Audit coms carry can for business failures

COMPANIES listed on the Johannesburg Securities Exchange Limited (JSE) are required to comply with King IV Code of Corporate Governance (King IV) as published by the Institute of Directors in Southern Africa.

King IV provides that the board of directors must establish subcommittees that, among other things, deal with each aspect of the board’s functions in more detail.

While the board of directors can delegate the function to its subcommittees, it retains the responsibility for that function. One of the most important subcommittees of the Board that King IV recommends is the Audit Committee.

The important requirement regarding the composition of the audit committee from both the King IV and Companies Act, is that all members of the audit committee should be independent, non-executive directors. This means that executive management should not serve on the audit committee.

The audit committee fulfils important tasks in ensuring that the financial information finally reported externally in the financial statements is free from material misstatements.

The question that puzzles many is how the Steinhoff and Tongaat Hulett scandals happened when these companies supposedly had properly constituted and functional audit committees?

The follow-up question to that is whether these audit committees rigorously perform their functions, or just ceremoniously rubber-stamped what management had decided.

Clearly, the audit committee should be able to pick up accounting policies that are not consistent with the applicable financial reporting framework adopted by the company.

In the case of South African companies, that framework is the International Financial Reporting Standards (IFRS), as prescribed by Section 29 of the Companies Act.

In response to the question above, it could be argued that while the audit committee is tasked with these crucial functions, it holds no responsibility for the financial statements. The ultimate responsibility for financial statements that are materially free of errors lies with the Board.

A complication that arises here is that while the audit committee is a statutory structure within a company that has legal obligations to perform certain tasks, it has no legal responsibility for these obligations.

When financial reporting goes wrong, other legal structures, like external auditors, the Board, etc, have to answer. The audit committee then conveniently hides behind the collective of the Board.

In light of the recent fraudulent financial reporting that is witnessed in corporates such Steinhoff, many more questions come to mind. Regardless of the answers, it is clear is that more effective and honest oversight is required over financial management and reporting.

Last year, South Africa lost the number one rating in its strength of auditing and reporting standards in the World Economic Forum Global Competitiveness Report. To regain its number one spot, the audit committee function is one of the structures that must be reconfigured and empowered.

Mthembu is a Chartered Accountant (SA) and Senior Lecturer at the Department of Accounting and Auditing, University of Zululand