Report of the Standing Committee on
Auditor General on the Budget and Strategic Plan of the Auditor-General 2008-
2011, dated 13 November 2007:
Introduction
The Office of the Auditor-General (AG) tabled its Budget and Strategic Plan
2008-2011, as required by Section 38 (3) of the Public Audit Act 25 of 2004, to
the Standing Committee on Auditor-General (SCOAG)) for its consideration. The
Committee held hearings with the AG on
Present at the meeting were:
Ms B A Hogan (Chairperson); Mr. D M Gumede; Rev N W Ngcobo; Mr. M L Mahlaba;
Mr. M Johnson; and Mr M J Nene (ANC); Mr. E W Trent; and Mr. M Stephens (DA);
Dr G G Woods (NADECO).
Mr. T Nombembe (Auditor-General); Mr. K Makwetu (Deputy Auditor-General);
Mr. S Boyd (Acting Chief Financial Officer); Mr. W Tutani (Business Executive:
Governance); and Mr. A Kamedien (Senior Manager: Corporate Services)
Review of Budget
1. Funding Basis of the AG
1.1 The AG generates its own revenues to fund its operations and receives no
funding from Government.
1.2 It separately bills each government department, public entity and
municipality for the audits; it is constitutionally and legally obliged to
perform.
1.3 In the public interest it aims to keep its auditing fees as low as possible
and its gross profit at an absolute minimum, generally to cover overheads.
1.4 As a working rule, any surplus it generates is returned to the National
Revenue Fund if the funding position[1]
reflects a surplus; if the funding position records a deficit, the AG would opt
to retain the surplus in order to fund its cash commitments.
1.5 A funding deficit is sustainable as long as it is less than the working
capital requirement, as this is regarded as a temporary phenomenon in that the
cash (debt) is usually collectable within 60 days.
1.6 Additional funding would be required should the funding deficit exceed
working capital.
1.7 The AG contracts out a fixed percentage of its audit work to private
companies during peak auditing periods. No surpluses/ efficiency gains are
generated out of work that is contracted out so it is necessary to contain
contract work within sustainable limits, to minimize the negative impact on the
funding basis of the AG.
2. Financial Projections for 2008/2011
2.1 Projected Rise in Audit Income
Audit income is projected to rise to R 1, 292.6 billion in 2009 from a
forecasted R 1, 072.4 billion in 2008. This is a 20, 5 percent increase. 55
percent of the increase is in Own Hours Income and 45 percent is due to salary
increases of 7 percent and general tariff increases of 4 percent.
The following are some of the critical factors underlying the increase in audit
income:
2.1.1 Span of control within the audit units and teams. The AG is still not
operating at an optimum level because of a number of auditors that do not
comply with the minimum qualifications framework, and therefore operate and are
remunerated at sub-optimal levels. The AG has decided to change the structures
that form a business unit. For 2008/09 a business unit will consist of 6
centres. Two new business units have been created at national level and 4
provinces (
2.1.2 Recovery Ratios. Recoverable
hours are set to increase by 11, 79 percent due to the increase in staff and
two more working days in 2008/09.
2.1.3 Tariffs. Tariffs are set to
increase annually by 4 percent. Actual increases are higher though and average
at 9, 5 percent due to salary increases of about 7 percent.
2.1.4 Own Hours Income. The
projected increase in the total number of own hours income is set to reverse
due to the dramatic rise in the contracting out of audit work. In 2008/09, 39
percent of work contracted out to private audit firms will be returned to the
AG. This is due to the anticipated increased capacity at the AG. Furthermore,
catch-up work, due to the late submission of financial statements will decrease
by 89 percent. New audits, especially those of certain public entities will
increase own audit hours as will the increased focus on performance information
auditing, asset auditing, the expanding operations of auditees and the use of
the capability model in assessing risk. In total, own hours audit income is
budgeted to expand 30 percent to R 857.1 million in 2009 above the previous
year’s forecast of R 657.9 million. In contrast, contract work expands by a
minimal 2, 14 percent from R 360.6 million to R 368 .3 million. However
contract work, as a percentage of audit income remains unacceptably above high
the norm of 20 percent at 30 percent.
2.2 Overheads
Overheads are set to increase by 23 percent from the R 297 million forecasts
for 2007/08 to R364, 9 million in 2008/09. Support staff remuneration recorded
at R 120 million for the financial year 2008/09, a 25 percent increase over the
forecast figures for 2007/08.[2]
2.2.1 Increased overheads are mainly driven by increased audit work and several
strategic operational imperatives in the office.
2.2.2 Overheads are projected to stand at 28 percent of audit income which
places
2.3 Capital Expenditure
2.3.1 Capital expenditure in the audit business units cannot exceed certain
ratios. It is set to rise by 72 percent to R 50 million in 2008/09, most
importantly because of the critical under-investment in technology in previous
years, often because of cost-cutting exercises.
2.4 Net Deficit
2.4.1 The disturbing trend of recording net deficits on the income statement
that started in 2006 [3]
continues in 2008, with a forecasted deficit of R 16, 5 million. The trend
should start to improve in 2009 with a projected net surplus of R 8.4 million
if corrective measures are successful.
2.4.2 The trend towards deficits is caused primarily by a marked shift towards
contracting for auditing purposes; this is prompted by skills shortages, high
vacancies and larger than expected numbers of late submissions of financial
statements, especially at local government level. In 2008, R 251 million was
budgeted for contract work; by 2009 the projected amount is R 368 million, a 47
percent increase over the previous year’s budget. Contract work as a percentage
of audit income reaches historical highs [4]in
2007 and 2008 (35 percent) and starts to decrease to 30 percent by 2009
2.4.3 Overheads as a percentage of audit income rise to 28 percent in both 2007
and 2008 and rise even further in later years.
2.5 Funding Deficit
2.5.1 Although the AG has been recording a funding deficit for several years,
in 2008 this deficit is forecast to be unsustainable insofar as the deficit of
R 150.8 million exceeds net working capital (R 96.2 Million) by R 54.6 million.
For 2009, the exceeded limit increases to R 88.6 million and the trend
continues unabated for the following two outer years of 2010 and 2011.
2.5.2 Two of the most important causes for the deterioration in the funding
base is the greater reliance on contract work (discussed above) and slow debt
collection which affects cash flows. In practice and on average, the AG
collects on 60 days and pays on 45 days resulting in a significant ongoing need
for working capital funding. The tight cash flow situation is made worse by
slow and non-paying debtors.[1] Total
arrears at beginning of 2007/ 08 amounted to R 59.6 million with local
authorities accounting for R 35, 2 million of that debt.
2.5.3 With the recorded deficit in 2006 and the forecast deficit in 2007, the
AG will require approximately R 63 million cash this year to meet its operating
capital, and reserve requirements for this year.
2.5.4 The AG has embarked on an ambitious programme to alleviate skills
shortages[5]
and is engaging with the National Treasury concerning the recovery of local
government debt in order to improve the funding basis of the AG, but these
initiatives will only be fully realized in time to come. However the fact
remains that even if the vacancy rate is brought down to the required 8.3
percent and debtor patterns remain the same, the AG will still require a cash
injection of approximately R 89 million in 2008/09
3. Committee’s Observations on the
Budget
3.1 The Committee is extremely concerned about the unsustainable funding
deficits that are projected for the end of this financial year (2008) and for
the following years onwards without any reversal. These are ascribable in the
main to the increased scope of audit activity, high staff vacancies,
inappropriate spans of control within the audit units and teams, increased
reliance on contract work and cash flow problems arising out of slow paying
debtors and bad debt.
3.2 The AG has embarked on a number of measures to rectify the imbalances,
including an ambitious recruitment programme to fill vacancies, thereby
decreasing reliance on contract work. Discussions are taking place with
National Treasury to secure the payment of debt, principally from non-paying
municipalities. However, even if vacancy levels are reduced, additional funding
will still be required and contract work as a percent of audit income will
remain unacceptably high, at 30 percent, which exceeds the norm of 20 percent.
3.3 Overheads stand at 28 percent of audit income and lies just below the median
range internationally of between 25 percent and 35 percent so it is unlikely
that significant savings can be made to cover the funding shortfalls.
Similarly, capital expenditure is set to rise dramatically by 72 percent, a
substantial increase necessitated by underinvestment in previous years,
primarily in computer technology, due to cost-cutting initiatives.
3.4 It must be concluded then that the funding problem affecting the AG is
primarily on the income side and driven ultimately by the critical skills
shortages in the accounting and auditing professions in
3.5 The AG is of the view that the current funding model can no longer cater
for meeting the working capital, reserve and capital expenditure requirements
of the Office and that a new funding model is required. Possible options
include the following:
i. Allocate budget to relevant Treasury.
The AG recovers fees from the relevant Treasury, being paid in advance, with
tariffs increased to fund capex and reserves after interest received.
ii. Allocate Corporate Services,
Reserves and Capex budget to AG. AG tariffs reduced to exclude Corporate
Services, whilst tariffs are increased to fund working capital requirements,
after interest received.
iii. National Treasury gives a quarterly
cash advance for operating expenditure. Tariffs increased to fund capex and
reserves after interest received.
iv. Increase AG tariffs for working
capital, capex and reserve funding.
v. Allocate Audit Budget to AG.
Auditees would note value of ‘service without charge’ in financial statements.
3.6 The most important consideration for any new funding model is that the
independence of the Office of the Auditor-General must not be compromised in
any way. For this reason, any option that would include grant appropriations
either from Parliament or the National Treasury such as in Options ii, iii or v
is the least desirable. This is also so because the AG’s Budget and Human
Resources practices would inevitably be scrutinized according to the norms and
practices pertaining to the Civil Service. In earlier years, the Office of the
AG, as with SARS, were deliberately placed outside the domain of the civil
service because of the specialist nature of their activities that are not
easily compatible with practices in the civil service.
3.7 Options I-IV all envisage a partial or full increase in tariffs. This seems
unavoidable but the National Treasury must be consulted on the matter.
Consideration would also have to be given to the impact an increase in internal
tariffs would have on the escalation of costs on contract work.
3.8 Option IV does not necessarily solve the cash flow problems arising out
slow payment of debt, especially by municipalities.
3.9 Option I appear to be the most desirable in that it potentially solves the
cash flow problems and eases the pressures on funding. It does, however involve
an increase in tariffs.
3.10 The Committee is of the view that there should be extensive consultation
and research on the proposals regarding the new funding model, but cautions
that process for the compilation of the national budget for 2008/09 is far
advanced. The proposals must be brought back to the Committee for approval.
3.11 The Committee endorses the request for a cash advance from National
Treasury for 2007/08.
3.12 The Committee requests that a document be prepared outlining all the legal
options afforded the AG to recover debt from municipalities in terms of the
Public Audit Act 25 of 2004, and local government-related legislation, and to
make proposals to the Committee in this regard.
3.13 The Committee undertakes to request all parliamentary committees, at
national and provincial level, that exercise oversight over local government to
consistently monitor the payment of audit fees at local government level, as
well as the timeous presentation of their audit reports to the AG. The AG
should prepare a schedule of non-paying municipalities for distribution in the
legislatures.
3.14 The Committee requests regular progress reports on the filling of vacancies
in the Office of the AG.
4. Committee’s Observations on the Strategic Plan 2008-2011
Whilst there are very little key differences between the strategic objectives
as outlined in 2006/07 and those for the years under consideration viz.
2008-2011, the Committee would like to draw attention to matters that it
considers especially important if the AG is to succeed in its objectives. These include:
4.1 Continued improvement in the quality of audits, with no instances of poor
reporting of auditors.
4.2 An improvement in the timeliness of municipal reporting which will be
primarily dependent on the improved financial capacities at local government
level. National Treasury must be approached to proactively assist in this
regard. The AG must make an informed opinion on the likelihood and extent of
late submissions, so as to manage backlogs without negatively affecting the
funding basis of the AG.
4.3 The Committee endorses the expansion of performance auditing to 10 percent
of total auditing but requests a framework that clearly specifies the focus and
parameters of performance auditing and performance information auditing.
4.4 The baselines have been set for measuring leadership and reputation and the
Committee awaits progress on these matters.
4.5 The reduction of the rate of staff turnover is critical to the
well-functioning of the AG as well as to its financial viability. The Committee
awaits reports on the success of the recruitment drive as well.
4.6 Operational excellence is absolutely critical and now that the baselines
have been established the Committee looks forward to a progressive maturing of
operational processes.
4.7 Cost of Auditing presents a great challenge to the AG, especially with
regards to the over-dependence on contract work. (Refer to discussions above).
4.8 Debt Collection continues to be a major challenge. The Committee requests a
schedule of outstanding debtors and progress reports on clearing debt.
Report to be considered.
[1] This refers to funding requirements that originate from commitments reflected in the balance sheet measured against the amount of cash and cash equivalents viz :
1. Reserves and Staff Liabilities
2. + Working Capital (Current Assets {excluding cash} less Current liabilities [excluding leave liability
3. + Capital Expenditure
4. + Hosting of Prestigious Events,
5. Less Available Cash Reserves
[2] Total staff complement is scheduled to increase by 274 personnel , with audit staff increasing by 234.
[3] 2006 Net deficit of R19,9 million; 2007 R1,8 million
[4] Normally budgeted at 20%.
[5] Cf P.60 of Budget and Strategic Plan of the Auditor-General 2008-2011.