Many company owners have welcomed the new Companies Act (“the Act”) as it seemed to waive the audit requirement which would result in lower costs.
However, as the dust has begun to settle a different picture is beginning to emerge. Complex requirements imposed by the Act could well end up costing a small medium enterprise (SME) more as they negotiate the requirements of fair presentation, internally or externally compiled financial statements (drawn up by an outside person or within the business), independent review or audit.
All companies and close corporations (CCs) have to compile a public interest score (PIS) every year to determine if they are required to have an audit performed. If your score is more than 350 points an audit is required. From 100 to 350 points an independent review must be performed, except if your financial statements are internally compiled (generated by your staff), in which case an audit is required. Below 100 points an independent review is mandated.
The exception to the rule is owner-managed entities that have less than 350 points, where no independent review is needed.
Issue 1: Fair Presentation
The Act requires that financial statements “present fairly the state of affairs and business of the company, and explain the transactions and financial position of the business of the company”.
It also states that it is a criminal offence if the financial statements do not comply in a material way with the above, and it opens directors and officers to civil liability claims.
As the Act rarely invokes criminal sanctions, the framers of the Act have clearly placed strong emphasis on fair presentation. So how do you ensure fair presentation? By using globally or, at least, locally recognised accounting standards.
The Act sets out standards for businesses to follow, in terms of their PIS points:
- 350 and above: IFRS (International Financial Reporting Standards) or IFRS for SMEs.
- 100 to 350 points: IFRS (International Financial Reporting Standards) or IFRS for SMEs or SA GAAP (Generally Accepted accounting Practice- the local standard).
- Below 100 points: If financial statements are externally compiled – IFRS or, IFRS for SMEs, or SA GAAP.
- Below 100 points: If financial statements are internally compiled – as determined by the business.
You will be starting to glean that there is a high probability there will be some external participation in your financial statements. There is also an increasing swing to IFRS or IFRS for SMEs as it is globally accepted and it ensures there are no potential legal difficulties.
Switching to IFRS will initially be a costly exercise as you will need to re-align your financial information to meeting IFRS disclosure requirements, plus there is more work involved in compiling financial statements.
If you have less than 100 points, you may determine what financial standards to use. Be careful! The consequences of not producing fair presentation still apply to you – see comments above. It’s worth getting an opinion from us as to whether or not your standards comply with the Act.
Issue 2: Financial Statements Internally or Externally Compiled
A further complication arises with having your financial statements internally or externally compiled (“internally compiled” means done by your staff). For example, if your business scores between 100 to 350 points, an audit is required if your financial statements are internally compiled. To avoid an audit you will need to get an independent person to prepare your financial statements. Again this could add to your costs.
Issue 3: Independent Review
Independent review is the process of ensuring financial statements comply with the requisite standard of financial statements. The reviewer will perform analytical reviews on your financial statements and will have discussions with management. Contrast this to audit where tests are performed on a business’ internal controls and substantive and detailed analytical tests are performed. Independent review offers limited assurance on your financial statements, whereas at the end of the audit process you get an opinion that your financial statements “fairly present the financial position of the business”.
Independent review will cost less than an audit but in terms of giving assurance as to whether your business complies with the requirements of “fair presentation”, it is in its own words “limited”. Also remember if you want to sell your business, acquire a BEE partner or get a bank loan, you will almost certainly require an audit and the auditors will need to audit two years to be able to give an opinion. In the long run, you may end up paying a lot more!
Finally, the owner-managed businesses will not have to worry about independent reviews.
Issue 4: What Are “Financial Statements”?
Another important point is that financial statements are not just your annual financial statements but the Act defines them as any financial statement given to any third party. So it would for example include the monthly management accounts or trial balances you send to your bank manager.
The consequences of this are two-fold – an increase in cost in many cases as businesses ensure their financial statements comply with the Act, and also increased risk due to the potential criminal or civil remedies incorporated in the Act for presenting inaccurate financial statements. This added risk could be a time bomb waiting to explode!
So, What Should You Do?
Think very carefully – and take proper advice – before switching to independent review. Remember, auditors express an opinion as to the fairness of your financial statements. This extra assurance, and the guidance which it gives to directors and management, is worth a bit of extra cost. They will also be skilled in terms of the new accounting standards.
If you didn’t require an audit before and now are required to have a limited review done, weigh this up against having an audit done. The assurance given may well outweigh the costs.
Finally, if you are owner-managed, consult your accountant as to whether your financial statements fairly present the state of your business.