Municipalities should aim for clean audits

South African municipalities should work towards achieving clean audits to ensure citizens that government resources have been effectively used for the purposes intended, says Justin Diedricks an associate director at Deloitte.

He says although more South African municipalities achieved improved audit outcomes during 2012, the country still has some way to go to show real progress, and there has to be a significant improvement in the number of municipalities moving upwards through the scale – from the worst, the ‘auditor’s disclaimer’ to achieve the ultimate accolade, a ‘clean audit’.

“The latest Auditor-General’s reports indicate that there are more municipalities showing progress in reporting standards, but there are still many that require serious interventions if they are to meet accepted financial standards,” says Justin Diedricks, Associate Director, Deloitte.

To achieve a ‘clean audit’ a municipality’s financial statements and annual report must give a true and fair view in accordance with the financial reporting framework used for the preparation and presentation of the financial statements and the Framework for Reporting against Predetermined objectives (service delivery reporting). There should be no significant non-compliance with laws and regulations and the reporting against predetermined objectives (service delivery reporting) should be true and fair. Only 13 municipalities achieved clean audits.

“An unqualified audit for a municipality is significant as it means an auditor has no significant reservations about matters contained in the financial statements. 115 municipalities achieved unqualified opinions. However, an unqualified opinion alone is not enough to get to a “clean audit” because the other two components, namely legal compliance and service delivery reporting also need to be taken into the clean audit equation. The citizen needs to essentially know that government resources have been effectively used for the purposes intended, in compliance with the prescripts.

A clean audit therefore indicates that:

·         The municipal financial statements and annual report have been prepared using the required principles which have been consistently applied;

·         That the statements and annual report comply with relevant statutory requirements and regulations;

·         There has been adequate disclosure of all material matters relevant to the proper presentation of the financial information subject to statutory requirements, where applicable;

·          Any changes in the accounting principles or in the method of their application and the effects thereof, have been properly determined and disclosed in the financial statements;

·         All laws and regulations have been complied with in all significant respects; and

·         The service delivery reporting or reporting against pre-determined objectives are fairly represented in accordance with the statutory frameworks.

“The commonly held perception that a clean audit means an unqualified opinion is not correct,” says Diedricks. You could have an unqualified opinion on the financial statements and still not achieve a clean audit because of significant non-compliance issues or service delivery reporting issues. “Clean audits are really a reflection of how well the municipality is being managed overall and is an important indicator of effective service delivery” says Diedricks.

Just below the status of an unqualified opinion is the ‘qualified audit opinion’.

A qualified opinion is issued when an auditor encounters situations which do not comply with the required municipal accounting principles. In this case there could be one or more areas of the financial statements that have been misstated, but do not affect the rest of the financial statements from being fairly presented when taken as a whole. A common example in municipalities is where there are concerns with fixed assets. A total of 53 municipalities received qualified opinions.

Towards the bottom of the audit rating scale is the ‘adverse opinion’ that indicates that there are several major problems with the audit. Unfortunately 7 municipalities received this rating

An ‘adverse opinion’ is issued when the financial statements of a municipality are materially misstated and, when considered as a whole, do not conform to required standards.

“The other most unsatisfactory result of an audit is the auditor’s ‘disclaimer,’ which is issued when an auditor, because he or she could not gather adequate evidence, is unable to present an opinion on the financial statements,” says Diedricks. A total of 55 municipalities achieved this highly undesirable audit result. A further 40 municipalities did not submit their financial statements for auditing by the prescribed date.  It is unlikely that they would receive a favourable audit outcome.

But clean audits for the majority of municipalities are achievable in a reasonable period of time – municipalities with unqualified opinions with concerns relating to compliance or service delivery reporting as well as those with qualified opinions aggregate to 59% of all municipalities. “In both these categories of municipalities, the issues that need to be addressed are well known and the remedies are available” says Diedricks. “The challenge is that the municipalities don’t have the skills or are unaware of the solutions that can be implemented and often do not accordingly ask for help from the correct sources. Focused attention to these relatively low hanging issues can dramatically change the landscape with a potential clean audit result in 12-18 months for approximately 59% of all municipalities.

For those municipalities that have adverse or disclaimer outcomes, there is also a real possibility of improved outcomes within a window of 12 to 24 months, although clean audits require a proper investment usually in a turnaround project of between 24-36 months. “Overly optimisticsolutions are not sustainable” says Diedricks and all remedies and solutions offered must be seriously tested for sustainability without the dependence on consultants. Skills development is therefore a critical component of any such intervention.

“The overall impression left by the present audited status of the municipal sector is that there are many municipalities that have at least six key areas that must be addressed if they are to elevate their status. “

“Of these focus areas; the most dominant are a lack of skills and the failure to apply basic good practices of financial management. This is followed by municipal leaders failing to take ownership of audit outcomes and acting upon them; the lack of operational action plans to address oversight; governance, risk and compliance practices which are ineffective and not institutionalised; and poor performance management.”

“Where municipal leadership has addressed problems, significant results are achieved. This year, six new municipalities have joined the ranks of municipalities with clean audits, bringing the total to 13, or 5% of the national total. These municipalities are in KwaZulu-Natal, Limpopo, Mpumalanga and the Western Cape.”

 

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