If external auditors will not confirm figures, why should we believe Eskom’s board?

The recently presented Eskom 2017 financial statements raise serious questions concerning the performance and compliance with respect to applicable legislation and rules by its directors, operational management and external auditors.

It is now public knowledge that external auditors SizweNtsalubaGoboda expressed an audit opinion that the financial statements fairly presented in all material respects the financial position of Eskom, with the qualification that Eskom did not have an adequate system for identifying all irregular expenditure and that no satisfactory audit procedures could be performed by the auditors to obtain reasonable assurance that irregular expenditure had in fact been accurately recorded.

This was, essentially, a polite way of explaining that the Eskom-supplied figure in the financial statements of R3bn in irregular and wasteful expenditure could not be verified, and that this might be just the tip of the iceberg.

Corporate governance and accountability feature prominently in the lexicon of corporate speak, and together with some applicable statutes and professional rules, it provides the backdrop against which the performance of directors, operational management and the external auditors must be measured, after taking into account disclosures made in the Eskom financial statements.

Eskom directors

The Public Finance Management Act (PFMA) clearly addresses the corporate governance and accountability of the accounting authority (board) and responsible officials to whom authority has been delegated.

Section 50 covers the fiduciary duties, which require that the board exercise utmost care to ensure protection of assets and that they act with fidelity, honesty and integrity and may not act in a way which is inconsistent with the responsibilities assigned to them by the PFMA.

Section 51 requires that the board maintains an effective and efficient system of financial risk management and internal control and that an appropriate procurement and provisioning system — which is fair, equitable, transparent, competitive and cost effective — as well as a system for properly evaluating all major capital projects prior to a final decision, is maintained.

Section 51 also demands that the board prevents irregular, fruitless and wasteful expenditure, losses from criminal conduct, and expenditure not complying with operational policies, and that effective disciplinary steps be taken against employees who undermine the internal control systems of the entity and who permit irregular or fruitless and wasteful expenditure.

Section 86 confirms that a board of directors (accounting authority) is guilty of an offence and liable on conviction, or to a fine or to imprisonment for a period not exceeding five years, if that accounting authority wilfully or in a negligent way fails to comply with sections 50, 51 or 55.

The code of ethics of the Institute of Internal Auditors of SA (IIASA) requires that principles including integrity, objectivity, confidentiality and competency be applied and upheld.

Internal control is the system within an entity that ensures operational efficiency, reliable financial reporting and compliance with laws and regulations, and the safeguarding of assets.

The chief audit executive of Eskom is required to ensure a well-functioning system of internal control and where necessary, the executive must obtain the necessary high level support from the board to achieve this objective.

The conduct of external registered auditors is governed by statute including the Auditing Profession Act. An external auditor should conduct his or her work with appropriate audit planning, to identify high-risk audit areas. International standards on auditing govern the profession, which cover professional scepticism

The 2017 Eskom financial statements

Although the media has covered the "highlighted numbers" in the Eskom financial statements, it is the disclosures within the statement of directors’ responsibilities, the report of the audit and risk committee, the report of directors and the report of the auditor that raise legitimate questions as to whether the board, operational management and the external auditors have discharged their respective duties adequately.

The statement of directors’ responsibilities confirms "that the financial statements have been prepared in accordance with International Finance Reporting Standards (IFRS), the PFMA as well as the Companies Act", and confidently boasts that "in meeting its responsibilities, the board sets standards and management implements systems of internal control. The controls are designed to provide assurance that assets are safeguarded…".

The report of the audit and risk committee confirms that the committee has considered "the effectiveness of the internal control systems and governance processes as well as the compliance with legal and regulatory requirements" and it has also "considered the performance of the assurance and forensic department" and concludes that "internal accounting controls are adequate … and that nothing has come to the attention of the committee to indicate a material breakdown in the functioning of controls … and that controls are still appropriate to ensure compliance with the Companies Act and the PFMA."

The report of the directors asserts "that the audit and risk committee ensures that internal controls are effective … and that Eskom’s internal audit function is managed by the assurance and forensics department, which reports directly to audit and risk committee", and that the board "has complied with its fiduciary duty towards the company in that all contracts were concluded in line with Eskom procurement policies and that all transactions have a clear commercial rationale".

Seven "key audit matters" are noted, which the auditor has identified as most significant to the audit, and these matters include the valuation of plant and equipment, future fuel supplies and trade receivables.

Eskom’s financial statements report that procurement on coal, nuclear, diesel and power from independent power suppliers totalled R83bn in 2017, and a further R23bn was spent on repairs and maintenance — all of which, in terms of Treasury requirements, would be subject to procurement and tender processes.

The financial statements also report that R56bn was spent on fixed assets, bringing total 2017 procurement spend to R162bn, a figure that dwarfs any other line item in the financial statements in terms of materiality.

Notwithstanding the material rand value of procurement, the external auditors, for reasons best known to themselves, appear to have concluded that procurement would not be a key audit matter that would be significant to their audit.

Available media reports indicate consistent failure of fiduciary duty by the board and a shambolic system of internal control with respect to procurement.

One must ask if the board and operational management are not in breach of sections 50, 51, 56 and 57 of the PFMA, and if the disclosures in the report of directors are accurate and fairly present the position, as required by statute.

Contradictions abound, and good examples are the board reporting satisfactory internal control compliance and acceptable compliance with the PFMA, while the auditor confirms "significant internal control deficiencies" and confirms that the directors have breached the PFMA as "effective steps were not taken to prevent irregular expenditure as well as wasteful expenditure, as required by section 51 (b) (ii) of the PFMA."

In 2016, Eskom reported irregular expenditure of R348m, and in 2017, it had increased by an astounding 860% to R3bn. If the auditors are unable to confirm this R3bn figure, then why should we believe the board? There must surely be serious concerns about the accuracy of the 2016 figure.

Systemic procurement corruption demands that an external auditor use professional scepticism, requiring detailed audit testing of procurement. However, for inexplicable reasons, it appears that detailed procurement testing is anathema to audit planning and audit work schedules of state-owned enterprises.

External auditors can cover their backs with tepid qualifications or they can choose to decline a lucrative audit appointment (R119m in the case of Eskom). Or they can accept it on the basis that they extensively test the high risk and material area of procurement, knowing full well that the pervasiveness of the procurement irregularities will probably lead to an adverse audit opinion, resulting in the withdrawal of all lines of credit and a "game over" situation in all respects for the entity.

The SizweNtsalubaGoboda findings with respect to internal control ask serious questions of the competency of the Eskom chief audit executive, and the confirmed breach of section 51 of the PFMA by the Eskom board should surely provide the necessary motivation for the National Prosecuting Authority to prosecute.

One has to only wonder why there has never been prosecutions of boards of state-owned entities when the stench of malfeasance is so evident.

• Mantell is a CA (SA) in business in Cape Town, who served articles at one of the big four