Navigating Between Independent Reviews and Audits

By Charles W. Kampfraath-Pawson

When it comes to assessing the financial health and compliance of a company, two main avenues are often pursued: independent reviews and audits. While both serve the purpose of scrutinizing financial records, they differ significantly in scope and approach.

An independent review involves a thorough examination of financial documents, including inquiries with management and stakeholders, as well as analytical procedures to evaluate evidence. It offers a broad overview of the company’s financial standing without delving deeply into every transaction.

In contrast, an audit is a more comprehensive investigation, employing various techniques to provide a higher level of assurance. Auditors meticulously examine financial statements, internal controls, and supporting documentation to issue an opinion on their accuracy and compliance with accounting standards.

Given the current economic climate, businesses are keen on optimizing their expenditures. Audit fees, which often constitute a substantial portion of annual expenses, become a focal point for companies seeking to streamline their budgets. However, when contemplating reductions in audit spending, directors and shareholders must conduct a thorough cost-benefit analysis to ascertain the value an audit provides compared to potential alternatives.

Under the Companies Act of South Africa, companies have the flexibility to choose between auditing or independently reviewing their Annual Financial Statements (AFS), depending on their Public Interest Score (PIS) and the compiler of the AFS. Directors can opt to internally compile the AFS or have them independently prepared.

The majority of companies are exempt from audit and review obligations due to their ownership structure, typically characterized as owner-managed. For those companies mandatorily subject to audit or review, the Act applies distinct criteria based on the type, activity, and size of the entity (Companies Act, 2008, Section 30(7), Companies Regulations, 2011, Regulation 29(4)).

Any company not obligated to undergo audited financial statement preparation must undergo independent review of their financial statements. The only exception to this rule applies to companies where all shareholders also hold directorship roles, thus exempting them from the audit or review requirement.

The PIS is determined by various factors, including the number of beneficial interest holders (shareholders), annual turnover, third-party liabilities, and average employee count. Companies with a PIS exceeding 350 are mandated to undergo an audit, while those below this threshold may elect an independent review instead.

However, if a company’s PIS surpasses 100 and the directors choose internal compilation of AFS, an audit becomes obligatory. Some businesses may qualify for exemption from audit or independent review requirements under Section 30(2A) of the Companies Act, provided their PIS is below 350 and all shareholders double as directors. Nevertheless, certain Memorandum of Incorporation (MOI) provisions may necessitate auditing, irrespective of PIS.

Significant disparities exist between audits and independent reviews, primarily concerning the level of assurance and the procedures undertaken. An audit offers reasonable assurance that the AFS are free from material misstatement, whereas an independent review provides limited assurance, stating that no discrepancies have been identified that would impede fair presentation of the AFS.

Due to the nuanced nature of interpretation and evaluation in independent reviews, they often require seasoned professionals to navigate complexities effectively. Audits, on the other hand, may involve a mix of staff with different levels of expertise, depending on the scope and nature of the engagement.

The choice between an independent review and an audit is influenced by factors such as the company’s size, industry regulations, and stakeholder requirements. While audits offer a deeper level of assurance, they also tend to be more time-consuming and costly. Independent reviews, while providing valuable insights, are generally less intensive and more cost-effective.

Directors contemplating between the two options must consider several factors. Firstly, they need to ensure compliance with legal requirements and stakeholder expectations. Additionally, they should be aware of the implications of switching between review types in consecutive years.

Switching between an independent review and an audit can have repercussions, especially concerning the continuity and validity of audit opinions. For instance, if a company moves from an audit to an independent review and back to an audit, it can lead to qualifications in audit reports, particularly regarding unaudited balances and transactions from previous years.

To mitigate these risks and make informed decisions, directors should seek guidance from their company’s auditors. By understanding the implications and trade-offs associated with each review type, directors can ensure effective financial oversight and compliance with regulatory requirements.