Compilation of financial statements and related matters
Regulation 27(1) to the Companies Act determines that a company’s financial statements may be compiled internally or independently. A company’s financial statements must be regarded as having been compiled internally, unless they have been “independently compiled and reported”, as defined in regulation 26 [Reg 27(2)].
Therefore, there is an assumption of “compiled internally”, if not “independently compiled and reported”.
Regulation 26(1)(e) defines “Independently compiled and reported”: It means that the annual financial statements are prepared by an independent accounting professional on the basis of financial records provided by the company, and in accordance with any relevant financial reporting standards.
“Compile”, or in the specific context, “Compilation of financial statements” are not defined in the Companies Act or in the Regulations to the Act. One could refer to relevant pronouncements of the IAASB, including the Glossary of terms to the IAASB Engagement Standards, ISRS 4410, par. 3-4 and Proposed revised ISRS 4410, par. 15(b) and 15(c). It would appear that “compilation of financial statements” is interpreted in a broad sense and may include varying scopes. It relates to any engagement where a practitioner assists management with the preparation of financial statements in accordance with an applicable financial reporting framework. Furthermore, the compilation is distinct from an assurance engagement and does not entail the type of procedures that provides a practitioner with assurance.
Consider: XYZ (Pty) Ltd is a private company with a public interest score of 120 and does not have the internal expertise to prepare its financial statements in the format and in accordance with the requirements of IFRS for SMEs. In the past (under the 1973 Companies Act) they have always provided their auditors (Firm Q) with a trial balance at the end of the financial year. The auditor, apart from performing the audit in accordance with International Standards on Auditing, has always assisted management with the compilation of the annual financial statements in accordance with IFRS for SMEs.
The auditor has always (in the past) considered this to be acceptable for two main reasons:
(a) The auditor wasn’t disqualified under the Companies Act – Section 275 of the 1973 Act. “Bookkeeper” (and “accountant”) has been interpreted as entailing services distinct from the compilation of financial statements. In this regard, Section 44(5) of the Auditing Profession Act determines that a person must NOT be regarded as responsible for keeping the books, records or accounts of an entity by reason only of making closing entries, assisting with any adjusting entries or “framing any financial statements” from existing records.
(b) In terms of the Code of Professional Conduct for Registered Auditors (the Code), providing an audit client with services relating to the preparation of financial statements creates a self-review threat. However, if the audit client is not a public interest entity and the services are of a routine or mechanical nature, there are safeguards that could be applied to reduce the self-review threat to an acceptable level (Code, Section 290.167-171).
Under the provision of the Companies Act, 2008, the Memorandum of Incorporation (MOI) of XYZ (Pty) Ltd requires the audit of the company’s financial statements. XYZ (Pty) Ltd wishes to continue with the “normal” arrangement; i.e. providing Firm Q with a trial balance at the end of the financial year and requesting assistance with the compilation of its annual financial statements. Consider the following questions under the Companies Act, 2008:
1 Is the auditor disqualified in terms of Section 90(2) to accept the audit engagement of XYZ (Pty) Ltd?
2 Assume that the MOI does NOT require an audit, but that the director’s have resolved that the annual financial statements are to be audited. Is the auditor disqualified in terms of Section 90(2) to accept the audit engagement?
3 Assume that the auditor is not disqualified and accepts the audit engagement, as well as providing assistance with the compilation of the financial statements (as in the past; providing specified non-audit services). Are these financial statements compiled internally or independently?
4 Assume that the Public Interest score of XYZ (Pty) Ltd is 400. Is the auditor disqualified in terms of Section 90(2) to accept the audit engagement?
1 The audit in these circumstances is considered to be a voluntary audit (as apposed to a compulsory audit) in terms of Section 30(2)(b)(ii). However, since the audit is required by the company’s MOI, Section 90 with respect to the appointment of the auditor still applies [refer to Section 90(1) and 90(2), and Section 34(2)].
The disqualification in terms of Section 90(2)(b)(iv) does not apply, since Firm Q, or the individual engagement partner, is clearly not habitually or regularly performing the duties of accountant or bookkeeper.
The disqualification in terms of Section 90(2)(b)(ii) does not apply, since Firm Q, or the individual engagement partner, is not an employee or consultant of the company within the meaning of that section.
Therefore, the auditor is not disqualified in terms of Section 90(2).
2 The audit in these circumstances is considered to be a voluntary audit (as apposed to a compulsory audit) in terms of Section 30(2)(b)(ii). Chapter 3 of the Act only applies to the extent required by the company’s MOI [refer to Section 34(2) and Section 84(1)(c)].
Provided the MOI does not determine the application of any of the provisions in Chapter 3 of the Act, Section 90 will not apply to the company and the auditor will not be disqualified in terms of Section 90(2).
3 Regulation 27(2) specifically refers to “independently compiled and reported”. Firm Q, or the individual engagement partner, has not been engaged to compile the financial statements and report on the financial statements; as would be the case when a practitioner is engaged in terms of ISRS 4410 and issues a compilation report on the financial statements.
The auditor will only issue an independent auditor’s report, although the auditor has also been requested to assist the company in making closing entries, assisting with any adjusting entries and “framing” of the financial statements (as contemplated in Section 44(5) of the Auditing Profession Act).
Therefore, since the financial statements are not “independently compiled and reported” they are regarded as having been compiled internally in terms of Regulation 27(2). The implication of this is that since the company’s Public Interest score is within the 100 to 350 range, the company will be required to have its financial statements audited (i.e. a compulsory audit).
4 The company’s Public Interest score exceeds 350 and is therefore required to have its annual financial statements audited (i.e. a compulsory audit). Section 90 is applicable to the company. Similar to the answer in 1, above, the auditor is not disqualified in terms of Section 90(2).
However, the auditor must still comply with the profession’s ethical requirements. In terms of the Code of Conduct, a company with a Public Interest score that exceeds 350 is by definition a “public interest entity” (as determined by laws or regulation). Therefore, the auditor shall not provide the audit client with any accounting or bookkeeping services, including the preparation of financial statements (Code, Section 290.172 and the definition in the Code of “Public interest entity”).
With regard to your view 1
I note that a voluntary audit is one which is not required by the MOI or the Act. Therefore in my view this is not a voluntary audit. We are interpreting section 90(3) as clarifying that s90(2) applies to the individual audit partner where a firm is appointed. Therefore if it is the same auditor performing the assistance with the TB then he cannot be the engagement partner or auditor relating to this audit.
With regard to your second question
s90(2) does not apply to
voluntary audits. I therefore agree with your view.
With regard to your third question
There is no definition other than those you have outlined. Obviously this is still subject to case law, but our interpretation is that if a company provides a trial balance and all the auditor does is put that TB into a format for AFS, then it is still internally compiled, if no decision making is involved. However, as soon as decisions are being made and entries passed, I would view it as independently compiled. I therefore suggest you obtain a legal opinion in this regard. Unfortunately SAICA does not have such resources available. However, I agree that if it is seen to be internally compiled then an audit will be required.
With regard to your fourth question
I agree that if the company's Public Interest score exceeds 350 it is therefore required to have its annual financial statements audited (i.e. a compulsory audit). And also that it should comply with the Code. I agree to with your view as to the applicable sections of the Code although note the following:
"290.173 Despite paragraph 290.172, a firm may provide accounting and bookkeeping services, including payroll services and the preparation of financial statements or other financial information, of a routine or mechanical nature for divisions or related entities of an audit client that is a public interest entity if the personnel providing the services are not members of the audit team and:
• The divisions or related entities for which the service is provided are collectively immaterial to the financial statements on which the chartered accountant will express an opinion; or
• The services relate to matters that are collectively immaterial to the financial statements of the division or related entity.
290.174 Accounting and bookkeeping services, which would otherwise not be permitted under this section, may be provided to audit clients in emergency or other unusual situations when it is impractical for the audit client to make other arrangements. This may be the case when:
(a) only the firm has the resources and necessary knowledge of the client's systems and procedures to assist the client in the timely preparation of its accounting records and financial statements, and
(b) a restriction on the firm's ability to provide the services would result in significant difficulties for the client (for example, as might result from a failure to meet regulatory reporting requirements).
In such situations, the following conditions shall be met:
(a) Those who provide the services are not members of the audit team;
(b) The services are provided for only a short period of time and are not expected to recur; and
(c) The situation is discussed with those charged with governance."
Source : SAICA
Source : SAICA