What is preventing another Steinhoff-type corporate disaster in South Africa?

By Mpho Mashatola

What is stopping another Steinhoff, Tongaat Hulett, African Bank, Eskom or SAA from happening in South Africa? This is an issue that should be a priority for those who have invested hard-earned money in banks and large corporations, those who are saving for the future, those seeking employment, as well as communities that depend on cash. corporate social spending.

The consequences of a business failure go far beyond the negative financial impacts and the impact on the livelihoods of those the corporate world has influenced. When a business failure occurs, the question to ask is whether we, as a country, have reacted adequately to prevent future business failures. The same questions can arise in the case of public entities.

In 2002, the United States experienced the largest corporate bankruptcy at the time – Enron Corporation. The scandal was so catastrophic that it contributed to the collapse of Enron’s external auditors, Arthur Andersen LLP, who were part of the Big 5. It was a spectacular debacle in which management failed to present the situation. financial and financial performance of the company in a fair and truthful manner in order to increase the share price and maintain Enron’s status as a darling of Wall Street at the time. Shortly thereafter, there was another corporate bankruptcy, which exceeded that of Enron in terms of the scale of the fraud that had taken place, WorldCom. These corporate failures prompted the enactment of a federal law called the Sarbanes-Oxley Act of 2002. The primary purpose of Sarbanes-Oxley is to protect corporate stakeholders, and I will cite a few of the articles that she introduced:

Article 302: This provision requires that a company’s accountants (typically the CEO and CFO) certify that financial statements are presented truthfully and that the disclosure controls designed to achieve them are functioning effectively.

Article 404: The provision requires management of an organization to certify that it has designed adequate internal controls to prevent and detect material error in the financial statements.

In order for management to perform this certification, the Act requires that entities follow an internal control framework. Most companies listed in the United States comply with the requirements of the Committee of Sponsoring Organizations of the Treadway Commission (COSO) Internal Control – Integrated Framework 2013.

The importance of a committed, strong and independent audit committee was further emphasized. An audit committee holds management accountable for its actions and challenges management on the decisions it makes and the financial statements it prepares. It was time for board members to move from being simple participants to being directors who are proactively engaging in the performance of the fiduciary functions for which they are appointed by shareholders.

In the event of company bankruptcy, the Sarbanes-Oxley Act contains punitive provisions that could cause the CEO or CFO to serve up to 20 years in prison and / or pay a fine of up to $ 5 million. of US dollars.

The law also created the Public Company Accounting Oversight Board to oversee the audit profession. The board requires audit firms to be registered with it. In addition, they establish auditing standards, in particular those relating to ethics, auditor independence and quality control. The board of directors is also responsible for conducting inspections / investigations and disciplinary action on registered companies and for enforcing Sarbanes-Oxley law.

The Sarbanes-Oxley Act (also known as the SOX Act) may not have completely reduced the risk of business failure, but it has created a change in behavior and corrected perceptions of the role of external auditors in the process. financial reporting process. There is often justified social anger towards external auditors after a business failure, and there are strong calls for stricter regulation of the audit profession.

While we cannot relieve auditors of their duty to conduct their audits with professional skepticism and in accordance with auditing standards, there is no law or regulation in South Africa that imposes on the external auditors the responsibility to prevent and detect fraud or misleading financial statements. This responsibility rests with management.

International Financial Reporting Standards clearly state in International Accounting Standard 1, Presentation of Financial Statements (IAS 1), that financial statements should fairly present the financial position, financial performance and cash flows of an entity. IAS 1 further requires management to assess the entity’s ability to continue as a going concern. Companies Act 71 of 2008 requires companies to provide financial statements that “fairly present the state of affairs and activities of the company” and that they must not be “misleading in any material respect” . He goes on to say that anyone who is a party to the preparation, approval and dissemination or publication of financial statements that are materially false or misleading is guilty of an offense. International Standard on Auditing 240, Auditor’s responsibilities for fraud in an audit of financial statements (ISA 240), states that “the primary responsibility for the prevention and detection of fraud lies with those charged with the governance of the entity and the management”.

ISA 200, General objectives of the independent auditor and conduct of an audit in accordance with ISAs, further states that “an audit in accordance with ISA standards is carried out on the assumption that management and, where applicable, those charged with governance of the company have recognized certain responsibilities which are fundamental to the conduct of the audit. . The audit of financial statements does not relieve management or those charged with governance of the company from their responsibilities.

It is therefore clear that it is not enough to look only to external auditors to protect the interests of stakeholders. As a company, we need to understand that we have put our interests in the hands of management and the board and that more needs to be done to hold management and the board accountable for their corporate obligations. impartiality and fairness of the financial statements. Executives are the executors of the strategy, the initiators of the same transactions that they fail to adequately disclose.

The management watchdog is first and foremost the audit committee. An audit committee chairman once said that when financial results are good (when profits are up), budgets are met, and reviews appear positive, it is human nature to create a bias. confirmation when reviewing these financial statements. These bottom lines are less scrutinized and less contested than when the bottom line doesn’t look so good, which it shouldn’t be. The role of the audit committee is to ensure independent and objective oversight of the financial reporting process.

Doesn’t such confirmation bias create additional pressure on management to fraudulently present an entity’s financial position, financial performance and cash flows? Shouldn’t the common goal be to create an environment in which management and employees as a whole are encouraged to prepare the most accurate financial information in accordance with relevant standards?

The second watchdog should be the internal auditors; the third is that of the external auditors. It is crucial that all actors play their part to ultimately protect the interests of an organization’s stakeholders.

The creation of the financial reporting ecosystem

The United States refers to a pre-SOX and post-SOX era, highlighting the drastic measures mentioned above that have been implemented to transform the accounting and auditing profession to restore investor confidence and protect stakeholder interests.

Have we done enough in this country to tackle unethical financial reporting and unethical corporate behavior in the private and public sectors? Even if those responsible for corporate scandals are held to account, it is still after a bloodbath of financial losses suffered by ordinary citizens of this country that may never be recouped. There should be more and more calls for prevention. The JSE issued paragraph 3.84 (k) of the registration requirements which requires the CEO and CFO to sign a declaration on the effectiveness of financial controls. This is a good start, as it recognizes and again emphasizes that management is responsible for putting in place financial reporting controls to avoid misleading financial statements or financial statements that are not prepared in all respects. material in accordance with applicable accounting standards.

However, what is the standard against which the CEO and CFO can measure the effectiveness of their financial controls? What Are Effective Financial Controls? If management is responsible for implementing financial controls, how will it be able to certify that its own financial controls are effective in an impartial manner? It is possible that internal auditors in South Africa will test these controls independently, but the question remains, against what standards?

Just as companies listed on the New York Stock Exchange use COSO 2013 as a framework for implementing an effective internal control system, South Africa also needs a framework. We already have a set of good corporate governance principles in the form of the King IV Code of Corporate Governance to address many of our entity-wide controls, but we do not have any to help management implement effective financial reporting controls. The framework should be ethical and should ensure that qualified, competent and experienced people fulfill their various roles. Management and employees as a whole should be empowered by the internal controls framework to “do it right” internally through collaboration without transferring the duties of the preparer to the external auditors.

The ultimate pursuit is the creation of a culture of excellence, honesty, integrity and pride in the organizations we work for and for the country as a whole.

Mpho Mashatola CA (SA) is Financial Controller at DRD Gold Limited. The article first appeared in Accountancy SA, the SAICA member magazine. Note that these are the opinions of the author and not necessarily the opinions of SAICA or the IOL.

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