The Auditing Profession in South Africa and its Impact on the Social Compact
Introduction
To be covered:
- Understanding of the Social Compact
- Role of auditing in upholding the social compact
- Evolution of modern auditing in South Africa and where we are today
- Initiatives to address key problems we face as a profession
- Conclusion
Understanding the Social Compact
First and foremost, let’s explore the social compact, what it means, and how the auditing profession acts as an enabler of the social compact.
John Rawls in his "A Theory of Justice.", as far back as 1971, best defines for me the social compact, often referred to as the "social contract", as a fundamental concept that captures the unwritten agreement between individuals and the institutions governing them within a society.
Rawls states that the social compact encapsulates the mutual expectations, rights, and responsibilities that both individuals and institutions hold towards each other, forming the basis for social harmony, collaboration, and the overall functioning of the community. Various political and social thinkers continue to explore the social compact, and its relevance is discussed in contemporary debates surrounding governance, citizenship, and societal cohesion.
For me, the social compact loosely refers to a shared understanding of what members of society believe they owe each other. But this is not entitlement, it is something more, deeper, more shared, and with deeper compassion.
Role of auditing in upholding the social compact
External auditing plays a crucial role in maintaining transparency, accountability, and trust within the social compact. By assessing the accuracy and reliability of financial information, external auditing has far-reaching effects on the social compact, influencing both individual and institutional behaviour.
In simple terms, one could say that auditors are enablers of the social compact.
One of the primary impacts of auditing on the social compact is the promotion of transparency. External auditors provide an independent and objective assessment of an organisation's financial statements, ensuring that the information presented accurately reflects the financial health of the entity. Transparency is important for investors, stakeholders, and the public to make informed decisions based on reliable information. The unbiased evaluation of auditors fosters an environment of openness, reducing the information asymmetry that could lead to distrust and uncertainty.
Accountability is another key aspect of the social compact, significantly influenced by external auditing. Auditors hold organisations accountable for their financial practices by identifying any irregularities or discrepancies. This is a critical component in preventing fraud and mismanagement, as organisations are more likely to adhere to proper financial procedures when they know they will be subject to external scrutiny. Accountability instills confidence in individuals and stakeholders, ensuring that organisations are held responsible for their actions.
Then there is the trust between individuals, institutions, and society at large that is deeply interconnected with the impact of external auditing. Trust is the bedrock of any functioning society, and external auditing helps maintain and enhance this trust. When stakeholders can rely on independently audited financial statements, they are more likely to invest, engage in transactions, and collaborate with organisations, knowing that there are mechanisms in place to validate the accuracy of financial information. In this way, auditing contributes to the overall stability of the social compact, as trust forms the basis for economic and social interactions.
Auditing acts as a deterrent against non-compliance, as organisations are aware that deviations from established rules could result in financial penalties and reputational damage.
The social compact can be broken.
Auditing plays such a major role in the social compact, which sounds noble for the profession right? Unfortunately, things can and do go wrong very quickly, breaking the social compact. Have you ever been the subject of a robbery or theft? Have your family experienced severe poverty, inequality? Poor service delivery? Pollution? Loadshedding? – the list goes on and on…
How about this one closer to today’s topic, has anyone or a family member lost their jobs or had their pension savings wiped out and they had to retire with nothing because of a corporate failure? African Bank in 2014 wiped out R7-billion in market capitalisation and R4-billion of Public Investment Corporation investments in a single day.
As South Africa’s largest corporate collapse, Steinhoff wiped out an estimated R300-billion in value as its shares plummeted on the JSE following the events in December 2017. The Government Employees Pension Fund, which is Africa’s largest pension fund with more than 1.2 million members and in excess of 450 000 pensioners, lost an estimated R20-billion alone.
These are nurses, teachers and policemen and policewomen. With over 12 000 shops around the world and 130 000 people working for shops linked to the Steinhoff group, a lot of jobs were on the line. In South Africa alone there were 50 000 people working in a Steinhoff company somewhere.
How does this make you feel? Angry, Resentful? Despondent?
The stark reality is that a single event can break the social compact, and these corporate failures are sometimes linked to audit failures, whereby both the appointed stewards of public organisations and their auditors failed in their roles, resulting in billions of losses to the public.
It can be said plainly that the social compact is under severe threat, not only here in South Africa, but worldwide.
These are all sad realities of today’s world and in this context, when everyone is suffering, that is when citizens start to really truly understand the suffering of others in their society.
This is the moment when we can renew the social compact, first between citizens to work effectively as a society to hold each other accountable, and then to hold authorities accountable. But first, we must look out for each other and not just ourselves.
Evolution of modern auditing in South Africa and where we are today
Historical development of the auditing profession in the country:
To understand the evolution of modern auditing in South Africa, we first need to look at what happened in the US in the early 2000s, which was seen as - the ‘trigger event’ for global audit reform at the time.
According to Kneckel (2016) prior to 2002 and the twin audit fiascos of Enron and WorldCom, the auditing profession was mostly self-regulated. The US-government responded by passing the Sarbanes-Oxley Act of 2002 which established an independent audit regulator, the Public Company Accounting Oversight Board (PCAOB), to set regulations and standards for the auditing profession in the United States. These changes quickly spread to other jurisdictions, eventually leading to the creation of the International Forum of Independent Audit Regulators (IFIAR) to facilitate audit regulation on a global basis.
The Enron failure also led to the closure of big-5 global network audit firm Arthur Anderson, which exacerbated market concentration concerns among the remaining other four networks - PwC, Deloitte, EY and KPMG.
Around the same time, the self-regulated audit profession in South Africa, faced similar challenges because of audit quality issues and ethical breaches by auditors.
Several audit firms were accused of failing to uncover or report on fraud and mismanagement at seemingly healthy, solvent public companies, e.g., Leisurenet (2000), Saambou (2001), Regal Bank (2002) and Fidentia (2007). The auditors faced severe criticism for not uncovering the issues during their audits, which led to heightened regulatory focus.
The South African government subsequently passed the Auditing Profession Act (APA) in 2005 which ended self-regulation in the country and established the Independent Regulatory Board for Auditors (IRBA), to set standards and regulate the audit profession.
Key legislation, including the new Companies Act of 2008, also redefined audit requirements and emphasised the importance of auditor independence.
Key milestones and regulatory changes shaping the profession
Roll forward 10 years, and the world again witnessed a number of high-profile corporate and/or audit failures such as Lehman Brothers in the US, Wirecard in Germany (2020) and Carillion in the UK (2018).
South Africa also saw similar failures again at African Bank (2014), Steinhoff International (2017), VBS Mutual Bank (2018), and Tongaat Hulett (2019) with the two big-4 auditors accused of not identifying or reporting fraud and misstatements at these public companies.
These failures severely tainted investor trust and confidence in the audit profession, damaging the social compact and further widening the ‘audit expectation gap’.
The ACCA defines the expectation gap in audit as ‘the difference between what the general public thinks auditors do and what the general public would like auditors to do’. This definition recognises that it is the difference between what the public thinks and what the public wants that drives public policy on audit.
These events attracted significant negative media coverage between 2017 and 2019. Financial journalists fulfil a public interest role on behalf of investors and they started to call for all role-players, including company management, governance structures, auditors and regulators to do more to protect the public against further major failures.
Calls grew for more accountability and consequence management throughout the entire financial reporting and governance ecosystem, with a focus on the auditors, which led the IRBA to revisit its regulatory strategy. It became evident that the APA of 2005 was no longer able to address the heightened audit risk and to sanction errant auditors effectively.
There were significant responses to this second wave of corporate failures. I will first highlight key reforms in South Africa, and then touch briefly on key global reforms.
In South Africa, the then Minister of Finance Pravin Gordhan was quite proactive. Already around 2012 he invited the World Bank to independently review and report on the accounting and auditing profession in South Africa. The World Bank report highlighted several areas for improvement in its Report on Standards and Codes (ROSC), including enhanced independence of governance structures, the regulation of accounting bodies, Limited Liability Partnerships, Risk-based Inspections and more robust Investigations and Disciplinary processes.
In a prescient move, and before the corporate failures that would soon unfold, the IRBA passed a 10-year limit on audit firm tenure to further strengthen auditor independence, with a 5-year lead time.
In addition to the five-year rotation of partners, the IRBA still believes that rotating audit firms further strengthens the independence of both auditors and firms. While the MAFR rule has been set aside recently by the Supreme Court of Appeal (SCA, the independence provisions outlined in the IRBA Code of Professional Conduct for Registered Auditors (Revised April 2023) are still in effect. We will continue to collaborate with National Treasury to reinforce the independence aspects related to firm rotation in our legislation.
The IRBA also approached National Treasury in 2017 with proposed amendments to the APA and President Ramaphosa subsequently passed the Auditing Profession Amendment Act (APAA) in April 2021, giving the IRBA the necessary powers to deliver more effectively on its mandate and removing some of the limitations of the old act.
In addition to strengthening the IRBA's independence, investigating and disciplinary processes, the amended act also provides for:
- Search and seizure powers;
- Subpoena powers for investigation;
- Referral powers of non-audit complaints for investigation to accredited accounting bodies; and
- Stricter monetary sanctions in relation to both investigation and disciplinary outcomes.
These amendments came at a critical time to help the regulator to restore confidence in the IRBA and the profession and rebuild public trust by strengthening accountability to society and restoring the social compact.
On the global front, the International Forum of Independent Audit Regulators (IFIAR) was established in 2006, now comprising independent audit regulators from 54 jurisdictions (including South Africa) representing all continents. IFIAR’s mission is to serve the public interest, including investors, by enhancing audit oversight globally.
The European Union introduced several audit reforms in Europe, including the UK with the release of the Brydon Report in 2019 titled Report of the Independent Review into the Quality and Effectiveness of Audit.
The Monitoring Group and the Public Interest Oversight Board (PIOB) were formed to advance the public interest in areas related to international audit standard setting and audit quality. In July 2020, the group issued a paper with recommendations to strengthen the international audit-related standard-setting system, including the Public Interest Framework, so that future development and oversight of international audit-related standards can be more independent and responsive to the public interest.
It was amidst these reforms, that the new ISQM 1 & 2 quality management standards were issued in December 2020 with an effective date of December 2022. These aim to enhance the way audit firms operate around ensuring high audit quality and ethics.
There is a lot more happening globally and locally, which I cannot share in the interest of time, but what I wanted to illustrate from what I just mentioned, is that it is evident that a much work was and still is underway to address audit failures and the expectation gap.
These changes are not a new phenomenon and a historical review of the evolution of auditing has shown that auditing and its regulation are evolving all the time in response to contextual factors.
Now that we know that change is inevitable and reforms are ongoing, there are novel factors that impact the auditing profession in South Africa today.
- Firstly, there are significant gaps in our financial reporting and governance ecosystem (FRAGE) that increase the risk of more corporate failures, including: a lack of accountability and consequence management of all role players, fragmented regulation, a lack of collaboration among regulators and law enforcement agencies, and the fact that accountants remain unregulated despite the 2013 World Bank recommendations.
- Secondly, the attractiveness of the profession is an emerging challenge. All six Global Network Firms recently indicated to IFIAR that they are experiencing challenges in attracting and retaining audit talent. Some of the reasons include more modern career choices available to school leavers, high entry requirements to study accounting, high tuition fees, low remuneration, high work stress and tight deadlines, and negative publicity about the auditing profession.
The contest for talent in South Africa is exacerbated by low math-literacy significantly reducing the student pool; and a number of push-and-pull factors such as political and socio-economic instability that on the one hand pushes emigration, and on the other pulls our highly skilled and in demand professionals to alleviate global shortages. The pandemic also enabled remote working through the use of technology to communicate and perform audit work from anywhere in the world.
Initiatives to address key problems that we face as a profession
It is not all doom and gloom though, and we can fix any problem, together.
On a positive note, there is still a lot that the auditing career has to offer aspirant accountants and auditors.
Attracting aspirant auditors
There’s increasingly more complexity in the audit environment due to rapid technological advancements such as artificial intelligence, advanced data science and crypto, and the advent of sustainability reporting/ESG and assurance thereon. These appeal to younger generations as these are not only intellectually stimulating to them, but it triggers their natural desire to make a positive social impact on people and the planet.
As part of our strategy to engage more with important role-players in the profession, I am always very excited when I’m invited to address students, trainees and young professionals at the firms, because they seem to be drawn towards the added value of auditing and the impact it has on society.
Let me give a simple example - everybody benefits from high quality financial reporting and quality assurance thereon, simply because investors rely on it, which in turn stimulates investment and growth. It also ensures the completeness of declared taxes that feed into the fiscus to sustain the country and even sustain the poorest of the poor through social grants (unemployment is approaching 40%) – these grants are often their only income. Banks rely on audited financial statements to lend, and employees benefit from working for a financially sustainable company to support their families.
So, the bottom line is that auditors play a much bigger role in society than is often realised, and I am appealing to all aspirant auditors, current auditors, academia, professional bodies, regulators and the media to advocate for the auditing profession and help reignite the value of audit in society.
Drawing on Graham Condrington’s ‘Mind the Gap’, I specifically appeal to our Millennials and Gen Z’s and their innate nature to do good and ‘Make an Impact’, they are the future of our profession, and those of us who came before them must start setting the social compact back on course; they are the ones who will really drive the change of mindset to accept responsibility and appreciate the value of auditing and its social impact.
Another issue that we must deal with in context, is negative publicity of the profession, sparked by high-profile failures. It is a statistical fact that audit failures make up only a small fraction of all public interest entity audits conducted annually, and most investors I engage with still rely heavily on auditors’ reports when assessing investment risk. Don’t get me wrong, I am not condoning any audit failure because what is also true is that even a single failure can have such a significant impact on broad society and the economy. But as much as failures are undesirable, it is also important to look at the entire profession in context and acknowledge the excellent work that most independent auditors and their teams do that benefit society.
The IRBA earlier this year accredited the Association of Chartered Certified Accountants (ACCA) as an additional professional accounting body providing another route to the audit specialisation programme for aspiring registered auditors. This widens the pipeline of qualified accountants who can pursue audit as a career we believe this will help alleviate the talent shortages that the firms are experiencing currently.
The Role of the IRBA in Advancing the Social Compact
I shared earlier some milestones on how we responded to the corporate failures and state capture, through the strengthening of the APA and our mandate.
I think it would be appropriate for me to share some of the specific activities of the IRBA in terms of its current 5-year strategy, which was developed in 2021 to help restore confidence in the profession.
The IRBA follows the concept of ‘right-touch’ regulation. “Right-touch” regulation means that we apply proportionate, consistent and targeted risk-based regulation to address undesired trends and events in the profession effectively. Without over- or under-regulating.
It remains critically important for the IRBA to be seen as an independent, respected audit regulator, both locally and globally. It is therefore our mandate and our duty to respond to the risk in the system, with enhanced standards, regulation and enforcement – hence the adoption of several reforms such as adopting the new quality management standards, updated Code of Conduct, performing robust risk-based inspections, applying appropriate fines and issuing principle rules such as firm rotation to further enhance auditor independence, ethics and quality.
In terms of our strategy and after performing an extensive situational analysis, we implemented a plan to restore confidence in the role of auditors and the regulator, linked to three strategic focus areas of ensuring sustainability and relevance, driving audit quality and implementing a comprehensive stakeholder engagement model that focuses on alliances and fosters broader collaboration without compromising our independence as a regulator.
In terms of this plan we established three distinct workstreams led by our executives: [1] to identify gaps in the FRAGE that impact on audit quality, [2] to identify impactful audit reforms, and [3] to enhance our own brand, internal capacity and processes to be a future fit regulator.
We believe that if we can collectively reduce risk in the ecosystem, the pressure on auditors to blow the whistle on misstatements after the fact will be mitigated. All our stakeholders support this approach, but highlighted the importance of collaboration with all role-players since we don’t have the mandate beyond regulating auditors.
In a recent Webinar hosted by the IRBA in April this year, we polled 167 attendees who prioritised the following reforms they believe would create the greatest benefit to the ecosystem.
- Legislated Supervision of Professional Accounting Organisations (PAOs).
- Legislated Supervision of Other Assurance Providers (E.g. Internal Auditors, Forensic investigators, IT auditors etc.).
- Reinforced Corporate Governance Code and Supervision.
- Enhanced Information Sharing and Collaboration between regulators.
- Legally Backed Combined Assurance Framework outlining the roles and responsibilities of each of the three lines of defense.
We aim to facilitate the publication of a discussion paper next year based on our stakeholder engagements, highlighting the top five gaps identified in the ecosystem with impactful recommendations that will address these gaps.
Another key focus for us is to strengthen the Reportable Irregularities process as a mechanism for auditors to blow the whistle on non-compliance in companies – but it must be followed by prompt investigation and consequence management by law enforcement agencies or other regulators in order to be effective.
Another recent development that attracted quite a bit of attention in the media was the Minister of Finance’s recent publication of new Maximum Fines for auditors found guilty of improper conduct.
This was in response to longstanding criticism regarding the inadequacy of our fines. While these fines may appear to be mostly punitive in nature, the intention is to promote ethical behaviour and professional due care among registered auditors. Globally recognised as a necessary regulatory tool, fines play a vital role in fostering accountability, particularly within the auditing profession where investor trust heavily relies on auditor opinions for investment decisions.
These activities are but a glimpse into some of our key initiatives and projects. We are working hard to help rebuild confidence and trust through effective regulation, and we collaborate closely with the firms to perform their professional work ethically, competently and diligently – thereby giving effect to their social compact in serving the public interest.
From a more philosophical perspective, we are in the realm of driving human behaviour, e.g., cognitive biases, self-interest, lack of professional scepticism, lack of independence and integrity, and commercial interest over ethical conduct etc. These are all negative traits that may be regarded as potential underlying root causes of failures. I am quoting Steven Landsburg – ‘The Armchair Economist’ who said, “Most of economics can be summarised in four words: ‘People respond to incentives.’ The rest is commentary.” In short, what this means is that humans will naturally do as little as possible to get the maximum gain especially when there is no standard or consequence, and to counter that behaviour, effective regulation and enforcement is necessary. This is the case for regulation.
The social compact includes several role-players, not only the auditors. It is therefore important to first drive a change in mindset across society, in all spheres, that leads to a change in behaviour and a growing sense of joint responsibility for each other (altruism). And through collaboration between stakeholders we can uphold the social compact, fostering trust in auditing and its wider effects on the broader social fabric.
Conclusion
In conclusion, external auditing plays a multifaceted and impactful role in shaping the dynamics of the social compact. Through transparency, accountability, trust-building, and regulatory compliance, auditing contributes to a stable and functional society where individuals and institutions interact with confidence. The assurance provided by external auditors ensures that financial information is accurate, reliable, and aligned with ethical and legal standards. In doing so, auditing reinforces the principles that underpin the social compact, promoting a harmonious relationship between individuals, organisations, and the broader society.
There can be no doubt that society needs auditors. All role players must do everything in their power to work together to rebuild confidence in the accounting and auditing profession and restore the profession to its former status as an impactful, noble profession.
To the firms, I’m saying, keep up the good work, improve your quality management systems, act independently and with integrity, and conduct high quality audits, it is your duty towards the social compact. You are agents of trust because #trustisourcurrency.
I’m also calling on every individual within the ecosystem to action, to support our profession and advocate its value and impact on society.
I am closing with one of my favourite quotes by Desmond Tutu, who said: "Compassion is not just feeling with someone but seeking to change the situation. Frequently, people think compassion and love are merely sentimental. No! They are very demanding. If you are going to be compassionate, be prepared for action!"
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