Independent reviews not necessarily simpler, or cheaper, than audits
Johannesburg, Monday, 18 January 2010 - Decision makers who consider a review engagement simpler and cheaper than an audit are earnestly advised to think again, urges Theashen Ashley Vandiar, Project Director: Auditing and Members' Advice, at the South African Institute of Chartered Accountants (SAICA).
Currently, he explains, all companies, whether public or private, are required to be audited in terms of the Companies Act of 1973.
"But in terms of the new Companies Act, only public companies and companies considered as being in the public interest are required to be audited. Non-public entities would have a choice between an audit and an independent review of their financial statements.
"The aim is to lower the regulatory burden for small businesses.
"However, there are huge misconceptions as to the cost and workload involved in a review engagement as compared to the lesser benefits derived from it."
One is the idea that a review engagement would be cheaper than an audit because no substantive procedures are required for review engagements.
Vandiar considers it critical that business entities fully understand the two options available to them in order to make the correct choice. He believes the confusion is exacerbated by the current draft regulations to the Companies Act allowing for three different levels of 'independent reviews'.
Depending on the size of assets and turnover, Vandiar explains that a company subject to an independent review may be required to:
- Only produce a compilation report, as is currently the case with close corporations;
- Have a "review" performed in accordance with International Standards on Related Services (ISRS 4400), a standard that relates to "agreed upon procedures"; or
- Have a review performed in accordance with International Standards on Review Engagements (ISRE 2400).
Only the third provides some form of assurance, says Vandiar, who points out that where a company is required to have an independent review and is subject to the third level, it becomes important for the directors to assess the benefits of an audit..
"An audit involves tests of controls and substantive procedures and would ultimately result in an opinion being expressed by a registered auditor. An audit results in a reasonable level of assurance.
"An independent review performed in accordance with ISRE 2400, on the other hand, involves only enquiry and analytical procedures. An independent review thus results in only limited assurance being expressed by a practitioner."
Accordingly, Vandiar finds that many view the review engagement, as an alternative to an audit, as cheaper and simpler.
"But what most fail to realise is that a review is a double-edged sword. Although it would be quicker than an audit, since a review comprises only analytical procedures and inquiries, it would by no means be cheaper or simpler, given the level of expertise required of the reviewer and his experience and knowledge of the client.
"In order for analytical procedures and inquiries alone to be meaningful, the person performing the review needs to have an in-depth understanding of the client's industry and business environment, as well as a detailed knowledge of the client's internal controls, management's background, operating functions, prior financial performance, etc.
"A trainee clerk is unlikely to possess the minimum knowledge required to conduct a review engagement that will be of benefit to the entity."
Vandiar stresses that the minimum qualifications and experience expected of the person conducting the review has a direct impact on the cost of a review.
"Although reviews will not be restricted to registered auditors, the reviewer should at least have a theoretical knowledge of auditing and should belong to a suitable professional body - the relevant qualification to belong to such a professional body in the first place."
Vandiar highlights the additional requirement that the reviewer performs the review engagement in line with international standards.
"Currently, International Standards on Review Engagements (ISRE 2400) is being revised by the International Federation of Accountants (IFAC) and reviewers will need to comply with ISQC 1 on quality control and be familiar with the International Standards on Auditing (ISAs)."
He says the most significant difference between a review engagement and an audit boils down to:
- The time taken to complete the engagement; and
- The outcome in terms of the difference in the level of assurance obtained.
"An audit is likely to take longer than a review because an audit involves substantive procedures, which, however, would result in the highest level of assurance, whereas a review performed in accordance with ISRE 2400 can only provide a limited level of assurance."
Vandiar maintains that the cost of an audit would not be significantly different to that of a review performed in accordance with ISRE 2400.
"Although an audit would take longer and involves more detailed testing, such functions would be performed by trainees whose charge-out rates are not as high as a qualified chartered accountant or any other suitably qualified and experienced person performing this type of review.
"Thus, even though an ISRE 2400 review would be quicker, it may not necessarily be cheaper. Yes, other levels of independent reviews as described in the draft regulations would be cheaper, but they do not provide any form of assurance whatsoever."
Vandiar advises that when it comes to deciding whether to have their financials audited or not, non-public entities should consider their stakeholder needs as well as their future plans to grow and engage public interest.
"Good governance can be supported by performance of an audit.Management of non-public entities that choose a review rather than an audit, based solely on the assumption that an independent review performed in accordance with ISRE 2400 is cheaper, will be sorely disappointed."