ERNST & YOUNG

Honourable Chairman and Portfolio Committee Members,

AUDITING PROFESSION BILL

On behalf of Ernst & Young South Africa, I wish to express our gratitude for being given this opportunity to present our views on the Auditing Profession Bill to you. We have already responded in some detail to the Secretary, Mr. Andre Hermans on the 30 September 2005, setting out our detailed commentary on the Bill.

It is not our intention to re-present all the detail in support of our views as set out in our prior letter but to use this opportunity to emphasise those matters which we believe are most important to be addressed to achieve the objectives of the Bill.

We strongly endorse the objectives of introducing new and revised legislation with the intention of making constructive improvements to the auditing profession in South Africa, which in turn should play a significant part along with all the other initiatives being taken to improve public confidence in assurance services.

Multi-disciplinary practices

We are disappointed that the Bill excludes the possibility of establishing multi-disciplinary practices.

Our country’s business and legal landscape has become significantly more complex over the years along with concomitant increases in the standard and complexity of financial reporting and related auditing standards.

Consequently a need has evolved for the recruitment and retention of a diverse range of skills to enable auditing firms to audit entities effectively. Examples of skills and experience that today are needed by the modem auditing firm to enable it to audit large and complex organisations are taxation, legal, actuarial, information technology, regulatory, forensic, environmental and certain specialist industry expertise.

Retention of senior people with such diverse expert skills is essential to ensuring a quality service capability and support for the audit process in such firms and to enable greater control of the quality' of such work being conducted in these areas of specialism.

Multi-disciplinary practices are permitted in many other countries and, subject to the inclusion of certain possible additional safeguards to deal with the legislature's concerns, we submit that such practices should be allowed.

Safeguards could for example include a requirement that the majority of the partners are registered auditors or a higher percentage if this is considered essential. In addition, the Act might include in the powers of the Regulatory Board the ability to regulate partners of multi-disciplinary firms where they are non-attest registered auditors.

The Bill's definition of 'audit" states, inter alia, that it means "the examination of financial statements with the objective of expressing an opinion with a high level of assurance as to their fairness and as to their compliance with an identified financial reporting framework and any applicable statutory requirements".

Insofar as it refers to high assurance this differs materially from the definition provided by the International Federated of Accountants (IFAC), which is the international body responsible for setting International Standards of Auditing followed widely in the world today and currently required in South Africa. IFAC's definition refers to "reasonable assurance

Our concern is that these are materially different definitions, particularly in so far as "high" implies a much higher level of assurance and will mean that the International Standards of Auditing which are regarded as the required standard in South Africa will not necessarily meet the definition set out in the Auditing Profession Bill.

Accordingly we respectfully submit that the definition should be changed to IFAC's definition which is one which is accepted internationally and a fundamental concept upon which their standards have been formulated.

We are aware of the 2002 study on the subject of levels of assurance having been published by IFAC. In the light of possible changes to IFAC's standards in this regard it may be preferable for the Act to just require compliance with IFAC's standards in future.

Section 44(5) states that a registered auditor may not become the auditor of an entity if at any time during the two years prior to the commencement of the financial period to be audited the registered auditor had "conflict of interest" in respect of that entity as prescribed by the Regulatory Board.

In commenting on this section we understand that the words "conflict of interest" have not been prescribed or defined by the Regulatory Board yet. However given these words' normally understood meaning we submit that this section's requirements are neither practical nor do they need to be included in the Act.

Practical Implications

From a practical point of view, we believe that it is conceivable that if such a rule were to prevail when an organisation is contemplating appointing another audit firm which has the resources and skills needed to conduct its audit, it may find that it cannot change auditors because all the firms which are suited to such an audit and have the resources to conduct the audit are all conflicted in the two year period prior to their prospective appointment.

In our opinion the matter which is of concern to the drafters of this legislation, namely auditor independence, should be dealt with in the conflict rules to be prescribed by the Regulatory Board in due course. We question why it is necessary to mention this limitation in the Bill when the full list of other limitations to the appointment of an auditor, are not covered by the Act.

If the Act requires a prospective registered auditor to be independent for two years before appointment:

• One restricts the choice of audit firms where there may be a few which have the resource capacity and the expertise required to conduct the audit
• It will require auditing firms to decide at least two years in advance of an audit which they would propose to become auditors of, so that they could ensure that they provide no non-audit services or were in any other way conflicted.
• Could provide complications for companies embarking on merger and acquisition activities where their group auditors are conflicted on a "lookback" basis from conducting the audit of the organisation to be acquired.

In our opinion the Bill in this regard promises to be overly prescriptive in a country such as ours, which is relatively small and has a small auditing profession.

We propose that it would be more practical to require an auditor to dispose of any financial interest the auditor has in an entity or to cease any other activity which could affect its independence before being able to accept the appointment as auditor of that entity. We would respectfully submit that this is adequate to ensure that the auditor acts independently in conducting the audit work.

Where from time to time specific circumstances dictate that rules relating to independence need to be revised then the Ethics Committee of the Regulatory Board will be able to respond timeously to deal with new circumstances as they arise. We respectfully submit that all matters relating to conflict should be formulated by the Ethics Committee of the Regulatory Board once it is formed.

International Requirements

We would like to bring to the Committee’s attention the fact that the International Federation of Accountants' Code of Ethics which was recently updated in June 2005 includes no similar "lookback" conflict limitation.

In paragraph 290.31 of IFAC's rules it states that "the members of the assurance team and the firm should be independent of the assurance client during the period of the assurance engagement. The period of the engagement starts when the assurance team begins to perform assurance services and ends when the assurance report is issued, except when the assurance engagement is of a recurring nature. If the assurance engagement is expected to recur. the period of the assurance engagement ends with a notification by either party that the professional relationship has terminated or the issuance of the final report, whichever is later." The IFAC code deals with different circumstances which may arise and sets out its requirements in so far as there may be threats to the firm's independence.

Other considerations relating to an auditor's independence will in any event also need to be considered by a Public Interest Company's Board Audit Committee in terms of the proposed Companies Amendment Bill.

Reportable irregularities

We fully endorse the intention of the legislature to have registered auditors assist in dealing with the full spectrum of corporate crime in South Africa.

The current Public Accountants and Auditors Act, Section 20(5) has been in existence since the middle of the last century and is one that has presented significant challenge to practicing registered auditors over the period since its enactment, in view of the large number of laws which have been enacted since then. many of which are extremely complex and require significant amounts of training and expertise in the discipline of law to enable the auditor to identify and assess the legality or otherwise of matters which come to her or his attention during the audit.

We are concerned that the amendments which are now contained in Section 45 of the proposed Act require auditors to report. without delay, in writing to the Regulatory Board in circumstances where a matter "is fraudulent or amounts to theft or is otherwise dishonest". Such terms included in the definition of reportable irregularities includes no requirement that such acts should be material and so would require the auditor to report even the most minor of matters if they fitted the Act's terms.

Furthermore in the event that the Bill is amended to make reference to material matters, the auditor will nevertheless find it difficult to apply these provisions in practice. Materiality would need to be viewed from the perspective of a wide range of stakeholders and accordingly the auditor is likely to conclude that all such matters should be reported.

We submit that it was not the intention of the legislation to result in auditors reporting all such matters to the Independent Regulatory Board for auditors.

Accordingly we are of the view that reportable irregularities should only apply to matters which are considered material in the opinion of the auditor with reference to a monetary parameter determined with reference to the size of the entity being audited or with reference to its profits, results or other basis which is capable of objective determination.

Furthermore the Bill includes the terms "dishonesty" and "breach of fiduciary duty". We are concerned that these terms are capable of very wide interpretation in practice and once again one expects that the auditor would be inclined to report many more matters which could fall into these circumstances to the Board, where it was not the original intention of the legislation to do so.

We appeal to the legislature to make the meaning of Section 45 crystal clear because of the potentially extremely serious consequences for both auditors and entities in South Africa.

Section 52 indicates that where the registered auditor "fails to report a reportable irregularity in accordance with Section 45: or for the purposes of, or in connection with the audit services of any financial statement. knowingly or recklessly expresses an opinion or makes a report or other statement which is false in a material particular (the auditor) shall be guilty of an offence". Where a registered auditor fails in this way. such a person is liable to a fine or imprisonment for a term not exceeding 10 years or both a fine and such imprisonment.

We are wholeheartedly supportive of appropriate levels of sanction for circumstances in which an auditor may not conduct his or her work according to the required standards and in accordance with the relevant rules and legislation and we are supportive of' criminal sanctions for criminal auditors who behave dishonestly or fraudulently. However we are of the opinion that the sanction of imprisonment for up to 10 years for circumstances specified in section 52 is unduly harsh for the following reasons:

1. In circumstances where there was no criminal intent an auditor could be exposed to this penalty where the auditor made a mistake unintentionally
2. The auditor is unable to limit his or her liability in South Africa and is therefore already exposed to punitive unlimited financial penalty
3. The independent regulatory board for auditors is empowered to remove a registered auditor's accreditation if the offence warrants this, among other penalties
4. Introduction of a sanction of this nature will exacerbate the continuing shortage of qualified independent auditors, particularly when one considers the need for continued success in transforming the accounting profession.

We wish to bring to the Committee's attention the fact that recently in the United Kingdom a proposed jail term of seven years was proposed for inclusion in corporate law. The matter of such a criminal sanction was comprehensively debated and found to be unreasonable as has not been proceeded with by the Department of Trade and Industry. This was reported in the Independent on Sunday newspaper on the 25^th of September 2005.

We respectfully submit that the criminal penalty and jail term of a maximum of 10 years be removed from the Act in view of the other potentially extremely punitive penalties to which an auditor is already exposed to and which are already such that they present a material deterrent to poor work or criminal activity. We believe that the current Section 52 could result in unintended consequences where there has been no criminal intent.

Finally we wish to reiterate our support for the steps being taken to develop an even stronger auditing profession in South Africa for the benefit of all.

Thank you once again for the opportunity to present our views to you. Yours faithfully

14 October 2005