Part 4.8 of the Memorandum on the Objects of the Bill states that the amendments propose that limited interest companies will be allowed to comply with less onerous accounting standards. It is unlikely that this objective will be achieved for the reasons noted below.

Section 285A(2)(a) of the Companies Act will require such companies to prepare financial statements to comply with the accounting framework of financial reporting instead of financial reporting standards. Paragraph 3 of this Framework states that "The Board of IASC recognises that in a limited number of cases there may be a conflict between the Framework and an International Accounting Standard. In those cases where there is a conflict, the requirements of the International Accounting Standards prevail over those of the Framework." This means that compliance with the Framework also requires compliance with financial reporting standards and accordingly does not provide limited purpose companies with any relief from the more onerous requirements.

Secondly, while section 440S (1)(b) of the Companies Act requires the Financial Reporting Standards Council to develop standards for limited interest companies, this is likely to take some time to develop. When the South African Institute of Chartered Accountants called for comments a few years ago on accounting standards for small and medium size enterprises it was our understanding that this was not supported by the SA Revenue Services. In addition, if such standards are based on those that seem likely to be developed by the International Accounting Standards Board, it appears that the standards will not be much less onerous than the current standards that would have to be applied by public interest entities.

Thirdly, one of the auditing pronouncements deemed to have been issued by the Regulatory Board in terms of the Auditing Profession Act, 2005 (SAAPS 2 – Financial Reporting Framework and Audit Opinions) requires financial statements that are regarded as being fairly presented (a requirement of section 285A(2)(c) of the Companies Act) to be prepared in terms of an identified financial reporting framework. Examples of frameworks that are regarded as acceptable are the South African Statements of Generally Accepted Accounting Practice approved by the Accounting Practices Board (section 11 of SAAPS 2). Accordingly compliance with the Framework without complying with the remainder of the financial reporting framework, would not be in compliance with the Framework as noted above; in addition one of the qualitative characteristics of financial statements is comparability, which requires transactions to be reported "in a consistent way throughout an entity and over time for that entity and in a consistent way for different entities" (paragraph 39 of the Framework). If companies were to use the Framework without the rest of the financial reporting framework then it is unlikely that consistency between companies will be achieved.

Possible solution

However, even though we have suggested a possible solution to enable the objectives of the bill to be met, we are concerned regarding the objective of the bill as it appears that the intention is to allow companies to determine their own accounting policies. This could result in companies adopting undesirable accounting policies, which could not be prevented as the bill is presently worded and could lead to undermining the credibility of financial reporting.

This section allows a limited interest company not to prepare "consolidated financial statements", but this might itself be a contravention of the Act as explained above regarding the requirements of accounting for limited interest companies; namely that compliance with financial reporting standards (including the need for consolidated financial statements) would be required at present.

In Section 53(1) of the Bill it is not clear whether the reference to the "first financial year" refers to years beginning or ending after the commencement date.

Section 285A(1) of the Companies Act

This section refers to financial statements being prepared in terms of financial reporting standards, but financial statements is defined as including provisional and preliminary reports, which are not catered for in financial reporting standards

In terms of the proposed Section 275A "an (registered) auditor appointed to a public interest company may not for the duration of the appointment perform any bookkeeping or accounting (as distinct from auditing) services and, to the extent that these would be subject to its own auditing, internal audit or tax advisory services for that company."

This section seeks quite rightly to limit the services which a registered auditor can provide a public interest company as sometimes such services could affect the state of mind or independent state of mind which is required of an auditor. However this section raises a number of questions:

In a rapidly changing commercial and economic environment where changing circumstances demand standards of ethical behaviour and standards relating to conflicts of interest or prohibited services for auditors, such an environment should be left to the close monitoring and rule setting of an independent body which has the expert resources to respond appropriately to such changing circumstances. With the advent of the Auditing Profession Act and the Independent Regulatory Board for Auditors we believe that there is now an independent body that will continually monitor and set standards at an appropriate level for our country based on the work of international standard setters and what is appropriate for South Africa.

The Independent Regulatory Board for Auditors will form an Ethics committee in the near future and that committee will be charged with ensuring that our rules are of an international standard and that where they need to go further are appropriate for South Africa. In our opinion, within the confines of the Companies Act legislation, and illustrated by some of the questions which arise from a reading of the terms used in Section 275A(1) we are strongly of the view that matters of a regulatory nature relating to prohibited non-audit services should be left to the Independent Regulatory Board of Auditors and it should not be a matter which the legislature should try to cater for in the legislation in this way.

Accordingly we would propose that Section 275A(1) not be included in its current form but that it be made clear that the Independent Regulatory Board of Auditors be charged with the responsibility of ensuring that rules are set for registered auditors in an appropriate way to preclude auditors from providing certain non-audit services in a way that would enhance if not guarantee the independence of the auditor. This approach to rule-setting will enable the prohibited services to be more precisely defined by the Regulator and will enable appropriate changes to be made timeously when required.

Alternatively the audit committee could decide which services can be provided as this is already provided for in section 270A(1)(d) of the Companies Act.

In a number of sections such as the proposed Section 274A reference is made to "the auditor or designated auditor". We question whether the Act should refer to two different terms when we presume what is being meant is "registered auditor" as contemplated and defined in the Auditing Profession Act of 2006? When the Act refers to these two terms as alternatives it suggests that it is referring to more than just the registered auditor as contemplated by Section 269 (Sub Section 6 & 7) of the proposed Companies Act Amendment. This could be clarified by defining "the auditor" as the auditor appointed in terms of the Companies Act and "designated auditor" as the individual registered auditor that is responsible and accountable for the audit of that company when a firm is appointed as auditor.

Much has been written in the lay press and in research documents about the effect which a board of directors can have on the registered auditor where they threaten the exercise of their power to fire auditors in the event that they should not go along with their point of view. This has in the past lead to auditors, who are under threat, possibly compromising their stances on matters of financial reporting and in regard to the audit of such company’s financial statements. This arises where a loss of work to an auditor could materially affect that person or their firm’s state of financial health. Accordingly such articles and research have suggested that one should take the power to appoint and the power to fire an auditor away from the executive directors and ask the Board Audit Committee to play a key role in such processes.

The proposed Section 270A Sub Paragraph 2 may possibly compromise the power of the board or the committee in this regard. This subsection proposes to provide the shareholders in general meetings with the power to appoint their own auditor "unless the audit committee is satisfied that the proposed auditor is independent of the company." So here one contemplates the situation where an auditor has a disagreement with a particular executive director on a matter affecting the financial statements and such director moves that another auditor be appointed and all that the executive director would need to show is that the proposed new auditor is independent of the company. It would appear to us that the threat of dismissal of an auditor has not been adequately dealt with by the proposed change to the legislation.

We concede however that professional standards to which the auditor is required to comply should mitigate against this risk of compromise on the part of the auditor but Subsection 2 of the proposed 270A seems to diminish the power that the board audit committee has in terms of Subsection 1 to dictate who should act as auditor of a company.

Also the proposed Section 273 places a considerable power in the hands of the executive and non-executive director to dictate who should be appointed as auditor. In our opinion all matters relating to the hiring and firing of the registered auditor should be left to the audit committee.

Section 274(2) of the Companies Act

This section refers to "the office of auditor for that year" when the appointment is not linked to any specific period – i.e. if an auditor resigns the subsequent auditor is responsible to complete any previously uncompleted audits; accordingly "for that year" can be deleted.

Section 280(2) of the Companies Act

Reference to section 22 of the Auditing Profession Act is not correct – it should be section 1

As communicated previously we have a concern that an auditor who is questioned during the course of an Annual General Meeting and needs to respond "according to his or her knowledge and ability to any question relevant to the audit of the financial statements" may result in the auditor breaching the confidentiality requirements contained in the Auditors Code of Professional Conduct. In terms of the code the auditor may not disclose any information which goes beyond that provided by the directors and which is included in the audit report without appropriate authority being given. There is also a risk that in answering questions posed to the auditor the registered auditor may inadvertently provide additional assurance over and above that which is allowed by international standards of auditing. Furthermore should the auditor be asked a question regarding a matter of detail it is possible that the auditor may not be able to answer the question immediately. It may be necessary for the auditor to refer back to his or her extensive files and accordingly, one may find that this requirement could result in the practical application difficulties that could result in the situation that the auditor is not in the position to reply timeously.

The proposed Section 300A of the Act now only seems to require the auditor to respond to such questions but in the event that the auditor cannot respond to the question at the time of the meeting this is not an "offence".

We also question who would determine whether the query that is to be answered is trivial or whether it is material.

We remain very concerned that this requirement will not be easy to comply with in a practical sense. If the legislation can be amended in such a way as to mitigate against the above risks then this would be in the interests not only of the audit profession but also in the interests of those who attend the annual general meeting.

As a practical suggestion we believe that if a question is to be addressed to the auditors at an annual general meeting that the person who wishes to address the auditor should provide the auditor with the question in writing ten days or a number of days before the annual general meeting, so that a properly documented response containing the relevant information can be prepared and shown to the directors of the company to ensure that there is no breach of confidentiality and an accurate response is given to the question.

Section 440W (3) refers to the word "auditors". Surely this should refer to "registered auditors". Throughout the Act the term "auditor" would need to be defined if the intentions of the Act are to be given effect to. As will be understood the "auditor" would include an internal auditor which will not be in line with the intention of Section 440W of the proposed legislation

Section 1 provides a definition of the "public interest company". The word "public" is used in subsection (ii) of this section but is not defined. We recommend that the word be defined. It is not clear whether it includes an offer to a selected group of people who are not existing shareholders; for instance does the word include a related party to the organisation, a director or officer of the company or close relative of such persons?

Furthermore, is it not appropriate that the definition of a public interest company should also include companies where the financial statements are "widely distributed" to many shareholders?

It is not clear whether the requirement regarding a subsidiary is to be considered from the perspective of (1) at any stage during the year, (2) throughout the year, or (3) only at the year end.

It is not clear in subsection (7) whether it allows a company to table financial statements at an annual general meeting prepared in terms of the requirements for a limited interest company, when the auditor would have already reported on those financial statements and at the date of the auditor’s report the required approval to use such standards would not have been provided. This section does not appear to contemplate the practical difficulties which would arise in such a situation.

The definition of a public interest company (section 1(h) of the Bill) is such that many South African subsidiaries of overseas companies could be regarded as public interest companies.

This could have the affect of imposing additional compliance burdens on such companies, which could result in the country not being perceived as investor friendly. The additional requirements are as follows:

Possible solutions:

The proposed Section 38(2A) inserts the requirement that, subsequent to the transaction, the consolidated assets of the company fairly valued needs to be more than its consolidated liabilities. It is not clear whether "consolidated liabilities" would include "minority shareholders’ interest". Surely it would be more than adequate to merely require that subsequent to the transaction the assets of the company fairly valued should be more than the companies liabilities "fairly valued"? In our view the inclusion of the term "consolidated" introduces a degree of complexity which is unnecessary. This section 38, like section 90 of the Companies Act, refers to "consolidated assets" and "consolidated liabilities" when it is not clear how this should be interpreted, particularly when an company does not have to produce consolidated financial statements because it does not have any subsidiaries. All that is essential is that the company’s assets should exceed its liabilities, both fairly valued.

Sub Section (2B) says that the directors must consider any contingent liabilities which may arise to the company. This section merely requires the directors to "consider" but not include the contingent liabilities in the assessment of the company’s liabilities. We would submit that it would be prudent to require that the directors should "include any contingent liabilities" in their assessment of solvency when financial assistance is being considered or given. Furthermore it is not clear how this consideration would be looked at by a court, seeing that non consideration would be an offence in terms of the Act.

Section 228(4) of the Companies Act

Section 270A(1) sets out the matters which need to be attended to by that committee.

In the draft bill published in the Gazette of 13 July 2005 one of the duties of the audit committee was (subsection (e)(i)) that the "financial statements … are in compliance with the provisions of any applicable law"

We believe that this is one of the most important duties of an audit committee and therefore should be included in the proposed section 270A of the Bill.

In many countries of the world and as contained in the "King II" report on Corporate Governance the essential ingredient of "financial literacy" is essential to the proper working of an audit committee. Given the objectives of the audit committee and the importance which the Companies Act places on such committees for the proper governance of companies of a public interest nature we are of the view that the legislation should at least require that one member of the audit committee should be "financially literate". Whilst we understand that this has been considered by the Department in drafting the legislation and has not been included in the Bill we believe it is of such importance to the proper working of an audit committee as to be essential in this legislation, if the legislation is to be regarded as complete and if the legislation is likely to be effective. An audit committee that does not have a member who is financially literate is likely to be an ineffectual committee in our experience, particularly insofar as it needs to consider whether the financial statements have been properly drawn up.

The proposed Section 287 and Section 287A makes it clear that it is an offence by any person who is party to the preparation of such financial statements to issue such documents or issue reports which are incomplete in any material particular or otherwise do not comply with the act or are perhaps false or misleading in some way. Furthermore Section 440 FF makes it clear that every director who has signed or is a party to a financial report which fails to comply with the financial reporting standard will be guilty of an offence.

It would appear to us that section 440FF deals with an offence which is already covered by Section 287 and 287A.

We question whether the proposed sanctions to be contained in Section 441 of the Companies Act are not in conflict in some way? For example, Section 441(bA), which refers to section 440FF, includes the sanction of a fine "not exceeding R1 million" whilst for a contravention of Section 287 or 287A the party would be exposed to "imprisonment not exceeding a period of three months or both a fine and imprisonment". We question whether the sanctions are not in conflict with each other given the three sections of the Act which establish such matters as offences.

We are also curious to note that the sanctions referred to in the previous paragraph are not as severe as the sanction to which a registered auditor is exposed as contained in Section 52 of the Auditing Profession Act. The Auditing Profession Act includes the possibility that a registered auditor who "knowingly or recklessly expresses an opinion or makes a report or other statement which is false in a material respect", being exposed to a fine or to "imprisonment for a term not exceeding 10 years or to both a fine and such imprisonment". It would appear to us that the legislature believe that the sanction which should be imposed on a registered auditor should be considerably greater than that which should be imposed on the directors of companies who are primarily in the first instance responsible for the preparation of the financial statements. We believe this disparity in the legislation in setting penalties is at variance with the intention of the legislature and also not in line with international standards.

Finally, in Section 287A it is not clear whether this section would include directors if they didn’t devise, prepare or recommend the particular scheme – i.e. they could argue they have put forward a scheme for consideration without any recommendations.

In Section 440S the words "establish" and "develop" are used in the context of setting financial reporting standards for both public interest companies and limited interest companies. These words do not seem to contemplate the likelihood that the International Accounting Standards Board will develop standards for limited interest companies.

We also wonder why Subsection 3 requires consultation with "representatives of limited interest companies". We would have thought that this would be a natural part of the process of developing such standards and did not need to be legislated. In addition we wonder whether this does not unnecessarily limit the activities of the proposed council insofar as there may not be any defined members who would be regarded as "representatives" of limited interest companies. Conceivably this could include the directors of each and every limited interest company in South Africa.