Response to the opinion expressed by the Independent Regulatory Board for Auditors (IRBA) on the reasonableness of the internal and external rates of the Auditor-General

Rate schedule
The Auditor-General publishes two different rate structures for each financial year, namely:
internal rates which are the rates the AG uses to bill its auditees for work performed by its own staff, and
external rates which are the rates used by private audit firms to bill the AG for contract work performed on its behalf.

Internal vs External rates
Although the IRBA did not express an opinion on the external rates, it is however important to raise the background of external rates to fully understand how the AG’s rates compare to the rates used by private audit firms. The internal rates serve as a benchmark for external rates and the two are compared to ensure that the rates are reasonable. The external rates are the product of negotiations between the AG and the South African Institute of Chartered Accountants (SAICA).

The negotiations between the AG and the Public Sector Committee (PSC) of SAICA on external rates for 2007 have been concluded. The PSC committee as the mandated representative on the private audit firms raised specific concerns regarding the comparison of internal rates to the external rates.

Briefly, their concerns were:
the extent to which the AG’s rates are discounted compared to private firms
the lack of profit margin afforded by the external rates
the effect on recent legislation and International Auditing Standards on the recoverable hours spent on audits.

Calculation of rates
The formula for rate calculation is A/B x C, where A is the average salary per employee, B is the recoverable hours per employee and C is the fixed mark-up factor to recover overheads and ensure a profit margin. The concerns touched on each of these factors.

In response the AG would like to state that:
The AG follows a breakeven business model as opposed to a profit-driven model. It contains its costs as far as possible, striving to be as effective and efficient as possible and not to add any unreasonable costs to government
The increase allowed for rate increases should not exceed 10%. The agreed increase was 4% on 2006-07 rates. The fixed mark-up factor should be set at 2.75 and not the 3.00 requested by SAICA.
The recoverable hours for each earnings interval are sufficient to conduct the required audit work at the accepted standard.

The aforementioned illustrate the approach of the AG to rate determination, its business model and rationale. This also applies to internal rates.

IRBA view
The opinion expressed by the IRBA touched on the following main points:
The non-typical manner that the AG uses to determine its rates.
The basis of calculating the rates.
The trend of increases in the mark-up factor over the last three years.
The increase in headcount.

The response to these main points is as follows:
To quote, “the internal tariff rates is not entirely in accordance with a typical calculation”.
The AG has maintained its method of calculation over the past number of years to provide a consistent approach that is comparable year on year. The principle of the full absorption of all overheads is used. Increases in rates were capped at 4% for the past three years. This is within accepted inflation targets. The budgetary processes we engage in enable us to budget for the cost, hours and income of each individual staff member. Therefore, we are able to achieve an accurate prediction of audit income.

The IRBA correctly stated that the mark-up factor is inherent. However, the accuracy of our budgeting for income is evident when actual results are compared to budgeted results. In this regard a variance of 3% between budgeted own hours income and actual own hours income was achieved in 2005-06.

Any new method would need to produce greater accuracy when income is determined. The executive of the AG would have to decide if it is feasible.

To quote, “a typical calculation to determine tariff rates..”
The mark-up factor is derived by dividing the income by the labour cost.
Using the IRBA example of 2006-07, audit managers earning between R390 000 and R490 000 produced income of R83 787 000 and labour costs of R40 560 000, resulting in an inherent mark-up factor of 206%. We agree with the accuracy of the IRBA calculations for audit managers. However, the mark-up factor is not missing as it is a derived value.

To quote, “there appears to be a significant amount of ‘bracket creep’”.
Using the audit managers as an example there has been a definite shift in the number of skilled staff earning in the upper pay range. This is due to various initiatives across all job grades by the AG, amongst others, the following:
Implementing the Minimum Qualification Framework (MQF) which requires all staff members to upskill.

Increased year-on-year expenditure on the number of staff members who have joined professional institutes (25% in 2007-08).

Increased year-on-year expenditure on training interventions (34% in 2007-08).
Increased year-on-year expenditure on bursaries (61% in 2007-208).

Positive results are rewarded with better positions and better remuneration. This does cause a gap in earnings between staff in training and staff who have progressed.

The year-on-year increases should begin to stabilise once all the initiatives have borne the desired results.

The AG has adopted an approach that extends its function from attestation to value adding. Greater emphasis is being placed on performance auditing that is a more expensive audit given the number of skilled auditors used to perform audits. Various initiatives to achieve a higher % of performance auditing are detailed in the Budget and Strategic Plan for 2007-10. This has also resulted in a greater manpower requirement.

Conclusion: The AG would carefully consider any initiative to amend its current processes. If any particular costing method will produce a better result it will be considered and further drive the next round of budget and tariff consideration.