Auditor-General encouraged by emerging positive trend in local government audit results, but calls on government leadership to intensify drive towards total good governance

30 Jul 2014

Fifteen municipalities and two municipal entities improved their previous year's audit outcomes to progress to financially unqualified opinions with no findings (commonly known as a ‘clean audit'), increasing the number of clean audits to 30 in the 2012-13 financial year, Auditor-General (AG) Kimi Makwetu announced today. Overall, there were 63 improvements in different categories of audit outcomes against 25 regressions.

The AG's report, his first since his appointment last year, covers the audit outcomes of South Africa's municipalities and municipal entities - these have a combined total expenditure of R268 billion for the financial year under review (2012-13). This expenditure was made up of R62 billion for employment cost (including councillor remuneration), R166 billion for goods and services, and R40 billion in capital expenditure.

In its annual audits, the Auditor-General of South Africa (AGSA) examines fair presentation and absence of material misstatements in financial statements; reliable and credible performance information for purposes of reporting on predetermined performance objectives; and compliance with all laws and regulations governing financial matters.

Unqualified with no findings (clean audit)

The audited institution achieves a clean audit when the financial statements are unqualified, with no reported audit findings in respect of either reporting on predetermined objectives or compliance with laws and regulations.

Out of the 319 audits completed, 22 municipalities and 8 municipal entities achieved clean audits. This constitutes an overall 9% as compared to the 5% obtained in 2012. And, amongst the 30 clean audits, 13 have sustained this achievement since 2011-12.

Makwetu says auditees in this category have demonstrated impeccable levels of discipline and oversight in their financial management and operational activities.

"At these auditees, the breakdown of controls is easily detected and corrected timeously. Such environments are characterised by readily available documentation. Most importantly, they have accountable managers and leaders who are able to provide explanations and additional evidence in support of the transactions they are reporting on. They also have the support of strong oversight by mayors and councils that back the efforts of municipal managers and chief financial officers.

"We commend the Western Cape and KwaZulu-Natal provinces for already tracking double digits in this category. They have also acknowledged that it is some way to go still to sustain and institutionalise these disciplines while they work hard to improve controls at other municipalities. So it is work in progress but shows good positive signs," says the AG.

Unqualified with findings

One hundred and thirty-eight auditees (41%) received financially unqualified opinions with findings. These are auditees that have passed the critical test of fair presentation of financial statements, which means that they accounted accurately for the financial transactions they have carried out. However, the 'with findings' aspect suggests that these auditees may not have been transparent in the manner in which they conducted their activities as there were instances where they did not follow the required processes.

Such deviations from internal controls, Makwetu says, were largely in the area of supply chain management. In this category there are a number of auditees that incurred unauthorised, irregular as well as wasteful and fruitless expenditure due to material deviations from internal controls that govern these transactions. Also, this is a category of auditees that submitted financial statements that were initially unreliable and incorrect. This was mainly due to absence of basic recording, approval, regular reporting and follow up on monitoring oversight controls.

He said the longer the auditees remain in this category, the more the unwanted practices settle and permeate the environment through ongoing and uncorrected weaknesses in control.

"When these basic control deficiencies persist, they fester into the environment until there is no way to account for transactions and activities. When auditees start to conduct public business according to their own defined rules rather than those generally accepted and approved, poor governance becomes inevitable. This is usually prominent in environments where there is lack of transparency and consequences.

"It is our considered view that, when government business is conducted outside the controlled environment, in all likelihood it becomes a free for all where any transaction is capable of being executed without the related accountability. As a result, opportunities for realisation of service delivery objectives are lost and recovery becomes almost a nightmare. It is desirable that the leadership of municipalities take this issue seriously as it is a condition prevalent in all categories of audit outcomes outside of the clean audit environment," Makwetu cautions.

Qualified audit opinions

Eighty-four auditees (25%) received ‘qualified' audit opinions, which means that they were unable to adequately and accurately account for all the financial effects of the transactions and activities they conducted. In this regard, the financial statements they presented were unreliable in certain areas.

Many auditees in this category furnished the AGSA with performance information that either was not useful or was unreliable, which compromised the ability to drive effective accountability.

The AG says his office found out that a number of rules and regulations that apply to financial management and reporting matters were not observed as required in specific legislation. In this regard, there were many instances where there were deviations relating to supply chain management and inappropriate reporting on performance.

Adverse opinions

The eight auditees (2%) with adverse audit opinions performed similarly to those with qualified opinions, with the exception that the conditions regarding unreliable financial statements were common in most areas of the financial statements. This is unlike the qualified opinion where this is limited to certain areas. Auditees in this category have demonstrated extreme levels of lack of accountability for financial statements.

The AG says this is a classic example of controls that have broken down everywhere. "Here, all business cycles of the institution have deficient controls. This state of affairs increases the levels of financial exposure and multiplies the prospects for significant losses that could result in most service delivery and programme objectives not being achieved."

Disclaimers

Fifty-nine auditees (18%) received disclaimed audit opinions. These auditees were unable to provide the required evidence to enable the auditors to perform tests to satisfy themselves regarding the fair presentation of financial statements.

Makwetu says at these auditees, the stewardship over their financial affairs is not at desirable and acceptable levels. Such environments are characterised by a failure to provide credible evidence to support amounts and disclosures in financial statements. "The auditor is, inevitably, unable to conclude on any of the assertions that are made by management on the financial statements of the auditee. Anything could have happened to the financial resources entrusted upon the auditee and the auditor has significant uncertainty about the financial statements, and thus unable to express an opinion on whether the financial statements can be relied upon," he said.

Non-compliance with relevant laws and regulations

The AG's report shows that in the year under review, 90% of auditees had findings on compliance with laws and regulations, many of which related to the area of supply chain management. Irregular expenditure was reported at 265 auditees (83%), mainly due to the lack of basic controls and inadequate implementation of appropriate consequences where there has been poor performance or transgressions.

The AG cautions that "the value of these controls cannot be emphasised enough as they are an important mechanism to narrow the space for widespread abuse of the public resources that are required to provide services to citizens".

Ineffective use of consultants in financial reporting

Makwetu says he is concerned that 261 auditees (82%) were unable to produce financial statements that were free of material misstatements, with 110 auditees (35%) receiving financially unqualified opinions only because they had corrected all the material misstatements identified during the auditing process. This, he says, is despite the fact that most municipalities used consultants (external service providers) to assist with the preparation of financial statements, with a total spend of R695 million. He says in many cases such spending on external service providers was over and above the fixed cost of employment paid to those who are employed to fulfil financial management and reporting responsibilities. "It is evident that improvements in audit outcomes will be attained and sustained only if local government builds the institutional capacity required to maintain adequate internal controls, systems and processes," says the AG.

Irregular expenditure

Makwetu says as a result of significant breakdown in controls, municipalities and entities entered into transactions in contravention of regulations and other prescripts. The AGSA has classified these as irregular expenditure which totalled R11,6 billion for the period under review. "We have ascertained through audit tests that R8 billion of this amount represents goods and services that were received despite the normal processes governing procurement not being followed. The balance of R3,6 billion is at risk due to lack of supporting documentation, and we were therefore unable to confirm whether goods and services were received or not," he cautions.

Key actions by leadership

Makwetu says the auditees that advanced to, and those that have sustained, clean audits have demonstrated that such audit results can be achieved by all in local government. The winning formula of these auditees, the AG says, is:

a) introducing basic accounting and daily control disciplines
b) enforcing compliance with all legislation
c)   employing staff in accounting and financial management positions with the required level of technical competence and experience
d) calling for information and reports regularly with a view to supervising implementation of financial management improvement plan
e) allowing the chief financial officer to be in charge of the financial records and report thereon to the municipal manager
f) the council keeping the monitoring of the financial improvement plan on its quarterly meeting agenda, and
g) the municipal manager reviewing management accounts with the chief financial officer every month.

The AG says his office is encouraged by the responses and commitments of the premiers, speakers, members of executive council (MECs) responsible for finance and local government, as well as the respective chairpersons of portfolio committees at all legislatures met during July 2014.

"All these leaders have recognised the importance of prioritising these basic but very significant actions for municipalities. Our office remains ready to redouble its effort to work closely with all of them towards achieving transparent and accountable financial management and governance. It is for these reasons that we call upon all municipal councils across all the nine provinces to, at a minimum, adopt and follow the above examples diligently throughout the year. With these simple practical steps, the dawn of a substantially improved financial management and performance reporting in local government will be accelerated. This is a goal within reach and a key ingredient in building trust in the credibility and accountability of local government. This could add to the arsenal required to restore trust in local government's capacity to deliver services to citizens."

Makwetu says he is equally buoyed by how Cooperative Governance and Traditional Affairs Minister Pravin Gordhan has received the AGSA's good governance messages and the minister's commitment to shift to a higher gear in his department's drive to support and enable the local government.

Gordhan was recently quoted by media agencies as saying that "every municipality should have a sound and functional management system with the appropriate level of internal control. Municipalities should also cut wasteful expenditure and focus expenditure on investment infrastructure in performing the service delivery role that they are required to perform".

The AG says it is heartening to hear the minister emphasising the same messages the AGSA has been spreading. This, Makwetu concludes, "could only signal a major push in the drive towards wholesale good governance in municipalities, and my office will continue to be part of such developmental initiatives by working closely with those charged with governance and oversight".

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Read the report: MFMA 2012-2013: Consolidated general report on the audit outcomes of local government

Statement issued by the Auditor General, July 30 2014

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