auditor, it is incumbent on the auditor him/herself to ensure they are independent in mind and independent in appearance. The provisions in the Companies Act that govern auditor independence place the duty upon the directors; not any directors; but the independent directors to ensure that the auditor is independent prior to the auditor’s appointment. For example, section 90 places the responsibility upon the directors not to appoint any auditor who is not independent of the company. Section 94 places this responsibility upon the independent directors of the audit committee. 

It is the auditor independence provisions in the Companies Act that provide insight and deliver the “clues” as to who should be paying the fiddler. The first clue is found in section 94 (7) (b) of the Companies Act – where the provisions state as follows: an audit committee must “determine the fees to be paid to the auditor and the auditor’s terms of engagement”. This task is split into two: the audit fee and the auditor’s terms of engagement. Two tasks that seem contrary to current practice and the auditing standards. The audit fee has always been the result of discussions between the “financial director” and the auditor. This is how the idea is formed that the payer  is the company itself. From my experience I have only seen either the “managing or financial” director sign the auditors engagement letter. This also adds to the belief that the payer is the company itself. However, this seems to be contrary to section 94 (7) (b) of the Companies Act. Well not it seems, it is. 

Why would the Companies Act contain such a provision? Well, it’s to tell us who really and in terms of the law should be responsible for the auditor’s independence. To ensure the auditor is protected from themselves. 

IRBA unfortunately can only determine whether an auditor was independent post the auditor signing the audit report; by that time, the damage is done. Professional oversight is after the fact, while Companies Act oversight is before the fact.

In regard to the audit committee determining the auditors’terms of engagement; one cannot interpret this is the audit committee telling the auditor what to do; as it is self-explanatory as why this cannot happen. So, what is the Companies Act trying to tell the audit committee? 

I submit the determination of the audit fee cannot be divorced from the auditors’ terms of engagement. Why? Well: The audit committee must ensure that audit fees charged by the auditor are not set at a level that could lead to audit quality being compromised. In determining the audit fee, the auditor must explain to the audit committee their audit strategy, what are the audit risks and how the auditor is going to mitigate those risks. The audit fee is a crucial determinant of audit quality and so is the auditors’ terms of engagement. The audit committee in determining the sufficiency of the audit fee must ask questions of the auditor such as: What level of resources will the auditor devote to the audit? Does the auditor demonstrate a sufficient understanding of the business, operations, and risk areas relevant to the financial report, and do they plan to respond appropriately to assessed risks? This includes relevant industry expertise, and valuation expertise appropriate for the types of assets, liabilities, and exposures of the company. Will the senior audit team members, particularly the engagement partner be sufficiently involved in the audit? Are the firm’s arrangements for supervising and reviewing the audit, and internal firm quality reviews and controls, adequate? Will the auditor review and rely on systems and controls in performing the audit, particularly where there are large numbers of systematically processed transactions? And How is the auditor addressing any general overall findings reported publicly by the IRBA from audit firm inspections or from the firm’s own internal quality reviews?

The question arises as to whether the audit committee has the right to ask these questions as the auditor cannot be told what to do. The audit committee has no right to tell the auditor what to do but the audit committee has a right to recommend the removal of the auditor by the directors immediately if they do not receive satisfactory and plausible answers to the questions. Such a sentiment is supported by King IV which suggests that the audit committee monitor audit quality. Reduced audit fees will clearly impact audit quality. 

 

The audit committee is an independent statutory committee made up of only independent directors who have no role whatsoever in the day to day running of the company. Hence the audit fee is the sole responsibility of the independent directors on the audit committee and no one else; not even management. 

The audit committee in playing its role in determining the audit fee and monitoring audit quality must do so on its own and without interference from management. The audit fee by law in South Africa is a matter between the audit committeeand the auditor. 

So, he who pays the fiddler calls the tune: the new payer is the audit committee a specially designed independent body that are not involved in the day-to-day management of the company. It is they who should pay audit fee; this is the disktats of public policy. The law is straight forward in respect of public interest entities; it is the audit committee who appoints and pays the auditor and monitors the auditor’sapproach to the audit; all in the name of “audit quality”. These rules are not being complied with; and the auditors quality suffers as result. The IRBA have no control over audit quality prior to the audit starting; but the audit committee does.