NEWS & COMMUNICATION Comments on the proposed Financial Reporting Bill [ Back to the News & Communication Page ] Prepared by the Secretariat of The Southern African Institute of Government Auditors Download the proposed Financial Reporting Bill (MS Word) Download the proposed Financial Reporting Bill (pdf) Approach Rather than commenting on technical aspects contained the proposed Financial Reporting Bill (hereafter referred to as the "proposed Bill") we have attempted to outline some of the problematics concerned with the introduction of an ad hoc piece of legislation, the stated intent of which is to address a deep- rooted problem having a serious socio economic affect on South Africa’s society. Our comments arrive from juxtaposing the intended objectives (as derived from the "background problems" highlighted in the memorandum to the proposed Bill) against the proposed actions and structures as contained in the proposed Bill. The proposed Bill, viewed as isolated document may be perfect, however, if viewed against the intended objectives, it's serious flaws become apparent. Lack of a holistic approach The proposed Bill deals with the following problems in a symptomatic and isolated manner: flawed accounting and auditing standards; high levels of non-adherences to existing standards; differences in statements of generally accepted accounting practices as published by various standard-setters world-wide; creative accounting practices and low levels of disclosure; uncertainty as to the role of the auditor in the reporting process; high level of unethical practices by both accountants and auditors; failure of professional accounting bodies to act responsibly and objectively within the accountability framework; the inherent flaws of self-regulation; low levels of adherence to Companies Act requirements; shortcomings in the system of professional entrance examinations in the accounting industry; a disregard for the public interest at the expense of vested interests (mainly of a business nature) by professional accounting bodies and their members; and other problems highlighted by financial scandals experienced in this country In formulating the proposed Bill, no attempt has been made to investigate some of the most grave concerns and problems related to poor reporting practices, such as: the failure of professional accounting bodies to "self-regulate"; the practice by accounting bodies and the South African Institute of Chartered Accountants (SAICA) and the Public Accountants’ and Auditors’ Board (PAAB) in particular, to protect and abet those moving in the accounting corridors of power at the expense of the public; the inherent flaws in the educational systems of both the PAAB and the SAICA, including the subject contents, professional examinations and systems whereby so-called training contracts are administered and managed; the role of auditing in the financial reporting process; the role and effectiveness of other regulating agencies; the exact nature and extent of the malpractices mentioned above. For example, the memorandum to the proposed Bill refers to "unsound accounting practices". It seems, however, that no investigation has been undertaken to identify and to quantify these "unsound" practices". Such an exercise would make it possible to evaluate the effectiveness of the proposed Bill – it would also ensure that the proposed Bill is formulated on a basis of facts, rather that unscientific converse. No inclusive and balanced solution can be devised unless an independent probe is undertaken in respect of the above mentioned problems. [ Back to the News & Communication Page ] Lack of defining underlying principles The proposed Bill lacks a coherent set of underlying criteria and principles. Although one of the main aims of the proposed Bill is to provide for the" setting of financial reporting standards", the proposed Bill lacks a coherent set of criteria and principles against which the outcomes and products of the standard-setting process can be evaluated. This leaves the standard-setting body without guidance, open to undue influences and also to a large extent non-accountable. It provides those affected by the standard-setter’s products (the final statements of accounting) no avenue of redress or basis on which to formulate an objection to the publication of flawed statements. History has taught us that the contents of accounting standards are changed continuously by the standard-setters. These changes occur if and when the standard-setters decide to do so. The public has very little, if any say in it. The main reason for the necessary changes cited are that the "old" statements were "deficient" and needed revision. These arguments are, however, assumed invalid if raised (during the comment period) by concerned members of the public when a newly published statement is obviously flawed. Without a set of accepted criteria and principles to which all published statements must conform, no convincing argument (or comment) can be formulated against flawed products of the accounting standard-setting products. This leaves the accounting standard-setters non-accountable and in a position of absolute power, which as history has also taught us, corrupts. The proposed Bill does not address this critical aspect, therefore highlighting the fact that it is not designed to take into account the public interest. Incorrect supposition regarding legal backing Many problems relating to financial reporting in South Africa are based on the fact that South Africa companies do not adhere to the most basic Companies Act requirements (for example, research by the University of Pretoria showed that only 3% of the top 300 listed companies fully adhere to Section 283 of the Companies Act – disclosure of audit remuneration). The proposed Bill is not addressing these problems. It is, however, assumed that another Act and certain Companies Act amendments will solve the problems. It should be obvious that the root of the problem lies deeper. The public interest is therefore not served by ad hoc amendments to the Companies Act. The proposed Bill incorrectly supposes, and later treats as a matter of fact (which is supposed to be generally accepted and supported by evidence), that legal backing of accounting standards will solve the problems associated with poor reporting practices, etc. Legal backing is not a magic wand that will solve the problems of poor financial reporting practices. If viewed in isolation of other elements of the accountability framework, it may actually be highly destructive and counterproductive within South Africa’s socioeconomic framework. Five countries, including the USA are listed in the proposed Bill’s memorandums having legal backing. The argument is then presented that it is also essential in South Africa. However, the country with longest legal backing (USA: since 1930) is currently experiencing the worst accounting crisis ever, necessitating the country’s President to intervene and to put forward an" emergency plan" to address the serious shortcomings. How has legal backing favoured the USA and ensured better reporting practices and less financial scandals? The solution to the problems the proposed Bill wished to address lie much deeper than the measures proposed. Lack of research and scientific basis The conclusions as formulated in the memorandum to the proposed Bill (paragraph3.1) are clearly not based on any research whatsoever and phrases such as "This approach will inevitably result in a more objective, credible, consistent and fair …" are unscientific, unfounded and misplaced in a document intended to support proposed legislation. The effect which the proposed Bill may have on smaller companies has not been researched and the problematics of defining a small/large company, taking into account company structures, creative accounting engineering, and South Africa's specific circumstances etc., has not been addressed. It is dangerous to target certain symptoms without having studied and captured the underlying causes of the holistic problem. Ignoring the role of the auditor The fact that auditors play a critical role in the financial reporting process (this is what the proposed Bill is all about) is universally accepted. The proposed Bill, however, ignores the audit function and the serious problems associated with the audit expectation gap and its negative influence on the quality of financial reporting. It seems irresponsible to introduce legal backing of accounting standards, without addressing legal backing of auditing standards and clarifying the role of the auditor . The Accountancy Profession Bill to be formulated form an integral part of solving problems associated with the financial reporting process. Publishing ad hoc legislation and changes to the Companies Act , before the Accountancy Profession Bill is drafted, severely limits the option of the Minister of Finance in introducing new structures and procedures. The Accountancy Profession Bill will change the regulatory framework and new structures will influence the Financial Reporting Bill. The Proposed Financial Reporting Bill cannot be drafted before the Accountancy Profession Bill. Composition of the Council The activities and products of the work of the Council influences everyone in South Africa. Changes in accounting standards have an effect on the calculation of distributable profits, taxes and levies collected and paid, bonuses paid to the workforce as well as the perceived performance of companies holding vast sums of moneys from both local and overseas investors, workers, trusts, and the general public. In view of the above, the composition of the Council needs to be extended to be inclusive of the various constituencies affected by the setting of accounting standards. The following constituencies also need to be represented: all spheres of government; financially related government agencies (e.g. Treasury, Receiver of Revenue); financial regulators (not self-regulators or Institutes structured on the same basis as exclusive clubs); organised labour; organised business; academia; the public In selecting Council members, cognisance needs to be taken of the fact that the functions of the Council differ from that of the technical committees. Therefore Council members need not necessarily have a high technical accounting qualification. It is much more important that they are independent, that they can analyse, assess recommendations, think logically and accept the notion of the public interest. Taking into account the enormous advantage which a representation on the Council potentially holds for members of the big auditing and accounting firms, all partners and senior staff of these firms should be disqualified from serving on the Council. Furthermore, no Council member should be allowed to hold a public office at any accounting and/or auditing institute. All Council members must be required to declare any interests they have with the big accounting and auditing firms. Excessive interests should also be a criteria for disqualification. Lack definition of accountability principles in the standard-setting process The proposed Bill does not contain safeguards to ensure the applicability of established and critical accountability principles in the standard-setting process , such as: openness; transparency; exclusivity; public access (the public’s right to be present at the standard-setting processes); availability of information (effects of proposed accounting standards); compulsory publication of draft documents so that they are assessable to the public; democracy in standard-setting; procedures to object against the standard-setting process / standard-setters; accountability of the standard-setting (declaration of interests); misuse of information before it is published ("insider trading" of accounting standards information); assurances regarding independence issues. Conclusion: The auditing and accounting industry needs to be subject to an independent investigation, which extends and builds on the constructive work done by the Commission of Inquiry into the Affairs of the Masterbond Group of Companies and Investor Protection in South Africa. The Accountancy Profession Bill has to be drafted before the Proposed Financial Reporting Bill. Only when the results of such investigation are known, and once the Accountancy Profession Bill is finalised, will it be possible to design strategies and structures to address the problems related to financial reporting in a holistic manner. Publishing the proposed Financial Reporting Bill before such information is available and such processes have been completed is not in the public interest. 8 May 2002 [ Back to the News & Communication Page ]
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