39: Bernard Agulhas
Chief Executive Officer - Independent Regulatory Board for Auditors
“Auditors are not expected to detect fraud but if the public expects them to do so then maybe we should change our standards and our skills”
15 January 2020
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CIARAN RYAN This is CFO Talks and today I am very happy to be joined by Bernard Agulhas, who is the chief executive officer of the Independent Regulatory Board for Auditors in South Africa. Welcome, Bernard.
BERNARD AGULHAS: Thank you for the opportunity, Ciaran.
CIARAN RYAN Great to have you. Now, recently you were talking at an event, and you were quite busy with end-of-year events talking to various groups of accountants, but it was a very interesting talk that you gave and that's why I wanted to invite you into the studio so that we can pursue it a little bit more. A number of different things are confronting the audit profession at the moment and there are a lot of challenges. I think one of the things we were speaking about off air was the reputation of the accounting profession, I think this is something that concerns every accountant, whether they are an auditor, whether they are a bookkeeper or whether they are a chief financial officer. Maybe you can recap what you said to the group recently and what IRBA, Independent Regulatory Board for Auditors is actually doing as part of that. Has the reputation of accountants suffered and what is being done to clean that up?
BERNARD AGULHAS: It was interesting that the convention that I spoke at was actually about 4IR and about disruptive technologies and our response to it but part of our response to the reputational crisis is also to ensure that we continue to look at the competencies, I will talk a little bit more about the reputational crisis, but one of the responses had been to ensure that auditors are competent to operate in the current environment. One of the criticisms against the profession, causing the negative reputation, had been that maybe auditors are no longer qualified and don't have the necessary skills to be able to audit in a changing environment, in an environment where there's more fraud, there's more corruption and a much more heightened expectation from the public for the auditor to do more. Therefore, what I also talked about was the skills but addressing the skills and the competencies of auditors is only one way to respond to the current negative perceptions. The first thing that we had to do was to look into what the other reasons and the root causes were for around the current negative perceptions around the auditing profession, and there were many, there were many causes for it and once we had identified those we could respond with the necessary projects and initiatives to restore the confidence. Even more than that we need to restore trust, which is a much bigger project to achieve, a much bigger objective to achieve. The public and investors rely on auditors to make investment decisions. It's important that auditors produce the right opinions because if they don't then you'll have investors, pensioners losing their money. This is not just about the cost to companies but the cost to pensioners, their life savings being lost. Therefore, if the public is expecting auditors to do more, then we have to respond to that and one of the responses is to ensure that auditors are properly skilled up, specifically when it comes to fraud detection. At the moment auditors are not expected to detect fraud but if the public expects them to do so then maybe we should change our standards and our skills requirements for auditors so that we can be responsive to the public's expectations.
Training auditors to recognise fraud
CIARAN RYAN Is there any move to change the educational curriculums so that auditors are better prepared or skilled to detect fraud?
BERNARD AGULHAS: Absolutely, there are changes to the curriculum and we are looking into what the future auditor should look like and we should certainly incorporate those competencies, not necessarily for 4IR or disruptive technologies, because that will change tomorrow, but what we need is an auditor that is agile and that can respond to those kinds of expectations. But when it comes to fraud and corruption, we need to ensure that in the current environment, where there's more fraud and corruption, that the auditors can at least be better trained to recognise when it exists in an organisation. They will never become fraud investigators, but they certainly need to have a better nose to see or to establish whether there's existence of possible fraud. This is one of the areas which we believe there is an expectation that we should respond to the current environment. There are other reasons and root causes. Another one is the fact that we have currently fragmented regulation, we don't have oversight or regulation of other role players in the financial reporting chain, there's only oversight over auditors. One of our biggest projects is to try to establish a regulator for the full financial reporting chain, including audit committees, directors, internal auditors, CFOs, they should also be subject to some oversight.
CIARAN RYAN What type of oversight are we talking about because I think in the profession in South Africa you are talking maybe 200 000 accountants, I'm including bookkeepers as well in that. Are you envisaging a regulatory regime, which would cover every single one of those, including bookkeepers?
BERNARD AGULHAS: We do, bearing in mind that this is not an IRBA initiative, it's something that was recommended by the World Bank in 2013, so it becomes something that National Treasury, under the minister's auspices, has to implement. So it's really a National Treasury project. Before we can…we have made a proposal to the minister and we made the proposal because we believe there's scope for the IRBA to become the audit and accounting regulator. At the moment we're only the audit regulator because all the structures are in place already. The first part of that proposal to the minister is that there has to be a lot of consultation, so part of the consultation will be who will be in and who will be out but even if we do include all bookkeepers, we won't be regulating each bookkeeper individually, we will be having oversight over the professional bodies to which they belong and at the moment there are only about ten of those. So if we have oversight over the professional bodies, we will expect them to implement measures to regulate their individual members.
CIARAN RYAN Do you think that would be effective, if we already see instances, like we have read a lot about Steinhoff and Tongaat in South Africa, and there's the equivalent overseas in other companies where there have been accounting scandals, even with regulation, auditors are capable of misbehaving. You and I spoke before about this, one of the mechanisms that has been adopted to try and curtail that is IFRS, the International Financial Reporting Standards. Now, if IFRS is tightening up on the way that auditors behave and yet we still see these kinds of scandals happening, where will more regulations solve this in your opinion?
BERNARD AGULHAS: Let me respond to the IFRS issue and then I will talk about auditor behaviour because I think they are probably two separate issues. I am not sure whether IFRS is going to tighten up on their current corruption that we're seeing because IFRS is really there to set the framework in which financial statements are prepared but the truth is that IFRS had become a lot more complex and, therefore, to comply with IFRS and to ensure that the financial statements actually are prepared in terms of all the IFRS has become very complicated. There's also been moves or changes to include much more judgement from the preparers in the preparation of the financial statements…
CIARAN RYAN And that's a problem, isn't it?
BERNARD AGULHAS: It is a problem because judgement is difficult to verify and that, again, makes it difficult for the auditor because beside the judgement that is allowed to the preparers of the financial statements, when the auditor comes, the auditor has to verify whether those judgements are correct, using his or her own professional judgement. Professional judgement is not the same as professional scepticism but if the auditor is going to accept just the judgement from the preparers and not ask questions around it and if the auditor is not sceptical, then they will accept those judgements. We have seen so many big company failures, how valuations of debtors, how valuations of sugarcane, how valuations of stock and assets…
CIARAN RYAN Land sales.
BERNARD AGULHAS: Yes, have caused financial statements not to include the correct information and to misrepresent because of those valuations. So when it comes to International Financial Reporting Standards, I think there should be less judgement allowed, it shouldn't allow too much for that. Then linked to your other point about auditors' behaviour, the auditor could ensure that the financial statements are prepared in terms of International Financial Reporting Standards, the auditor could also comply with all their own auditing standards, there's a difference. But if the auditor's behavior is not what it should be, then we are still going to have audit failures. With auditor behaviour I am referring to ethics, an auditor can understand the standards and do a good audit but if the auditor is not ethical, if the auditor is not independent, if the auditor has no integrity and if the auditor behaves in a way… In fact, most of the investigations that we are doing at the moment we are finding that it's not so much the auditor not having the competencies to audit, it's the auditor's behaviour, auditors weren't independent, auditors weren't ethical, auditors didn't apply professional scepticism, they didn't have a questioning mind.
Dominant CEOs listed as fraud risk factors
CIARAN RYAN It's a very interesting thing, we have all been working in an environment where you get this alpha-male-type personality, very domineering, and accountants have this reputation for being soft, so they can be steamrolled by a character who is very dominant. Is that something that you find when you investigate these things that these auditors are not exercising professional scepticism, not asking the right questions, what is it?
BERNARD AGULHAS: The example that you mention about maybe a dominant CEO as a client is, in fact, listed as one of the fraud risk factors in our fraud standard, the auditing standard that deals with fraud and the auditor's responsibility to detect fraud, the International Standard on Auditing (ISA) 240, at the end it lists a couple of risk factors, one of them is a dominant CEO. So the auditor needs to be aware that when the auditor does the risk assessment, the auditor needs to be aware that he or she is dealing with a dominant CEO and accommodate their procedures and adapt their procedures for that. If the auditor ignores that, it means that they haven't responded appropriately to that risk and that becomes a risk in the audit itself. So yes, it is very prevalent and if you couple that with an auditor who's not sceptical, questioning and doesn't stand up and who has the courage to do the right thing, you might find that they will issue the incorrect opinion.
CIARAN RYAN What about a situation where you have one of these characters, these dominant CEOs and the auditor ends up having lunch and socialising with them and they become quite pally, is that a problem?
BERNARD AGULHAS: The reason that we introduced mandatory audit firm rotation was exactly because of that situation where we found that the relationship between a lot of clients and the auditors were too cosy. It's not only manifested in them playing golf together or being friends with each other, it's also manifested in the tenure of the audit firms. So when we did our research for mandatory audit firm rotation and you find that the same auditor has been auditing the same company for over 100 years, even if there was not an independence issue, certainly the perception that the relationship is too close must exist.
CIARAN RYAN They are almost embedded in the business, aren't they?
BERNARD AGULHAS: They are part of the business, they start giving advice to the management. The whole reason that you have auditors is so that they can provide an independent opinion. That is why mandatory audit firm rotation was introduced to force the auditors to separate from their clients after ten years because the audit committee certainly were not separating the auditors from the company. Independence is not only an issue between the auditors and the clients, we also looked into the relationship between the audit committees and the CFOs or the management of the company.
CIARAN RYAN There should also be a separation there.
BERNARD AGULHAS: There should be independence from those charged with governance from the directors. If that is not there it means that they are also not questioning management sufficiently. So independence is a much wider issue that needs to be addressed.
CIARAN RYAN Just going back quickly to this overarching regulation that you were speaking about, you've made recommendations to Treasury based on this World Bank recommendation from 2013, where does that sit at the moment and what has been the response from government on this?
BERNARD AGULHAS: We have submitted a proposal to Treasury about two months ago. Treasury obviously has to look at the benefits of it and maybe any disadvantages, they have to look at the costs, to implement comprehensive regulation will mean changes to legislation, there has to be consultation. I imagine that Treasury will consult amongst themselves before they embark on such a project. The IRBA is already in regulation, so we could make proposals to the minister but at the end of the day the minister could decide that he will set up a separate regulator or just incorporate everything under one regulator, which is the comprehensive regulator.
CIARAN RYAN That would mean a change to the Public Auditors Act, is that what it is?
BERNARD AGULHAS: The Auditing Profession Act.
CIARAN RYAN It used to be called the Public Auditors Act.
BERNARD AGULHAS: The public part of it is confusing because we used to be the Public Accountants and Auditors Act and we're now the Auditing Profession Act, the Auditor General's act is called the Public Audit Act but ours used to be the Public Accountants and Auditors Act, it would require changes to that because our mandate is currently only over auditors.
Industry regulation boosts public confidence
CIARAN RYAN Have you had any consultation with accounting bodies like the South African Institute of Business Accountants or Chartered Accountants, what do they say?
BERNARD AGULHAS: Yes, the IRBA has been consulting informally with most of the professional bodies, they have their own structure called the Forum of Accountancy Bodies. I have spoken to them about this proposal to have them regulated, initially when it was introduced there was some resistance because nobody really likes to be regulated and we have done our best to explain the benefits of regulation to them. Currently we are in a situation where we find that more bodies are coming to us and asking if they can be part of the comprehensive regulation. One of the benefits, of course, is that when the public knows that there is some oversight over the work that is delivered, the public has more confidence in the work that they deliver. So regulation actually adds another confidence level to the public.
CIARAN RYAN Just maybe explain what would be the benefits or how would the life of an accountant change if this regulation came in?
BERNARD AGULHAS: It shouldn't change because the accountant should already be doing what they're expected to do, they should behave ethically, they should already do the right thing and they should be complying with their standards and deliver and be competent to deliver the services expected of them. The only difference is that currently any of those accountants, if they are found guilty of any misdemeanour they will just lose their qualification or their designation. So if you are a chartered accountant, for example, which is the only body that's currently under our oversight, the institute could require them to not use their CASA designation. That's all but they can continue to practice.
CIARAN RYAN Just to be clear, not all CAs are auditors.
BERNARD AGULHAS: Correct.
CIARAN RYAN I think there are 45 000 or 50 000 CAs but there's only about 4000 auditors. So you've got quite a small pond that you're playing in there but it is an important one.
BERNARD AGULHAS: It's a small pond, it's an important one and also it's the pond that needs to respond to the public, that's the pond that performs the public function and that is why they have to be regulated. What we have found, and certainly with the current environment, we found that it's not only auditors that have this public responsibility, it's everybody in the reporting chain. In fact, once you are a professional person, whether you are an accountant, a bookkeeper, a lawyer, a doctor, you have a public function to perform. Whereas in the past auditors were regulated because they were performing this public function with the understanding and appreciation that everybody in that financial reporting chain actually performs a public function, they should also be regulated. The regulation would just mean that there is a way to hold them accountable because at the moment if you lose your designation you can continue to do what you do. With regulation there could be worse consequences, we could stop you from carrying out your trade and that means that we are holding them accountable. One of the other reasons that we find that we have this negative perception about the profession is because of this lack of accountability, people are not being held accountable for their actions. We also need to ensure that whatever we do there is accountability, it's not just in the profession, I think in the country, everybody needs to be held accountable for wrongdoing.
CIARAN RYAN I don't know if you have read the book called the Bean Counters: The Triumph of the Accountants and How They Broke Capitalism, it's quite an interesting book and I interviewed the author, Richard Brooks. One of the things that came out in that book was the concentration because you've got the big four and, of course, that's where most of the auditors are sitting worldwide. It's almost a cartel or a monopolistic arrangement there. You've got a lot of the scandals, you've got a lot of adverse judgements actually against these big four companies. I know in South Africa there has been discussion about bringing in co-audits, in other words, how do you get black-owned accounting firms to start playing on a more equal footing in this country. Maybe just explain what progress has been made in that regard in South Africa.
BERNARD AGULHAS: Let me just take a step back before I respond directly to your question. One of the objectives of mandatory audit firm rotation was also to open up those opportunities to those other firms and our initial objectives that we wanted to achieve with mandatory audit firm rotation was independence, lack of independence, lack of transformation and the fact that there was too much concentration in the market, meaning that you couldn't allow the big four firms to continue to audit 96% of JSE-listed companies without giving anybody else an opportunity. So that was one of our initial objectives to try and break up that concentration. What we also then realised and another initiative that we've been working on is to reach out to audit committees, audit committees are not under our jurisdiction, they are not regulated by us but we have now started to engage a lot more with the Audit Committee Forum, which is a group of audit committee chairs, and explaining to them the importance of independence, about audit quality and also how we can support them to make the right decisions around appointing audit firms. I have also appealed to them to not limit themselves to appointing the big four only. So it starts with them, they have to open their minds to also appreciate that we don't have four firms in South Africa, we have 2000 firms, there are 2000 firms registered with the IRBA, 4000 individuals but 2000 firms, and those firms can only get an opportunity if the audit committee appoints them. We will never support an audit firm taking on a client that they are not competent to audit, if you don't have banking skills you can't audit a bank. But there has to be initiatives to start introducing them to those audits, one of them is what we refer to as a joint audit. Joint audits hadn't worked in South Africa in the past because there's so much dominance from the big four, most of the work and most of the income or even if the smaller firm does less work but earns more income it's just not working. So what the audit firms and the audit committees had said was if you want us to start joining auditors, giving them the opportunities slowly and introducing them into these more complex sectors like JSE-listed companies, banks, then you have to give the auditors some guidance on how to do a proper joint audit and that's one of our big initiatives that we are busy with at the moment. As far as the audit committees go, we have also developed a set of audit quality indicators that audit committees can use to evaluate the quality of auditors, the independence of auditors, the ethical behavior of auditors and so to help us, we have to help the audit committees to also address the issues that we are concerned about, like introducing more firms into the audit market.
“If we have machines producing everything, you need a new skillset for the auditor”
CIARAN RYAN One of the things that came up in the discussion recently on 4IR, which I have only recently learnt stands for the Fourth Industrial Revolution, so I'm a little bit behind the curve myself on this one. Maybe you brought it up, when you are auditing you do this materiality testing, sampling basically, that's what auditing is, these automated systems and robots, whatever they are, you can actually do this, instead of doing a sample of maybe 2%, you can do a 100% sample in real time, what does that actually mean for the audit profession? A lot of that grunt work is going to be taken over by computers.
BERNARD AGULHAS: I think it's great that we can move from sampling to doing 100%, it's a very positive move but in the end, you will still require an auditor to interpret the results and to look for exceptions. There could still be failures like the software could fail, you still need somebody to interrogate the data to interrogate the software producing the data, to do analytical reviews of the data. Just the fact that you've tested everything doesn't mean that you can draw conclusions from it. One of the competencies of an auditor is to be sceptical, is to apply professional judgement, to be able to take a set of data and interpret it, analyse it and draw conclusions from it. So I still believe that the role of the auditor has become even more important now because if we have machines producing everything, you need a new skillset for the auditor to be able to take and mine that information to come up with the proper conclusions.
CIARAN RYAN I think it was Alan Turing, who during World War II developed the Turing Machine, which decoded the German secret codes so that they could then know when they were going to attack and all that sort of thing. He said – and we're going back 60 years – that machines and computers will always need an oracle. First of all, you have got to programme it correctly and, secondly, you have got to interpret it and that's exactly what you are saying. We're running out of time here but a couple of quick questions here, if you don't mind, let's just talk about audit rotation of the JSE companies, in 2019 it was reported that 17% of JSE companies had rotated their auditors and I believe that's gone up to 21% at the moment.
BERNARD AGULHAS: That's correct.
CIARAN RYAN And there is a deadline by 2023, are you encouraged by the rate at which auditors are being rotated?
BERNARD AGULHAS: We are very encouraged, given the fact that it's almost four years ahead of the implementation date of April 1 2023. The fact that companies have voluntarily rotated and amongst those 21% that rotated, we have also tried to find out what the reasons for the rotation were and I think 41% has indicated that they are rotating because of mandatory audit firm rotation, not because they were unhappy with their auditors, they are rotating because they don't want to be in a situation in four years' time that they want to rotate but there's conflict because there's also other provisions in the Companies Act, which says that in the case of a company if you've been performing certain services for that company for the last five years, you can't then be appointed as the auditor. That means that they don't want to sit in 2023 and say that three of the companies, audit firms that provide other services to them, so they only have the choice of one audit firm. You don't want that situation. What has also been encouraging is that from the firm's perspective, a lot of the smaller firms, medium-size firms, we call them the next tier firms, I think in the UK they call them challenger firms, they have come to the IRBA and talked to us about how they could prepare themselves, for example, by merging, by forming liaison with international audit firms, so that they can build up the competencies to be able to audit these big clients because initially they thought that they don't have the skills anyway. But they are preparing themselves and similarly clients, the companies themselves, have come to the IRBA and said if we want to appoint new auditors, these are, for example, challenges that we face, how can we get past that. The reason that we gave mandatory audit firm rotation a lead time of five years was so that we could iron out all these issues, it's very encouraging that everybody is trying to identify the problems, work with us to overcome the problems, so that on April 1 2023 MFR will be introduced seamlessly.
CIARAN RYAN One of the other things that happened quite recently as well is that IRBA now has search and seizure powers, similar to what they have in the South African Revenue Services and the Financial Services Conduct Authority has. In fact, I think you exceeded yourself there because you as a body were only asking for subpoena powers and they said no, we're going to give you the whole shop. Have you exercised those powers, do you intend to, how is that working out?
BERNARD AGULHAS: It's interesting because our amendments were in Parliament at the beginning of 2018, our amendments was a set of amendments that moved through Parliament in probably six months because of the expectation that we respond to the current crisis and Parliament has been very supportive of the legislation. Interestingly though, it had been stopped because of the search and seizure powers and there were a lot of objections to it. What Parliament had asked us was to consult further with auditors. When we did so, when we talked to the auditors and National Treasury talked to auditors, we found out that they were very concerned about these powers, expecting that the IRBA now had full authority to walk into an office or audit practice and take whatever they want, take computers, take information like the police, which was never the intention. That is not what the IRBA intended to do. We shouldn't be using our search and seizure powers if the auditors cooperate with us. If we get the information to do an investigation, we won't need to go to those lengths to be able to get information. If auditors cooperate with us, then they will never have to worry about search and seizure. So we haven't used it yet, the amendments are still in Parliament. If it gets legislated, which we hope will happen quickly because there are other amendments that not only give us more powers but that actually help us to carry out our duties a lot more efficiently. We are hamstrung with a lot of the provisions in the current legislation. If the act does go through, then yes we will have the search and seizure powers but we should only use it in extreme situations.
CIARAN RYAN Understood. Final question, where do you see the profession a year from now, how would you like to see it?
BERNARD AGULHAS: The last couple of years have been very unusual for our profession, a lot of things happened. I am positive about the profession regaining its former glory. If all these initiatives from the IRBA, from the audit firms, from other stakeholders like audit committees, if all these initiatives are implemented, I can only see that we will restore it to its former glory. I am very hopeful and not only hopeful but I can already sense that there's been a recognition that a lot has to be done and so there's no longer resistance or reluctance to make the changes, there's no collaboration between all the parties to work together to change things back to what it was before.
CIARAN RYAN There was one other question that I had, are you reading any good books?
BERNARD AGULHAS: I can't think at the moment, I am reading a lot at the same time. We were on holiday in India and I bought some books there, books on ethics and values and cultures. I can't remember the name of the author, it's a very difficult name but I am reading that at the moment because I think it's important that we try and use some of the recommendations from those books in our own profession in South Africa.
CIARAN RYAN Bernard Agulhas, let's leave it at that but thank you for that fascinating discussion and wishing you a very, very prosperous 2020.
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