DRAFT AUDITING PROFESSION BILL

Accountancy SA,  Jul 2005  by Coppin, Garth

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Preposals prohibiting auditors from having material interests in companies they audit for the two years before they accept audit appointments in them are not only impractical, but inequitable as they deprive them of the right to engage in legitimate commercial activities like any other citizen.

These proposed prohibitions are contained in the Draft Auditing Profession Bill released by National Treasury towards the end of last year. They had requested all stakeholders to submit written submissions before the Bill is enacted into law.

Since the collapse of energy giant Enron in the United States and the corporate failure of companies such as Leisurenet in South Africa, government has set the wheels in motion to overhaul the regulatory regime governing the auditing and accounting profession in a bid to minimise the recurrence of these events.

Independence

The proposal stipulates, among other things, that an auditor cannot audit the financial statements of a company it has had financial interests in during the last two years.

An auditor is unlikely to know whether there is going to be a change in audit and accordingly to expect an auditor not to have any financial interest in all potential future audit clients is impractical. Practically it might mean that auditors cannot have any financial interests in any entity because of the possibility that they might be required to audit that entity in the future.

Taking a more pragmatic view, it is more practical to require an auditor to dispose of any financial interest in the entity in question before accepting appointment to audit the financial statements of the entity in question.

The Bill should shed more light on the definition of financial interest and clear up potential ambiguities that could result from different interpretations. The definition of financial interest should be reconsidered to provide more clarity on what is being envisaged or excluded by the proposed Bill.

Should independence issues be covered by legislation considering that the Public Accountants' and Auditors' Board (PAAB) Code of Professional Conduct already covers these?

Accordingly, we believe that independence issues should be considered by the Board for Auditor Ethics. This will make it easier for changes to be made to independence requirements, where considered necessary, and also allow for interpretations to be issued, if required, on how independence requirements should be applied.

Determination of Liability

Public indemnity insurance is a major area of cost to audit firms, hence in some cases it becomes difficult and expensive to obtain insurance cover for certain levels of cover. One of the reasons for this is that when a company fails, aggrieved parties might look to the auditor of the company to reimburse them for their losses.

While auditors accept that they should be held responsible for their actions, the law as it stands at present provides for joint and several liability. An auditor could therefore be required to pay for the full loss even though they are only to blame to a very small extent. As investors know that auditors carry professional indemnity insurance, they are more likely to sue an auditor who might be able to recover their losses, than the parties who are the main reason for the losses suffered. Auditors can additionally suffer by having to spend an inordinate amount of time defending their actions.

The bill should make provision for liability to be determined in such a way that the auditor is only responsible for the proportion of the loss or damage that can be ascribed to the auditor based on the relative degree of fault. When the bill does cover limitation of liability it only deals with those who have a contract with the auditor, but does not extend this to the many other parties who do not have such a contract. There is also a need to attract suitably qualified people into the profession without them being too unduly exposed to possible financial risks, and limited liability partnerships is one suggestion to deal with this issue.

While it is generally accepted that auditors should be liable for their actions, the proposed amendments to the Companies Act should make it an offense for directors, employees and other stakeholders to mislead, deceive or fail to provide material disclosures.

We do not believe it appropriate for changes to be made to the regulation of auditors, if the necessary changes applicable to other role players are not dealt with.

Rotation of auditors

One positive aspect of the bill is the issue of rotation of audit partners as opposed to the rotation of audit firms. Rotation of audit firms can be costly and could increase the risk of errors in financial statements not being detected in the first years in audits of complex groups.

Auditors might be spending a large amount of time trying to find out how things operate, whereas if the previous auditors had continued to audit the company they would have that knowledge and would instead be able to ask difficult questions based on their knowledge of the company. We are however concerned that the rotation period of four years is too short, as it could require an auditor to rotate off an audit fairly soon after he had obtained a high level of knowledge on complex groups.