Danger of new Companies Act leading to significant rise in fraud

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Any information herein was accurate when published on 12 July 2010

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Audits for small businesses will fall away and might result in corporate irregularities, such as theft and tax evasion, writes Sanchia Temkin

Auditors are concerned that impending company laws that will do away with audits for small business may lead to an increase in fraud and other corporate irregularities, such as theft and tax evasion.

James Roberts, head of forensics at audit firm BDO, says "There is a very real risk after the introduction of the new Companies Act that the level of fraud will increase significantly in those companies that are not audited." Mr Roberts says that despite the fact that an audit is not designed to detect fraud irregularities, it nevertheless acts as a deterrent and introduces a level of financial discipline.

"The main focus of an audit is to look at the manipulation of earnings. If one has to look at corporate scandals, such as Macmed, the financial statements of such companies are usually overstated. Auditors have a trained eye to pick up such fraudulent irregularities," Mr Roberts says.

The amended Companies Act, which is expected to be introduced in the fourth quarter of the year, provides that only listed companies and those deemed to be in the public interest, be audited.

However, this will be optional for private companies and small businesses, which may choose between an independent review or an audit.

The independent review is a report issued on the financial statements of smaller businesses by independent professional accountants. It is an alternative document to the traditional audit route issued by a registered auditor.

Ashley Vandiar, project director for assurance at the South African Institute of Chartered Accountants, says auditors are required to have an analytical understanding of the company they are auditing.

He points out that an audit results in the highest level of assurance being expressed, which gives users the comfort of relying on the financial statements when making decisions.

He says an audit involves tests of controls and substantive procedures, resulting in an opinion then being expressed by a registered auditor. On the other hand, an independent review involves an inquiry and analytical procedures.

An independent review therefore results in only limited assurance being expressed by an accounting practitioner, Mr Vandiar says.

Very few professionals carrying out a review will have an indepth understanding of the client's industry, knowledge of the client's internal controls and financial performance, he says.

This is where the difficulty arises and the potential for fraud increases, he says.

Further, Mr Vandiar points out that auditors are required to report corporate irregularities, such as theft or fraud they may encounter while carrying out an audit to the Independent Regulatory Board for Auditors.

On the other hand, professional accountants are not required to report financial irregularities to regulators they may pick up during the course of an independent review, he says.

He says this has been pointed out to the government, which was of the view that entities subject to the review process were not in the ‘public interest'.

Andrew Hannington, who is national chairman of PKF chartered accountants and business advisers, says it is accepted that for smaller owner-managed businesses there is little value in having an audit.

"Yet experience shows that in many of these companies the auditor is asked to condone tax fraud. With the changes suggested by the proposed company laws, this protection of the tax base will therefore be lost" he says.

He says that in family businesses there is a tendency to hide turnover, especially cash sales.

"Who will test for this when an audit is no longer required?" asks Mr Hannington.

Should the company insist on continuing with the tax fraud, the auditor is obliged to report such irregularities, or face a jail sentence of up to 10 years - naturally, something no auditor wants."

These requirements make the auditor extremely vigilant, says Mr Hannington, to the extent that as much as 10% of the audit cost is spent on doing a tax audit on the client company, to ensure compliance with very complex tax laws.

Further, the Tax Practitioner Bill proposes companies be subject to an audit - in clear conflict with the new Companies Act.

temkins@ bdfm.co.za

Disclaimer: Please note that this article is at least 12 months old.
Any information herein was accurate when published on 12 July 2010