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Comments from ACCA
May 2006

Executive Summary

1. The Association of Chartered Certified Accountants (ACCA) welcomes the opportunity to add to our comments made in August 2005 on the previous Bill. In ACCA’s view, the Bill provides a sound basic regulatory framework for financial reporting, viz a statement of the standard to which financial statements must be prepared, provision for offences where this standard is not met, a standard-setting machinery and provision for the monitoring of the quality of financial reporting (via the Investigation Panel).
   
2. ACCA is pleased that the drafters have taken on board many of the suggestions we made previously, e.g. to focus auditor rotation rules on engagement partners rather than firms and to peg mandatory rotation at five years rather than for as previously provided for, and to remove some of the less realistic functions of the audit committee. ACCA wishes to highlight two points from our detailed comments which follow:
   
3. The first concerns the statement of basic requirements for financial statements (clause 33). Though the idea of this is sound, it needs to provide a better definition of what technical standards are required to be met by limited interest companies. The given definition is unclear. Also, this provision, and subsequent related provisions, need to acknowledge that IFRS incorporates a fair presentation override – accordingly, it is not technically correct for the regulatory system to imply that it will insist on complete compliance with every single element of every single IFRS.
   
4. The second concerns the provisions regarding the financial reporting standards council (clause 50), which need to be more exact as to what sort of standards the council will exercise responsibility over for non-public companies. The council is currently required to ‘develop standards’ for these companies (while it must ‘establish financial reporting standards’ for public companies (which must be ‘in accordance with’ IFRS). The Bill could much better say that the council must develop and set financial reporting standards for all companies but that those for public companies must be IFRS or in accordance with IFRS. Also, the scope for the council to diverge from or add to IFRS needs to be clarified.
   
5. ACCA trusts that these further comments will be of help and we look forward to the final legislation.

   
   Issued by the Association of Chartered Certified Accountants (ACCA)
   May 2006

   
   Detailed comments on clauses

   Clause 22 - Audit Committees

6. Our preferred approach would be to omit any reference in the Bill itself to the specific functions and procedures of audit committees, and to leave such matters to be dealt with in authoritative non-statutory guidance. Enshrining such matters in legislation will make it more difficult for guidance in this area to respond to developments in business affairs and evolve in line with international best practice. It also risks imposing excessive formality and rigidity on the way that committees carry out their functions.
   
7. This being said, we welcome the fact that significant amendments have been made both in respect of the composition of audit committees and their prescribed functions. In particular, we welcome the fact that audit committees are no longer to be expected to give an opinion on the quality of the external audit. The concessions notwithstanding, we continue to believe that the requirements are likely to prove onerous for smaller, non-listed public interest companies which are by no means likely to possess non-executive directors with the skills and experience necessary to perform the role to the level which makes the establishment of a committee effective in governance and control terms. We recommend that the Government should consider, under the powers to be made available to it under the proposed section 269B, restricting the requirement to appoint audit committees on the prescribed basis to listed companies, as is the norm internationally, or at least to non-listed companies of a prescribed size.
   
8. We query two elements in particular of the list of prescribed functions set out in the proposed section 270A. The first of this is sub-section (1)(g). This would require committees to receive and deal ‘appropriately’ with complaints relating to the accounting practices and internal audit of the company or to the content and audit of the company’s financial statements. As drafted, this suggests that the committee is to have a formal complaint-handling role. Such a requirement is potentially far-reaching and burdensome to the committee, and the practical implications should be considered carefully. We recommend that, if a provision of this kind is to be retained, it should at least omit any reference to complaints regarding the audit of the company’s accounts, since such matters are more appropriately dealt with by the audit regulator.
   
9. The other element we query is sub-section (5). We do not contest the various tasks set out in the passage, but would point out that all the information referred to may not always be readily available, and committees should not be expected strictly to obtain information if it is not available.
   
   
   

   Clause 27 - Rotation of auditors

10. We support the proposal to focus the new legal rules on auditor rotation on the individual partners engaged on an audit assignment and not to audit firms as a whole. We consider that there has been no objective evidence put forward to support the proposition that rotating the audit firm necessarily leads to a consequential improvement in audit quality. The only major country to impose mandatory rotation of firms is Italy, and research there has concluded that, while firm rotation does not improve audit quality, it does push up client costs (since new firms have to spend additional time familiarising themselves with the client’s business and systems). It is worth noting that the European Union’s recently-revised directive on auditing has also adopted an approach which focuses on rotation of engagement partners rather than firms. We agree with the proposal to require rotation of engagement partners after five consecutive years of involvement. This is a sensible cap to impose.
    
    

    Clause 29 – non-audit services

11. We would point out that the heading for the proposed new section 275A refers to the current designated auditor, yet the text itself does not appear to be restricted to such persons.
    
12. As regards the text of new section 275(1), we suggest that consideration be given to adding, to the list of services which an auditor may not perform for a company client, advice relating to accounting systems.

    
    Clause 33 – General requirements for financial statements

13. This is a key passage of the Bill for financial reporting purposes. With respect to limited interest companies, the clause states that they must comply with the ‘accounting framework of financial reporting standards’. There is no obvious meaning to this term – presumably, the thinking is that, while these companies do not have to comply with ‘financial reporting standards’ themselves, they should comply with some elements of them. This is not sufficient - either the intended meaning of the term should be defined further, conceivably by referring to the planned ECSAFA guidance for SME reporting, or some other term needs to be used. If it is the intention of the planned Financial Reporting Standards Council to issue special standards for limited interest companies, then the obvious option would be for any reference in the proposed section 285A to be to those standards.
    
14. When referring to ‘compliance’ with accounting standards, however, it is essential for the law to acknowledge, implicitly or explicitly, that there is provision in IFRS for companies to depart from the specific provisions and requirements of particular standards if there is good reason to do so in the context of the overriding requirement in IFRS for financial statements to give a ‘fair presentation’ of the company’s financial performance and situation. Departure in such circumstances is not regarded technically as amounting to breach of a company’s compliance with IFRS, and SA law should adopt the same approach. However the requirements of clause 33 are finally framed, this vital point must be accommodated. Similar considerations should apply to whatever reporting standards are required of limited interest companies.
    
15. We refer separately in our comments on clause 50 to the potential uncertainty created by the ambiguous references to reporting standards for the two types of companies and call for this uncertainty to be resolved.

    Clause 35 - Offences in relation to financial statements

16. 16. In clause 35, it is proposed that where financial statements are incomplete in any material particular, the company as well as its directors commits an offence (and will, presumably, be liable to financial penalties). We do not consider that it is right that the company and its shareholders should have to suffer financially or otherwise for the faults of those officers whose responsibility it actually is to prepare and issue these statements on behalf of the company.

    Clause 50 – Financial Reporting Standards

    New clause 440S
17. The equivalent clause first published in the Companies Amendment Bill provided that the Financial Reporting Standards Council was to develop financial reporting standards for both public interest and limited interest companies. The revised clause states that the Council is to ‘establish’ ‘financial reporting standards’ for public interest companies and to ‘develop’ ‘standards’ for limited interest companies. Sub-section (2) goes on to say that financial reporting standards are to be ‘in accordance with’ IFRS. We understand that the main purpose of the revised wording is to differentiate between the type of reporting standards which are to be required of the two classes of companies.
    
18. The wording also suggests that the role of the Council in relation to the standards for the two classes of companies will be different in nature. The implication is that standards for public interest companies are to be IFRS endorsed by the Council without any amendment to their texts, while the text of the ‘standards’ for limited interest companies is to be prepared and approved by the Council itself. In the former case, this would, on the face of it, restrict the power of the Council to make any amendment to IFRS which might be considered desirable to suit SA circumstances. If this were thought to be unduly restrictive, then some amendment to the text of the clause should be considered, most obviously with reference to the proposed requirement for standards to be public interest companies to be ‘in accordance with’ IFRS.
    
19. With respect to standards for limited interest companies, we suggest that consideration should be given to the possibility of allowing limited interest companies to adopt IFRS if they so wish – this may be considered useful in the context of groups of companies.
    
20. We also query the intention behind the different wording used in respect of standards for the two classes of companies. If the standards for public interest companies are to be IFRS, as is made clear by sub-clause (2), then in our view there is no need for different wording to be used. As it stands the revised clause appears to suggest that ‘financial reporting standards’ are to be deemed to be only those standards, i.e. IFRS, which are to apply to public interest companies. We consider that this gives the wrong impression. It would be sufficient for the clause to provide that the Council is to develop and establish financial reporting standards for a) public interest companies and b) limited interest companies. The existing sub-clauses (2) and (3) can then add the desired qualifications. In any case, we suggest that the existing reference to the development of ‘standards’ for limited interest companies needs to make clear that it is to reporting or accounting standards as opposed to standards more generally.
    
    Clause 440T
    
21. We query the need for including provision for interested parties to receive notice of vacancies in legislation. This can more appropriately be dealt with on an administrative basis. Similar considerations apply with regard to clause 440Y.
    
    Clause 440U
22. Clause 1(a) says that the Council is to give notice of any prospective ‘amendment’ of financial reporting standards. This appears to suggest that the Council has the power to amend the text of financial reporting standards. Given our comment on the previous clause that the revised wording appears to suggest that ‘financial reporting standards’ are effectively IFRS, it also appears to suggest the Council has the power to amend the content of IFRS as applicable in SA. This underlines the importance of establishing more clearly i) whether the Council has any discretion as to the text of IFRS for SA purposes and ii) the definition of financial reporting standards. The consultation period of one month allowed for consultation appears to us to be rather short. Three months would be more reasonable.
    
    Clause 440V
23. In sub-clause (2), the text says that the Minister may appoint ‘a suitably qualified officer’ to carry out a monitoring role. We suggest that there be some elaboration on what body this person is intended to be an officer of.
    
    Clause 440W
24. The revised objective of the Financial Reporting Investigative Panel is to ‘promote the reliability of financial reports’ and ‘to recommend appropriate measures for rectification and restitution’.
    
25. We would suggest that a more appropriate wording for the first of the above two quoted matters, given the Panel’s essentially re-active role, would be to ‘monitor compliance by public interest companies with their financial reporting obligations’. To suggest that the Panel is involved in ‘promoting’ the reliability of financial reports might give the erroneous impression that it has some form of campaigning role, which we do not understand to be the intention.
    
26. On the second matter, we query whether it is appropriate to refer to the Panel recommending measures ‘restitution’. The term ‘rectification’ would be adequate to cover the powers provided later on for company reports to be amended in cases of proven non-compliance. If the intention is to cover the Panel’s intended powers to initiate court proceedings, then some more explicit term should be chosen.
    
27. Clause 440W (3)(c) - composition of the panel – refers to “chartered accountants”. It is ACCA’s view that the membership of the Panel should not be restricted in this way. The criterion for membership should be technical competence and ACCA therefore proposes that this clause be amended to harmonise it with clause 440P, which deals with the composition of the Financial Reporting Standards Council. This clause (in sub clauses b and c) refers to “persons responsible for preparing financial statements” and in sub clause d “users of financial statements”. We suggest these terms be used, rather than “chartered accountants”.
    
    Clause 440AA
28. This clause sets out a number of procedural provisions with respect to the investigation of complaints. Our reading of this suggests that the requirements are administratively demanding. We query simply whether the requirements are reasonable and likely to be achievable in practice.
    
    Clause 440FF
29. In sub-clause (1), we suggest that the text needs to stipulate that a director commits an offence if he or she was a party to ‘the approval’ of an offending report.
    
30. More substantially, we consider that this clause as a whole needs to make a much clearer separation of the two types of consequences which could ensue from the Panel finding that a report has failed to comply with one or more financial reporting standard. We suggest that the clause needs to be re-drafted so as to achieve this objective.
    
31. We support strongly the idea of having a mechanism such as the panel to monitor companies’ compliance with the reporting rules. But it is excessive, in our view, for the clause to start off by stating that a company which is found to be in breach by the Panel commits an offence.
    
32. The first consequence of any adverse finding by the Panel should be administrative, whereby an offending company is required to take appropriate remedial action to revise and re-publish its financial report so as to rectify the defects identified by the Panel. The Panel needs to be given express powers under the Bill to require companies to take such remedial action and to identify a time frame within which this should be done. In most conceivable circumstances, the likely commercial impact of the making of such an order will be sanction enough for a listed company, and any company in this situation will doubtless be eager to take the necessary remedial action as quickly as it can.
    
33. The second consequence, namely court action, should be reserved for those, probably rare circumstances where a company fails to co-operate with orders given by the Panel to make good the defects identified. The Panel needs to be given express powers to initiate court proceedings against the company concerned. The form of criminal penalties attributable to the company and its directors should also be set out in the clause.
    
34. We have also made the point, in our comment on clause 33 of the new Bill, that IFRS does not insist on absolute adherence to standards’ specific requirements in all circumstances – there is recognition of a reporting company’s right to depart from the specific requirements of one or more IFRS if there is good reason to do so in the context of the requirement to satisfy the ultimate, overriding test of giving a ‘fair presentation’ of the company’s financial position. In giving the Panel authority to investigate, and take action on the strength of, breaches of individual standards, this important point must always be borne in mind.
    

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