Financial reporting and compliance in South Africa

Smit, Pat

The state of play

Last month I had the good fortune to play a game of golf with an old friend from my high school days who told me a sorry tale of financial reporting skulduggery. He owns a few shares in a JSE-listed company, which recently included in its consolidated income statement revaluation gains on an investment in a subsidiary. “Is this OK under accounting rules these days?” my friend asked, “I’ve been out of the profession for a while but unless basic principles have changed, this can’t be right.” I assured him that basic principles have not changed much and suggested that he query the reported profits with the company. To this he replied that he had done so, not only with the company’s finance director but also with its auditor, both of whom had failed to satisfactorily answer his question and basically told him to get lost or to “take his complaint to the appropriate authority”.

So, he asks, what is the appropriate authority for such complaints? This is a good question. The short answer is “There isn’t one”.

The present position is:

* The JSE’s revised listings requirements require compliance with South African Statements of Generally Accepted Accounting Practice (GAAP), which generally do not permit market value gains on a subsidiary’s share price to be included in the group’s income. So on the face of it one could complain to the JSE that their regulations have been contravened. However, the JSE currently has no mechanism for dealing with such complaints.

* An investor could also complain to SAICA that its members (the company’s finance director and auditor are presumably Chartered Accountants) are acting improperly, but SAICA has no power to enforce accounting standards.

* Finally he could approach the Public Accountants’ and Auditors’ Board to use its statutory powers to examine the auditor’s work papers for evidence of malpractice, but that body’s practice review team focuses on compliance with auditing standards rather than accounting standards.

The bottom line is that there is presently no effective process for addressing grievances about financial reporting transgressions. This cannot be good for investor confidence and is in marked contrast to the regulatory environment in most major international securities markets.

How did I advise my friend? “Sell your shares”, I said, “If they play these games in their published accounts, who knows what may be going on behind the scenes”. “Too late”, he replied, “I’ve already taken a beating on the share price”. Perhaps the market wasn’t fooled after all.

All is not gloom – in fact, we are ahead of most other countries in adopting International Accounting Standards. For example, Europe plans to adopt these standards only in 2005. The USA continues to cling to its own standards, which in some key areas are actually less onerous. In the international trend towards convergence of accounting standards, South Africa is actually amongst the leaders. This will ultimately enhance the credibility of our financial markets.

Indications are that practical implementation of reporting standards in South Africa is also improving and that most companies willingly follow best international practices. However, some companies apparently still prefer to portray their results as they intended them to be where the standards may give a less flattering presentation. This negatively affects perceptions about all South African companies.

The end goal for financial reporting

It is in all our interests to create a financial reporting environment characterised by internationally respected accounting standards which are consistently applied and where any serious transgressions are identified and dealt with promptly. This will allow investors to confidently make comparisons between companies based on reliable financial information.

What needs to be done?

For the past several years South Africa has been playing catch-up with International Accounting Standards. We now finally have a complete set of world-class standards which aim to inspire confidence in local and international investors. However, our culture of elasticity in interpretation and selection of accounting principles may take longer to change. Most other major global markets have opted for consistency and standardisation so that investors can make reliable comparisons and choices between investment opportunities. We need to follow suite before we can expect foreign investors to take us seriously.

Who should enforce financial reporting standards in SA? Clearly, the auditors should do what they are paid to do and highlight any serious departures in their reports. However, it is not enough to rely solely on the auditor. International experience is that investors also need a separate monitoring mechanism so that any wrong accounting or incomplete disclosure can be corrected promptly. Even in modern rugby, citing procedures can be invoked to discipline players for foul play, which is not detected by the referee or his assistants.

What has been done about this? SAICA has for years been lobbying government to provide clear legal backing for accounting standards and a regulatory body to enforce compliance. However, SAICA has little to show for its efforts to date. More encouragingly, the JSE has changed its hands-off attitude to financial reporting standards and now requires companies to apply these standards. Unfortunately there is no effective means of policing this. As we all know, even good laws are ineffective without enforcement.

It has been said about good financial reporting that only 100/% is achieved by having high quality accounting standards. The other 90% depends on implementation and interpretation by companies and their auditors and enforcement of compliance by regulators. In SA, we now have world class accounting standards. The easy part is over. If we want to be recognised as having a strong reporting environment we now need to focus on implementation. Many challenges lie ahead in implementing the new standards, including disclosure of related party transactions and segmental results, accounting for business acquisitions and treatment of goodwill, and the valuation of derivatives and other financial instruments through the income statement. This will be no easy ride.

The way forward

We now have world-class accounting standards. These standards are generally regarded as being mandatory under the Companies Act and the JSE’s revised regulations. What we lack is consistent implementation and a regulatory system for ensuring compliance.

The way forward is for all the role players to play their parts:

* Companies can do more to study exposure drafts of proposed new standards, comment on any anticipated practical problems in advance and ensure that they are ready to implement the standards on their due dates;

* Auditors can do more to raise awareness and promote consistent interpretation and implementation of standards by their clients;

* The JSE can do more by monitoring compliance with its own requirement to apply Statements of GAAP or at least responding to complaints by stakeholders;

* SAICA can do more by providing the JSE with technical support in assessing complaints;

* The press can be more proactive in publicising instances of poor reporting highlighted by auditors, the JSE or SAICA; and

* Government must fulfil its role by removing the remaining ambiguities in the Companies Act and providing the legal framework for an effective regualtory funtion.

In this way, we can gain the respect of the international investor comminuty as a country where financial information can be trusted to “tell it like it is.”

Pat Smit. CA(SA), is a Partner at Deloitte & Touche and has been actively involved in accounting standard setting in South Africa for many years. He is the current Chairman of SAICA s Accounting Practices Committee.

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