Investigation of the value-added role of internal
auditing in the governance of selected South
African municipalities
N Jiyane
orcid.org 0000-0002-7640-199X
Dissertation accepted in fulfilment of the requirements for the
degree
Masters of Commerce in Accountancy
at the
North-West University
Supervisor: Dr JJ Swart
Co-Supervisor: Ms O Stumke
Graduation: May 2020
Student number: 30006643
I, Nontando Jiyane, declare herewith that the dissertation entitled “Investigation of the value-added role of internal auditing in the governance of selected South African municipalities” which I herewith submit to the North-West University is in compliance with the requirement set for the degree “Masters of Commerce in Accountancy”, is my work, has been language edited in accordance with the requirements and has not already been submitted to any other university.
Signature:
i Title: Investigation of the value-added role of internal auditing in the governance of selected South African municipalities
Keywords: governance, internal audit function, value-adding, municipalities, mandatory establishment
The aim of the study was to investigate the value-added role of internal auditing (IA) in the governance of selected South African (SA) municipalities. Legislations and frameworks that formed the theoretical foundation of the study included the Municipal Finance Management Act (MFMA), the King report on corporate governance (King lV Report (2016)), Committee of Sponsoring Organisations (COSO) and the International Standards for the Professional Standards of Internal Audit (ISPPIA). The MFMA makes it mandatory for each municipality to have an Internal Audit Function (IAF). Therefore, this study seeks to ascertain if IAFs in SA municipalities are performing value-adding activities or are established to meet the legislative requirement. Data were collected through documentary reviews of the selected municipalities’ annual reports for the financial period 2014/15 to 2016/17. 2016/17 annual reports were the latest published annual reports at the time of data collection. The collected data were analysed and interpreted qualitatively.
Analysis and interpretation of data led to the finding that there are various roles played by the IA to fulfil its value-added mandate in SA municipalities. Such roles are prescribed by the ISPPIA, MFMA and there are some other roles, for example, investigation of fraud, corruption and other irregularities and training deduced from extant research. Empirical findings suggest that much as there are IAFs that are performing these roles towards fulfilling the value-added role, there are some municipalities which have established IAF for the sake of complying with the MFMA. The findings further reveal that it is not mandatory for IA to disclose the work they have performed, and no framework guides the extent of disclosures to be made. These findings lead to the conclusion that IAFs that perform the identified roles are value-adding mechanisms to their municipalities. Further, the study concludes that some municipalities have an IAF established for compliance with the MFMA and are not value-added mechanisms. The value added by IA can be determined through assessing reliance placed by the AGSA on the work performed by IA, the recommendations made by the IAF or performed audit engagements measured against planned audit engagements.
ii
Now unto Him who is able to keep me from stumbling and to present me standing tall in His brilliant presence, the presence of His glory with triumphant joy, to the only God and Saviour, Jesus Christ of Nazareth, who alone is wise, be glory and majesty, dominion and power, both now and in the next level.
To my loving and caring husband, Jabu, and beautiful daughter, Inkosi, thank you for your understanding, encouragement and unwavering support.
To my supervisor, André Swart, for your time and patience, I am grateful for the commitment and prompt responses. When the journey got heavy, your availability, insight and guidance gave me strength.
My co-supervisor, Olive Stumke, thank you for critically reading every piece of work; your insight and guidance encouraged me to keep going.
Linda Scott for language editing services.
North-West University for affording me the opportunity to do this study.
iii
ABSTRACT ... i
ACKNOWLEDGEMENTS ... ii
TABLE OF CONTENTS ... iii
LIST OF ABBREVIATIONS AND ACRONYMS ... ix
LIST OF FIGURES ... xi
LIST OF TABLES... xii
CHAPTER 1: INTRODUCTION AND BACKGROUND OF THE STUDY ... 1
1.1 INTRODUCTION ... 1
1.2 PROBLEM STATEMENT ... 5
1.3 OBJECTIVES OF THE STUDY ... 6
1.3.1 PRIMARY OBJECTIVE ... 6
1.3.2 SECONDARY OBJECTIVES ... 6
1.3.3 THEORETICAL OBJECTIVES ... 6
1.3.4 EMPIRICAL OBJECTIVES ... 7
1.4 RESEARCH DESIGN AND METHODOLOGY ... 7
1.4.1 LITERATURE REVIEW... 8
1.4.2 EMPIRICAL STUDY ... 9
TARGET POPULATION ... 9
SAMPLING FRAME ... 9
SAMPLE METHOD ... 10
MEASURING INSTRUMENT AND DATA COLLECTION METHOD ... 10
1.5 ETHICAL CONSIDERATIONS ... 12
1.6 PROJECT PLAN ... 12
iv
2.1 INTRODUCTION ... 14
2.2 THE BACKGROUND AND DEVELOPMENT OF IA ... 15
2.3 THE NATURE OF IA WORK ... 18
2.3.1 NATURE OF WORK: GOVERNANCE PROCESSES ... 19
THE CONCEPT AND BACKGROUND OF GOVERNANCE ... 20
GLOBAL GOVERNANCE DEVELOPMENTS ... 21
GOVERNANCE IN SOUTH AFRICA ... 22
SYNOPSIS OF THE KING REPORT ON GOVERNANCE IN SOUTH AFRICA ... 22
GOVERNANCE IN SOUTH AFRICAN LOCAL GOVERNMENT (MUNICIPALITIES) ... 25
IA AS A GOVERNANCE MECHANISM: THE KING REPORT ON CORPORATE GOVERNANCE SA ... 26
2.3.2 NATURE OF WORK: RISK MANAGEMENT PROCESSES ... 29
2.3.3 NATURE OF WORK: CONTROL PROCESSES ... 29
2.3.4 COMMITTEE OF SPONSORING ORGANISATIONS OF THE TREADWAY COMMISSION (COSO) FRAMEWORK ... 30
2.3.5 COSO GUIDANCE TO IAS ROLE IN RISK MANAGEMENT AND CONTROL PROCESSES ... 30
2.3.6 DISCLOSURE ON THE WORK PERFORMED BY THE IAF ... 33
2.4 THE VALUE-ADDING ROLE OF THE IAF... 34
2.4.1 DETERMINING THE VALUE-ADDED ROLE OF THE IAF ... 36
IAF RECOMMENDATIONS IMPLEMENTED BY THE ORGANISATION ... 38
NUMBER OF AUDITS PERFORMED MEASURED AGAINST THE PLANNED AUDITS ... 40
RELIANCE PLACED BY THE AGSA ON THE IA REPORTS ... 41
v
CATEGORIES OF SOUTH AFRICAN MUNICIPALITIES ... 46
CONSTITUTION OF THE REPUBLIC OF SOUTH AFRICA 1996 ... 47
THE WHITE PAPER ON LOCAL GOVERNMENT OF 1998 ... 47
MUNICIPAL STRUCTURES ACT 117 OF 1998 ... 47
2.5.2 IAS ROLE IN THE GOVERNANCE OF MUNICIPALITIES ... 48
2.5.3 LEGISLATION MANDATING THE ESTABLISHMENT OF AN IAF (IAF) IN SOUTH AFRICA’S MUNICIPALITIES ... 50
THE MUNICIPAL FINANCE MANAGEMENT ACT 56 OF 2003 (MFMA, 2003) ... 50
THE MUNICIPAL SYSTEM ACT ... 51
THE MUNICIPAL PLANNING AND PERFORMANCE MANAGEMENT REGULATIONS ... 51
THE NATIONAL TREASURY IA FRAMEWORK ... 52
2.6 THE AUDITOR GENERAL OF SOUTH AFRICA AUDIT OUTCOMES ... 54
2.6.1 CLEAN AUDIT OUTCOME ... 54
2.6.2 FINANCIALLY UNQUALIFIED AUDIT OPINION ... 55
2.6.3 QUALIFIED AUDIT OPINION ... 55
2.6.4 ADVERSE AUDIT OPINION ... 55
2.6.5 DISCLAIMER OF AUDIT OPINION ... 55
2.7 CONCLUSION ... 56
CHAPTER 3: RESEARCH DESIGN AND METHODOLOGY ... 57
3.1 INTRODUCTION AND OVERVIEW ... 57
3.2 RESEARCH DESIGN ... 57
3.3 RESEARCH POPULATION ... 59
3.4 RESEARCH SAMPLE ... 60
vi
3.6.1 STAGE 1 – REVIEW, EXPLORE, PREPARE AND ANALYSE DATA ... 71
3.6.2 STAGE 2 - DATA CONDENSATION ... 71
3.6.3 STAGE 3 - DEVELOPING CATEGORIES AND CODING OF DATA ... 72
3.6.4 STAGE 4 - CODING THE CONDENSED DATA ... 72
3.6.5 STAGE 5 – DATA SUMMARY TABLES ... 76
3.7 TRUSTWORTHINESS AND CREDIBILITY ... 76
3.8 CONCLUSION ... 76
CHAPTER 4: ANALYSING AND INTERPRETATION OF DATA ... 78
4.1 INTRODUCTION ... 78
4.2 FINDINGS ON DISCLOSURES OF THE WORK PERFORMED BY THE IAF ... 79
4.2.1 DISCLOSURES ON THE ROLE OF IAF: NATURE OF WORK ... 81
4.2.2 DISCLOSURES ON THE ROLE OF IAF: TYPES OF AUDITS ... 85
4.2.3 DISCLOSURES ON THE ROLE OF IAF: OTHER ROLES ... 89
4.2.4 SUMMARY OF FINDINGS PER SUB-CATEGORY ... 93
SUMMARY OF FINDINGS: DISCLOSURES ON INTERNAL CONTROLS ... 93
SUMMARY OF FINDINGS: DISCLOSURES ON RISK MANAGEMENT ... 94
SUMMARY OF FINDINGS: DISCLOSURES ON GOVERNANCE ... 95
SUMMARY OF FINDINGS: DISCLOSURES ON INVESTIGATIONS ... 97
SUMMARY OF FINDINGS: DISCLOSURES ON COMPLIANCE ... 98
SUMMARY OF FINDINGS: DISCLOSURES OPERATIONAL AUDITS ... 99
SUMMARY OF FINDINGS: DISCLOSURES ON FINANCIAL AUDITS ... 100
SUMMARY OF FINDINGS: DISCLOSURES ON VALIDATIONS AND FOLLOW-UPS ... 101
SUMMARY OF FINDINGS: DISCLOSURES ON TRAINING OFFERED TO MUNICIPAL EMPLOYEES. ... 102
vii
PERFORMED ... 103
4.2.6 CONCLUSION: DISCLOSURES ON WORK PERFORMED BY THE IAF ... 104
4.3 DETERMINANTS OF THE VALUE-ADDED BY THE IAF... 105
4.3.1 CONCLUSION: DETERMINANTS OF VALUE-ADDED ROLE OF THE IAF IN SOUTH AFRICAN MUNICIPALITIES ... 109
4.4 COMPLIANCE WITH LEGISLATION MANDATING THE ESTABLISHMENT OF IAF ... 110
4.4.1 CONCLUSION: COMPLIANCE WITH MFMA ... 114
4.5 COMPARISON OF FINANCIAL PERFORMANCE AND WORK DISCLOSED ... 114
4.6 LATEST DEVELOPMENTS: CONTRIBUTIONS OF THE IA ACCORDING TO MFMA AGSA OUTCOMES 2017/18 ... 117
4.7 CONCLUSION ... 119
CHAPTER 5: CONCLUSIONS AND RECOMMENDATIONS ... 122
5.1 INTRODUCTION ... 122
5.2 SYNOPSIS OF CONCLUSIONS FROM CHAPTER 1 TO 4 ... 122
5.2.1 CHAPTER 1: INTRODUCTION AND BACKGROUND OF THE STUDY ... 122
5.2.2 CHAPTER 2: LITERATURE REVIEW ... 123
5.2.3 CHAPTER 3: RESEARCH DESIGN AND METHODOLOGY ... 124
5.2.4 CHAPTER 4: ANALYSIS AND INTERPRETATION OF DATA ... 124
5.3 CONCLUSIONS OF THE STUDY ... 125
5.4 LIMITATIONS OF THE STUDY ... 127
5.5 RECOMMENDATIONS... 128
5.6 CONTRIBUTIONS OF THE STUDY ... 129
5.7 CHAPTER CONCLUSION... 129
ix A : Assurance services
AC : Audit Committee AG : Auditor General
AGSA : Auditor General of South Africa C : Consulting Services
CAE : Chief Audit Executive
COGTA : Department of Cooperative Governance and Traditional Affairs
COSO : Committee of Sponsoring Organisations of the Treadway Commission DM : District municipality
DPSA : Department of Public Service and Administration ERM : Enterprise risk management
IA : Internal audit
IAF : Internal Audit Function IIA : Institute of Internal Auditors
IIARF : Institute of Internal Auditors Research Foundation IIA-SA : Institute of Internal Auditors South Africa
IKUTU : IIA-SA, KPMG, UNISA, TUT and UP IoDSA : Institute of Directors Southern Africa
IPPF : International Professional Practice Framework
IPPF-PG : International Professional Practice Framework- Practice Guide IRBA : Independent Regulatory Board for Auditors
ISAs : International Standards on Auditing
ISPPIA : International Standards for the Professional Practice of Internal Audit JSE : Johannesburg Stock Exchange
KING IV : King IV Report on Governance for South Africa 2016 or King IV code or King IV report
LM : Local municipality
MFMA : Municipal Finance Management Act MM : Metropolitan municipality
x NWU : North-West University
PFMA : Public Finance Municipal Act RM : Risk management
SA : South Africa
SOE : State-owned enterprises SOX : Sarbanes-Oxley Act of 2002 STATSSA : Statistics South Africa
TR : Treasury Regulations GP : Gauteng Province WC : Western Cape EC : Eastern Cape KZN : Kwa Zulu Natal LP : Limpopo Province FS : Free State
NW : North West
xi
Figure 2-1: Pressures that influenced the revision of King l Report (1994) ... 23
Figure 2-2: The three lines of defence in effective risk management and control ... 32
Figure 2-3: IAF Performance Measurement Balanced Scoreboard ... 37
Figure 3-1: Data analysis process ... 70
Figure 4-1: Categories and codes for work performed by IAF ... 80
Figure 4-2: Disclosures work performed by IAF on control processes ... 93
Figure 4-3: Disclosures work performed by IAF on risk management processes ... 95
Figure 4-4: Disclosures on work performed by IAF on governance processes ... 96
Figure 4-5: Disclosures on work performed by IAF on investigations ... 97
Figure 4-6: Disclosures on work performed by IAF on compliance ... 98
Figure 4-7: Disclosures on work performed by IAF on operational audits... 99
Figure 4-8: Disclosures on financial audits performed by the IAF. ... 100
Figure 4-9: Disclosures on work performed by IAF on validations and follow-ups ... 101
Figure 4-10: Disclosures on work performed by IAF on training ... 102
Figure 4-11: Summary of total disclosed work performed by IAF per category ... 104
xii
Table 2-1: The King Reports on establishing the IAF ... 27
Table 2-2: Literature on determining the value-added by the IAF ... 44
Table 2-3: Legislation on the establishment of IAF in municipalities ... 52
Table 3-1: Number of South African municipalities per province ... 60
Table 3-2: Profile of the selected municipalities ... 64
Table 3-3: Coding scheme ... 74
Table 4-1: Nature of work disclosures - metropolitan municipalities ... 82
Table 4-2: Nature of work disclosures – District municipalities ... 83
Table 4-3: Nature of work disclosures – Local municipalities ... 84
Table 4-4: Disclosures on types of audit engagements – Metropolitan municipalities ... 86
Table 4-5: Disclosures on types of audit engagements – District municipalities ... 87
Table 4-6: Disclosures on types of audit engagements – Local municipalities ... 88
Table 4-7: Disclosures on other roles – Metropolitan municipalities ... 90
Table 4-8: Disclosures on other roles – District municipalities ... 91
Table 4-9: Disclosures on other roles – Local municipalities ... 92
Table 4-10: Municipalities that disclosed IAF work per sub-category ... 103
Table 4-11: The literature on value-added determinants ... 106
Table 4-12: IAF Value-added determinants frequency counts ... 107
Table 4-13: Legislation on work to be performed by the IAF ... 110
Table 4-14: Compliance with MFMA: Metropolitan municipalities ... 111
Table 4-15: Compliance with MFMA: District municipalities ... 112
xiii Table 4-18: Direct quotes on the role of IA from the 2017/18 AGSA MFMA reports ... 118
xiv
Appendix 1: Disclosures on the role of IAF in internal controls ... 144
Appendix 2: Disclosures on the role of IAF in risk management ... 148
Appendix 3: Disclosures on the role of IAF in governance processes ... 150
Appendix 4: Disclosures on the role of IAF in investigations ... 154
Appendix 5: Disclosures on the role of IAF in compliance ... 156
Appendix 6: Disclosures on the role of IAF in operational audits ... 158
Appendix 7: Disclosures on the role of IAF in financial audits ... 160
Appendix 8: Disclosures on the role of IAF in validations and follow-ups ... 162
1
CHAPTER 1: INTRODUCTION AND BACKGROUND OF THE STUDY
1.1 INTRODUCTION
Researchers such as Alzeban and Sawan (2015:61), Dal Mas and Barac (2018:814), Ismael and Roberts (2018:288), Lenz and Hahn (2015:24) and Quick and Henrizi (2018:1) agree that in the dynamic economic environment, corporate scandals compromised business ethics and governance flaws throughout the world, which calls for increased relevance of the internal auditing (IA) profession. The Auditor General South Africa (AGSA) released the municipal audit outcomes for year 2017/18 towards the conclusion of this study and (AGSA) (2019:1), in their press release, expressing concern over the increasing governance failures in South African (SA) municipalities and emphasising the critical role played by the internal audit function (IAF) amongst other role players in improving governance processes.
Groff, Pietra and Sitar (2016:51) agree with Erasmus and Fourie (2014:2) that the governance challenges experienced globally have seen internal audits move from their traditional reactive approach to a more proactive approach that does not only offer assurance and compliance services but also consulting and value-adding services. Ismael and Roberts (2018:288) concur, highlighting that internal auditors play a critical role in raising awareness on governance, risk management and control processes to address governance challenges. Karagiorgos, Drogalas, Gotzamanis and Tampakoudis (2010:16), supported by Christopher (2015:956) conclude that in response to governance challenges, the Institute of Internal Auditors (IIA) in 1999 revised the definition of IA to incorporate the extended role of IA from a mere assurance providing activity to include a consulting and value-added role. The IIA (1999) defines IA as:
“an independent, objective assurance and consulting activity designed to add value and improve the organisation’s operations. It helps the organisation to accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes”. (IIA, 1999).
2 The revised IA definition saw IA researchers and practitioners revisit the role of the IA profession. Roth (2003:33) deduces from the definition that, the ultimate objective of establishing an IAF is to add value to its stakeholders. Flostoiu (2012:162) supports that by explaining that the definition clearly highlights that IAs should add value and assist management to improve the business operations. Quick and Henrizi (2018:1) support Erasmus and Fourie (2014:2) who posit that the new definition of IA has subjected the profession to scrutiny due to its value-adding role anticipated by its stakeholders. An example of such scrutiny is PWC (2016:6) warning that IA is facing the threat of being marginalised between a variety of other assurance, compliance and risk management functions, which calls for the profession to work on increasing its relevance; hence the value-adding role.
Lenz and Sarens (2012:533), however, argue that such scrutiny is because IA is a profession comparatively at its infancy; hence, it needs to guard its identity and position in the governance debate. They further propose that the purpose, role and approach for IA need to be clearly emphasised to avoid gap expectations between the profession and its stakeholders. Ježovita, Tusek and Zager (2018:16) allude that such expectations from different stakeholders pose a challenge to IA as it has kept up with the dynamic changes in the business environment. Vasile and Popescu (2011:60) argue that making the value-adding role clear and assessable would be the solution in enhancing the image of the profession both to its internal stakeholders and to the general public. Consequently, D'Onza, Selim, Melville and Allegrin (2015:183) conclude that senior management is also concerned about ensuring that the value-added role of IA is not scrutinised, questioned and challenged. Flostoiu (2012:162) emphasises that the value added by IA through its recommendations contributes towards improving the prospects to attain the objectives of the organisation. AGSA (2019:7) agrees, highlighting the critical role played by the IAF amongst other roles played, indicating that non-implementation of recommendations of role players such as IA hampered the positive impact they could have had on improved governance of municipalities.
Van Rensburg and Coetzee (2016:181) highlight that such concerns, scrutiny and anticipations on the capability and value-added role of the IA profession comes at a time when South Africa’s public sector is faced with widespread corruption, lack of
3 responsiveness, accountability and transparency. Mulaudzi and Masenya (2018:13) also lament the impact of corruption in the South African public sector, which has led to the state capture phenomenon.
Motubatse (2016:35) states that the anticipated value-added role by IA has been explicitly acknowledged by the South African government, which has passed legislation to make it mandatory in the public sector, including municipalities and all state-owned enterprises (SOEs) to establish an IAF. Ackermann (2016:99) identifies the regulatory roles of IA in South Africa’s public sector and explains that IA has an obligation to fulfil this value-adding role in the public sector as in other sectors. The regulatory roles identified by Ackerman (2016:93-99) form the foundations on which this study is based, thus, as much as establishing an IAF is mandatory and must be complied with, the function must ensure that it fulfils its value-adding role. Barac and van Staden (2014:18) state that the establishment of IAF in the South African public sector has also been influenced by voluntary codes like the King Report on Governance.
Mans-Kemp, Erasmus and Viviers (2016:94-95) state that the King Report on Governance in South Africa, published by the Institute of Directors South AfricaIoDSA, is a voluntary code that was first published in 1994 as the King l Report (1994), which was revised to the King ll Report (2002), followed by the King lll Report (2009). This version recommended a risk-based approach to IA. In 2016, the IoDSA released the King IV Report (2016). Koma (2009:458) concludes that the King report on Governance is a valuable code in the public sector as it ensures sound governance in the public fraternity and in promoting efficiency in delivering services like welfare, healthcare and social security. The IoDSA (2016:31) emphasises that IA should be a governance mechanism that supplies foresight and not merely provides insight to organisations they are serving. The expectations on the role of IA in the governance of municipalities is emphasised through the Public Finance Management Act (PFMA) (1999) and the Municipal Finance Management Act (MFMA) (2003).
The PFMA (1999) and the MFMA (2003), which were introduced to improve service delivery and ensure financial accountability in the public sector, mandates the establishment of an IAF according to MFMA, 2003: s62(1)(c)(ii), s95(c)(iii). In addition, Municipal Planning and Performance Management Regulations (MPPMR) (2001)
4 Regulation 7(1)) mandates municipalities to implement systems that require auditing performance measures by IA and the work conducted by IA to be reported quarterly to the municipal manager.
The AGSA’s consolidated general report on audit outcomes of local government for the year 2014-2015 acknowledges that the IAF forms part of the key role players in providing assurance (AGSA:2016). The IAF is part of the second level of assurance providers, providing internal independent assurance and oversight role. The AGSA’s office confirms that IAF contributes to audit outcomes and that failure by management to address IA findings leads to negative impacts on the audit reports (AGSA:2016). Prior research on the role of IA are discussed in the following paragraph.
Research performed on different aspects around the value-added role of the IAF by for example, Barac, Plant and Motubatse (2009:980-988), conclude that IAFs are perceived to be adding value in SA companies. Flostoiu (2012:162) agrees, stating that if enough resources were allocated to the IAFs, the performance of organisations would be enhanced through its value-added role. Similarly, Turner (2013:48) concurs, explaining that the availability of resources and status of the IAF in an organisation are one of the conditions that lead to the recognition of the value-added by IAFs. D'Onza
et al. (2015:182-194) agrees with Roth (2003:33-37) that the array of value-adding
activities performed by IAFs differ from one industry to the other, while Mihret and Woldeyohannis (2008:567-595) urge that the IAFs should move from merely performing compliance activities to performing activities that add value to their organisations. Vasile and Popescu (2011:57-64) concur, further highlighting that there is need to come up with measures to determine the value-added activities that should be performed by the IAF. Research has also been performed on other issues relating to the IAF and are discussed in the next paragraph.
Soh and Martinov-Bennie (2011:1-30) investigated the effectiveness of the IAF. Motubatse, Barac and Odendaal (2015:401-407) examined the challenges faced by the IAF. Lenz and Hahn (2015:18) examined the factors that influence the effectiveness of the IAF. Motubatse (2012:470-485) and Barac et al. (2009:980-988) assessed perceptions of the IAF by different key role players in IA while Koma (2009:452) and Nevondwe, Odeku and Tshoose (2014:268) outline how the
5 application of governance can be promoted. Further, Coetzee, Fourie and Burnaby
(2015:514) and Lenz and Sarens (2012:532) assess the growth of the IA profession
while Coetzee et al. (2015) examine the IA role and the evaluation of the quality of IA services. However, limited research has been performed to investigate the value that the IAF adds to South African municipalities where legislation mandates the establishment of the IAF.
Barac and van Staden (2014:17-31) compare IA in the public sector to one in the private sector and Ackermann (2016:93-99) explores the state of IAs regulatory role. These form the departure point of this study and highlight the need to investigate the involvement and influence of the IAF on the performance of the municipalities since it is mandatory for each municipality to have an IAF according to Section 165(1) of the MFMA. Mihert and Woldeyohannis (2008:581) also propose that research be done on the value added by IA within a pre-defined milieu. Therefore, this study will investigate the value-added role of IA in the governance of South Africa’s municipalities. The relevance of this study has further been enhanced by the drive towards clean audit outcome from the AGSA, wherein there is need to understand the role that IA plays.
Motubatse (2016:133) concludes that sound governance influences the achievement of clean audit outcomes. In 2009, the Department of Corporative Governance and Traditional Affairs (COGTA) launched a project termed ‘Operation clean audit’. The expectation of this drive was to ensure all South African municipalities achieve clean audit outcomes by 2014. During the concluding stage of this study, the AGSA released its MFMA general report for 2017/18, which was not available during the data collection stage of this study. AGSA (2019) states that the target for this operation has not been achieved, instead the number of clean audits for period 2017/18, which are the latest AGSA outcomes, indicate a decline from 2016/17. Therefore, this study will investigate how the IAF contributes, through its value-added activities, towards the sound governance of South African municipalities as explained in the problem statement below.
1.2 PROBLEM STATEMENT
As indicated and discussed in the background of the study above, it is evident that it is not clear whether the IAF contribute to the expected value in municipalities or just
6 established for the sake of compliance with the regulation. If the value-adding role is not upheld and emphasised by both management and the IA professionals, establishing the IAF will be seen as waste of resources and the image of the profession will continue under scrutiny and will be damaged, as predicted by Barac and Van Staden (2014:28), Lenz and Hahn (2015:6), Lenz and Sarens (2012:533) and (PWC) (2016:6).
There is, therefore, a need for research to investigate whether the IAF upholds its value-added role and if such is recognised and acknowledged by the municipalities of South Africa. The proposed objectives of this study are outlined below.
1.3 OBJECTIVES OF THE STUDY
The following objectives have been formulated for the study.
1.3.1 Primary objective
The primary objective of this study is to investigate the value-added role of IA as a governance mechanism in South Africa’s municipalities.
1.3.2 Secondary objectives
Through the literature review and documentary analysis of municipalities’ annual reports for the period 2014/15 to 2016/17, available on the municipalities’ websites and AGSA’s published reports, the study will investigate whether IA adds value to the municipalities or if it is established merely to comply with the legislative requirement.
1.3.3 Theoretical objectives
To achieve the primary objective of the study, the following theoretical objectives are formulated for the study
To identify activities performed by the IAF locally and globally;
To identify the value-added determinants, of the IAF locally and globally;
To identify legislative frameworks that mandate the establishment of IAF in South African municipalities;
To identify the role of the IAF towards the attainment of clean audits in South African municipalities.
7 1.3.4 Empirical objectives
To achieve the theoretical objectives of the study, the following empirical objectives are formulated for the study are achieved through documentary analysis:
To identify disclosures in the annual reports of selected South African municipalities on activities performed by the IAF;
To identify the determinants of the value-added role by the IAF in South African municipalities;
To identify legislative frameworks that mandate the establishment of IAF in South African municipalities and investigate compliance with the identified legislation by the IAF in performing its activities;
To compare financial performance as per the AGSA reports to the disclosures on the work performed by the IAF of each selected municipality;
To identify acknowledgements by AGSA on the contributions of IAF towards clean audits.
1.4 RESEARCH DESIGN AND METHODOLOGY
Mamaile (2018:139) explains that a research design gives the overall strategy that integrates the different parts of a study, supplying the roadmap that enables the researcher to answer research questions, taking into consideration the factors that might affect the relationship of variables. Creswell (2009:3) emphasises that a framework for research design should interconnect the paradigm, strategies of inquiry and the research methods.
Creswell (2009:18) argues that if there is lack of previous research on a concept, qualitative research assists to explore the topic and quantitative research helps to address the problem by bringing an understanding of the factors that influence an outcome. Maree (2015:51) agrees with Creswell (2009:18) and states that qualitative research gives the depth of information provided and quantitative research emphasises the breath of the information. Wright, O'Brien, Nimmon, Law and Mylopoulos (2016:97) argue that qualitative research gives special attention to context to allow a deeper understanding of a phenomenon.
Yilmaz (2013:311) defines quantitative research as “a research that explains phenomena according to numerical data which are analysed by means of
8 mathematically base methods, especially statistics”. Choy (2014:99) agrees with that definition and states that quantitative research design assists in establishing correlations of variables. Maree (2015:269) supports the use of both research methods in one study, giving rise to a mixed method research design and defines mixed methods research as one that uses both the qualitative and quantitative approach in one study to understand fully the research problem. However, this study seeks to gain deep understanding on the value-added role of IA in municipalities; it is, therefore, not going to require the use of any mathematical methods as it does not seek to establish any correlations.
Bloomberg and Volpe (2016:41) argue that qualitative research allows the researcher to gain better understanding and conceptualise the matter under investigation through interpretive practices. Therefore, a qualitative research design is used in this study and documentary analysis as a data collection method. Paradis, O'Brien, Nimmon, Bandiera and Martimianakis (2016:264) propose that documentary analysis, also referred to as content analysis or textual analysis, can be used as the main method of data collection in a research project.
This study comprises a literature review and an empirical study, which is explained below.
1.4.1 Literature review
Swart (2013:10) explains that to get to the solution of a research problem, the literature review is the first step and the next step would be the empirical review towards interpretation of the collected data. Salkind (2013:110) concludes that the literature review provides a theoretical framework for successful research and that it brings perspective on the proposed research, connecting it to the existing literature. Bloomberg and Volpe (2016:105) highlight that the literature review assists the researcher in identifying and understanding the gap in the body of knowledge. Therefore, this study will use the extant academic literature published by local and international researchers. Other sources of information will include newspaper articles, articles from magazines and the Internet. Legislative frameworks and reports will also be consulted to identify legislation that influences the establishment of an IAF.
9 1.4.2 Empirical study
This research empirical portion of the study comprises the following methodology dimensions:
Target population
Salkind (2013:185) states that a population comprises of participants to whom the results of a study can be generalised. The 257 municipalities nationwide comprise of eight metropolitan municipalities, 44 district municipalities and 205 local municipalities will form the population of the study. From this population, the study will only use a sample of municipalities as explained in the following paragraph.
Sampling frame
Elfil and Negida (2017:52) define sampling frame as “the list of all subjects in a population”. Therefore, the following is the sampling frame in this study:
Municipalities in the Gauteng province were used as a sample in this study. According to the Statistics South Africa (StatsSA, 2011) provincial profile, although Gauteng is the smallest province geographically, it is home to 24.1 percent of the South African population. The Gauteng Provincial Treasury (Treasury, 2016) states that Gauteng gives a reflection of the economic performance of South Africa, contributing approximately 35 percent towards the country’s economy.
AGSA (2018), in its 2016/17 MFMA general reports, indicate that Gauteng province municipalities have different financial performances, therefore, Gauteng gives us a representation of all types of municipalities, different financial performances and different audit outcomes. Of the 11 municipalities in Gauteng, three are metropolitan municipalities, two are district municipalities and six are local municipalities. Therefore, using municipalities in Gauteng will ensure that all subgroups of the population are considered in the study. To improve the heterogeneity of the sample, the study included some municipalities from other provinces that possess desirable characteristics and information to meet the objective of the study. Such municipalities include metropolitan, district and local municipalities that had either clean, qualified, adverse or Disclaimer audit outcomes in the period 2014/15 to 2016/17. The sampling method is explained in the next section.
10 Sample method
Bloomberg and Volpe (2016:147) explain that a sample “is a selection of participants from a population”. Maree (2015:172) argues that in most studies it is not possible to examine the whole population, giving rise to the need to select a valid sample to be representative of the population. Maree (2015:172) further agrees with Salkind (2013:93) and identifies three main restrictions of dealing with the population, which are time, cost and that the population would be too large to handle.
Participants for this study were selected using heterogeneity purposive sampling. Etikan, Musa and Alkassim (2015:2) explain that purposive sampling is a non-random technique that allows the researcher to select participants due to qualities they possess. Maree (2015:79) supports that and further states that in purposive sampling participants are selected because of their potential to give the richest possible information while ensuring that subgroups are adequately represented. Bloomberg and Volpe (2016:148) further state that purposive sampling aims at information-rich participants who will facilitate gaining insight of the subject being explored. Purposive sampling will ensure that all types of municipalities are included in the study. Maree (2015:78) states that it would be disastrous if some of the subgroups are not adequately represented.
Therefore, through purposive sampling, municipalities in Gauteng have been selected to form the sample for this study. Gauteng comprises of different types of municipalities, metropolitan, district and local municipalities and is regarded as a province that mirrors South Africa’s economic performance. Gauteng has municipalities with different financial performances as shown by the AGSA reports for period 2014/15 to 2016/17. The measuring instrument and data collection method used are discussed below.
Measuring instrument and data collection method
Paradis et al. (2016:264) argue that documentary analysis is ideal to investigate organisational views through organisational reports. Dumay and Cai (2015:122) assert that analysing documents as a data collection method allows the researcher to gather data conveniently from an unobtrusive source of information and allows the researcher
11 to gather more truthful data, as participants would have given enough thought and attention to compiling it.
Documentary analysis was, therefore, chosen as a data collection method for this study. Gaur and Kumar (2018:281) and Renz, Carrington and Badger (2018:825) agree that using organisational reports provides a more factual analysis. Documentary analysis allows the researcher to analyse reports from different categories of municipalities in Gauteng. It allows the researcher to analyse data from municipalities with different audit opinions as per AGSA audit reports and reports from municipalities from year 2014/15 to year 2016/17 was used. In 2009, the Department of Corporative Governance and Traditional Affairs (COGTA) launched a campaign termed ‘Operation clean audit’. The expectation of this drive was to ensure all South African municipalities achieve clean audit outcomes by 2014. This study finds it ideal to start from 2014 when the results of the operation is evaluated. The reports for financial year 2016/17 were the latest published AGSA reports at the time of data collection. Therefore, the study found it appropriate to use periods 2014/15 to 2016/17.
Data for this study was gathered from annual reports accessed from the AGSA’s website and from the respective municipalities’ websites. Renz et al. (2018:825) explain that collected data in qualitative documentary analysis then needs to be condensed, prepared, coded and analysed through a tested process. The process of analysing data is illustrated and discussed in Figure 3-1 and Section 3.6, respectively, of Chapter 3 and the next paragraph explains the coding method used.
Maree (2015:105) explains that coding allows faster retrieval and collection of all data and text identified, allowing transparent and objective presentation of facts. Maree (2015:105) defines coding as “marking the segments of data with symbols, descriptive words or unique identifying names”. Hence, data retrieved from reports was coded into relevant categories. Saldaña (2013:4) states that coding assists the researcher to have different symbols to explain and interpret attributes in a given set of data. Descriptive coding was used in this study. Saldaña (2013:261) states that descriptive coding is best in a study with a wide variety of data forms and is appropriate for all qualitative researches. Descriptive coding allows the coding of different audit opinions from the AGSA reports from different types of municipalities, with different IAF
12 structures, which may be outsourced, co-sourced or in-house and are performing different activities.
1.5 ETHICAL CONSIDERATIONS
Desk research tools were used in the study, where publicly available data were collected from relevant sources and there was no contact between the municipalities’ personnel and the researcher. The researcher acknowledges the importance of ethical consideration throughout the study; however, the researcher did not foresee any potential problems to affect individuals or participants negatively in the study. A North-West University (NWU) ethics checklist was completed and submitted to the Ethics Committee for consideration and approval.
1.6 PROJECT PLAN
1.6.1 Chapter classification
This study comprises the following chapters:
Chapter 1 Introduction and background to the study
The background of the study, research problem and objectives is presented in this chapter. The chapter also includes primary and secondary objectives.
Chapter 2 Literature review
In this chapter the literature from academic journals, international standards for the professional practice of internal auditing (IA) and relevant legislation is reviewed to support the study.
Chapter 3 Research design and methodology
This chapter presents the research design and methodology used. Population size, sample size and research method is also discussed.
Chapter 4 Results and findings
Data collected through the literature review and documentary analysis, interpreted and the results are presented in this chapter.
13 Chapter 5 Conclusions, limitations and recommendations
Conclusions, limitations and recommendations are made in this chapter, including recommendations for further research based on the literature review in Chapter 2 and the results and findings in Chapter 4.
14
CHAPTER 2: LITERATURE REVIEW
2
2.1 INTRODUCTION
The literature review in Chapter 1 highlights the need to investigate whether IA adds value to the governance of South African municipalities. This being a response to previous research performed by Alzeban and Sawan (2015:61), Dal Mas and Barac (2018:814) Ismael and Roberts (2018:288), Lenz and Hahn (2015:24), Mihret and Woldeyohannis (2008:568) Soh and Martnov-Bennie (2011:2) and Quick and Henrizi (2018:1), which highlights that in the wake of corporate scandals, poor business ethics and dynamic business environment, the relevance of IA as a governance mechanism has increased. Kroukamp and Cloete (2018:61) explains that South African municipalities have been paralysed and hampered by corruption and lack of accountability, leading to poor service delivery to its citizens. AGSA (2019:7) concurs, expressing concern over the worsening governance failures in South African municipalities. That indicates that South African municipalities have not been spared this global wake of poor governance. Mbewu and Barac (2017:15) conclude that this significant decline in sound governance puts the IA profession in the spotlight to prove its significance and legitimacy as a governance mechanism. The Municipalities Finance Management Act (MFMA, 2003) makes it mandatory for all municipalities in South Africa to have an IAF. Mbewu and Barac (2017:15) argue that clean audits are a result of good governance and an effective IAF must contribute towards the attainment of such in their respective municipalities. This chapter presents a literature review on the value added by the internal audit as a governance mechanism in selected municipalities of South Africa.
Bloomberg and Volpe (2016:104) explain that the literature review provides a theoretical background, understanding and perspective on the leading concepts that allow a researcher to obtain a research framework and achieve the stated objectives of the research. Winchester and Salji (2016:308) propose that the literature review should not be a mere academic requisite, but an essential appraisal in a study that places the study’s findings into context.
The chapter starts with an introduction to the literature review, which is presented in Section 2.1. After the introduction, the background and development of the IA
15 profession is presented in Section 2.2. Section 2.3 elaborates on the nature of work of the IA work as delineated by the International Standards for the Professional Practice of Internal Auditing (ISPPIA) and the value-added role of IA. The ISPPIA, in Standard 2100, 2110, 2120 and 2130 demarcates the nature of IA work under governance, risk management and control processes, which are outlined in Sections 2.3.1, 2.3.2 and 2.3.3. Section 2.3 provides a discussion on the disclosures made on work performed by the IAF in Section 2.3.4. A discussion on the value-added role of the IAF is outlined in Section 2.4. Section 2.5 provides a background of South African municipalities, its structures and the legislation that motivates the establishment of IAF in municipalities. Before the conclusion, ‘operation clean audits’ and the current state of the municipalities is discussed. Finally, a conclusion of the chapter is presented in Section 2.7.
2.2 THE BACKGROUND AND DEVELOPMENT OF IA
This section presents a description of the background of IA and a discussion of how the profession developed from its traditional approach to the current state of being a value-adding function. Hald (Cited by Hubeidatu,2015:2) states that “necessity created IA and is making it an integral part of modern business. No large business can escape it. If they haven’t got it now, they will have to have it sooner or later, and, if events keep developing as they do at present, they will have to have it sooner”.
Mihret and Grant (2017:700) agree with Sawyer et al. (2003:3) who argues that the historic role of IA was to check the validity of transactions and records and initially formed part of the accounting profession, having its primary objective to ensure accuracy of financial records. Sawyer et al. (2003:5) further highlights that since 1941, when the IIA was formed, IA has managed to distinguish itself from external auditing, moving from the concentration of financial audits to broadening its scope to cover operational and compliance audits, with financial audits now constituting a small part of IA
The IIA in its International Professional Practices Framework (IPPF) defines IA as “an independent objective assurance and consulting activity designed to add value and improve an organisation’s operations. It helps an organisation accomplish its
16 objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes”. (IIA, 1999) Karagiorgo et al. (2010:18) hold the view that the definition of IA indicates that IA assists the organisation to accomplish its objectives. Christopher (2015:956) agrees with Karagiorgo et al. (2010:18) concluding that the IA definition is an illustration that the IA profession has evolved to being a significant role player in the enhancement of sound governance.
Roussy and Brivot (2016:714) concur with Sawyer et al. (2003:3) who explores the definition of IA and concludes that IA has grown to be a partner of management towards achieving organisational objectives through its value-added activities. Sawyer
et al. (2003:3) explains that IAs mission is to add value to the organisation through its
independent evaluation of risk management, control and governance processes according to the definition given by the IIA. Changwony and Rotich (2015:15) agree with Mihret and Woldeyohannis (2008:569) in concluding that IA was previously regarded as a management watchdog due to its traditional role of safeguarding assets and verifying the reliability of financial information and compliance.
Mihret and Grant (2017:699), however, state that despite IAs accentuated critical role in governance, IA remains an unexplored research area. Lenz and Sarens (2012:533) points out that the lack of adequate research into the role of IA has led to the questioning of its role compared to other assurance providers such as external auditors. Van Staden and Barac (2014:20) emphasise that IA is that part of the four cornerstones of governance that plays a coordinative role amongst the other three cornerstones of governance, which are external auditing, management and the audit committee.
De Jager and Padayachee (2015:47) and Lenz and Hahn (2015:6) argue that in a dynamic and complex environment, IA can rise stronger as a profession or can be marginalised by other assurance providers. Lenz and Sarens (2012:533) points out that as a profession in its infancy compared to other assurance providers, IA has to render more than just the traditional services and should be engaged in more value-adding activities as proposed in the definition given by the IIA, for example, evaluating and improving the effectiveness of governance, risk management and control processes.
17 Christopher (2015:955) states that as a value-adding cornerstone on which sound governance is founded, IA plays an important role of monitoring controls on behalf of the board and providing advisory services to management. Sinaga and Simanjuntak (2016:79) confirm that by explaining that governance, through its mechanisms such as IA, is a way of controlling and monitoring the performance of entities thereby adding value to all the stakeholders. Cascarino (2007:5) assert that an effective IAF becomes essential as the need for sound governance increases, hence the responsibility of the IAF evolved from a mere compliance tool to include more value-added activities, which are discussed in Section 2.2.
Mihret and Woldeyohannis (2008:568) emphasise that the role of IA needs to change significantly to align with the dynamics of organisational needs and technological changes. These and other internal and external factors, according to Sawyer et al. (2003:3), influenced the systematic evolving of the profession of IA leading to its definition, which establishes its role to add value in matters relating to internal control, risk management and governance processes. Mihret and Woldeyohannis (2008:582) further conclude that modern IAs core paradigm is advisory and consultative and its thrust is to add value in the organisations they serve.
Changwony and Rotich (2015:16) explain that the current role of IA entails scrutinising governance practices and evaluating the risk management and controls processes. De Jager and Padayachee (2015:47) states that such roles are an indication that IA has risen as a management-oriented profession that serves as a mechanism to enhance sound governance through its value-adding consulting role instead of the traditionally mere compliance-oriented role, which according to Mihret and Wolderyohannis (2008:596), is confrontational and reactive in nature. Mihret and Grant (2017:700) argue that recommendations made in IA reports should promote insight, guidance and support to management. Shahimi, Mahzan and Zulkifli (2016:25) further argue that through its consultative role, IA entails partnering with management, in a problem identification and solving nature that ensures the achievement of strategic objectives and assists businesses to deal with new challenges.
Ackermann (2016:99) states that the IAF has the role to assist audit committees in their governance oversight role, which increases the demand for IAF to assist through the provision of their value-adding, independent, objective assurance with the aim of
18 helping organisations to achieve institutional objectives. The IIA provides a framework to guide internal auditors and the IAFs in their practice of IA through its IPPF. The IPPF contains mandatory guidance but also has some recommended guidance. The International Standards for the Professional Practice of IA (ISPPIA) commonly referred to as (Standards) guides on the attributes of the internal auditors and the IAF and how IA engagements must be performed. The IIA (2016:1) explains that the ISPPIA provides a framework to guide IAFs to perform their work in a unified way towards fulfilling their role to add value to the organisation through their functional areas, which are governance, control and risk management process. Therefore, the nature of IA work as prescribed by IIA is outlined in the next section.
2.3 THE NATURE OF IA WORK
The nature of work for internal auditors is prescribed by the ISPPIA, issued by the Institute of Internal Auditors (IIA, 2017). Chambers and Odar (2015:34) explain that the ISPPIA provides an international framework for performing IAs and criteria for evaluating the quality of the services each IAF provides. Changwony and Rotich (2015:15) agree, pointing out that the ISPPIA guides individual internal auditors in executing their responsibilities. Groff et.al (2016:54) emphasises that if IAF is to add value to their organisations, they must aim to enhance their core focus, which is evaluating and improving the effectiveness of the organisation’s governance, risk management and control processes as stipulated in ISPPIA, Standard 2100 discussed in the following paragraphs.
As highlighted above, the role of IA has been prescribed by the IIA in the ISPPIA issued by IIA. Standard 2100 explains the nature of IA work. The IIAs ISPPIA is a framework that guides all IA attributes and performances. IIA (2017) prescribes that the functional areas of the IAF in Performance Standard 2100 and its sub-standards 2110, 2120 and 2130, wherein it is stipulated that the IAF must evaluate and contribute to the improvement of the organisation’s governance (Standard 2110), risk management (Standard 2120) and control processes (Standard 2130). ISPPIA 2100 further states that the IAFs value-adding role is enhanced if the activity is proactive and provides insight and foresight into the future.
19 Wilkinson and Coetzee (2015:187) explain that for IA to render its services fully as a cornerstone in organisational governance, it must perform two types of services, which are consulting and assurance services. This is supported by IIA (2017) that explains implementation standards have been provided to guide in the implementation of attribute and the performance standards. The implementation standards have been divided into assurance (A) and consulting (C) services.
Assurance service: Soh and Martinov-Bennie (2015:81) explain that IA is a feedback mechanism, providing reasonable assurance that there is credible reporting from the internal functions of the organisation. This is confirmed by IIA (2017:2), which informs that assurance services are initiated by the IAF through its head of the department, to provide reasonable assurance towards attaining specific objectives of the organisation. The head of department, normally referred to as Chief Audit Executive (CAE) is responsible for setting the objectives of the engagement. It is a three-part engagement and the parties include the internal auditor, the process owner and the users of the engagement report.
Consulting Services: IIA (2017:2) advises that consulting services (C) are advisory in nature and are performed at the request of the engagement client. Consulting services involve only two parties, that is, the internal auditor and the engagement client. Roussy and Brivot (2016:723) explain that IAs consulting services provide management with personalised assistance and advice towards sound decision making.
Therefore, to add value to the organisation, IAF renders both assurance and consulting services under the core areas of internal auditing, which are governance, risk management and control processes further discussed in the following paragraphs.
2.3.1 Nature of work: Governance processes
Suleiman and Dandago (2014:223) explain that internal auditing is a critical governance mechanism that enhances ethical behaviour and monitors performance of different functions of the organisation. This is supported by Standard 2110 of the IIAs international standards for the professional practice of IA (IIA:2017), which states that the IAF can add value through performing evaluations and making recommendations on both strategic and operational decisions, having oversight over
20 risk management and control processes, encouraging appropriate ethical values, safeguarding effective organisational performance management and accountability, communicating fundamental risk and control information, coordinating the activities of, and communicating information among the key role players in the organisation. Institute of Internal Auditors- South Africa in its Implementation guides, Therefore, the Institute of Internal Auditors in its Implementation guides (IIASA, 2019:126) pronounces that the basis for applying this standard, ISPPIA 2110- Governance processes must be founded on the understanding of the concept of governance. Therefore, the background and development of governance is explored.
The concept and background of governance
Changwony and Rotich (2015:15), Christopher (2015:954), Karagiorgos et al. (2010:17), Lenz and Sarens et al. (2012:200), Mans-Kemp et al. (2016:94), Sinaga and Simanjuntak (2016:77), Soh and Martinov-Bennie (2011:2), Tornyeva and Wereko (2012:95) and Waweru (2014:461) agree that although governance is not a new concept, it is receiving more attention since the fall of the corporate giants, which was attributed to lack of sound governance structures and processes. The above-mentioned researchers agree to the fact that corporate scandals that led to the failure of corporate giants such as Enron (2001) and Worldcom (2002) influenced a shift of the world’s attention to focus on sound governance.
Masegare and Ngoepe (2018:584) agree with Solomon (2011:5) that the evolving and dynamic nature of governance makes it difficult to give a universally acceptable definition of governance. Nakpodia, Adegbite, Amaesh and Owolabi (2018:391) explain that the definition is also influenced by country-specific internal and external factors and the fact that governance evolves and improves over time. Florea (2013:79) urge that governance definitions differ, and they need to be interpreted and applied in their proper context. It is, therefore, important to define governance so that it is appropriately used in the context of this study. Wilkinson and Coetzee (2015:185) warn that the term governance might be used out of context if not carefully defined in the context within which it is used. This study focuses on governance within the context of South African local government, therefore, the definition as stipulated by the King lV Report (2016) is used. The King IV Report (2016) defines governance as “the combination of processes and structures implemented by the board to inform, direct,
21 manage and monitor the activities of the organisation towards achieving its objectives”. (IoDSA, 2016). Before looking at governance within the South African context, it is important to outline briefly global governance developments. From the definition, it can be deduced that governance is about the proper functioning of organisational structures, processes and strategies towards achieving organisational objectives.
Global governance developments
Cuomo, Mallin and Zattoni (2016:226) analyses corporate governance codes globally to ascertain the possibility of diffusing the different codes across national boundaries. The identified codes include the Cadbury Report on governance in the UK in 1992, which was commissioned specifically to address the financial aspects of governance and called for the strengthening of roles of non-executive directors and other committees like the audit committee. The United States (US) Sarbanes–Oxley Act of 2002 provided legal requirements to enforce sound governance on all US SEC-listed companies and all their subsidiaries and associates worldwide. The King l Report (1994) was published in 1994, which led to South Africa being acknowledged as a pioneering country to have a formal code of governance. Solomon (2011:199-202) also suggests the need to harmonise the application of the concept of governance globally, giving an example of the International Accounting Standards Board, which enhances consistency in financial and accounting reporting.
The IIA (2014:2) highlights that governments worldwide are structured differently, and they have different roles and jurisdictions, therefore, no single governance framework applies to all sectors and organisations. Cuoma et al. (2016:223) concur and explain that the governance arena faces a challenge of having a unified code of sound governance due to the differences in culture, jurisdictions, social and economic settings. Therefore, this study is informed by the definition as given in The King IV Report (2016).
Haji and Anifowose (2017:374) acknowledge that the rise in the attention to governance worldwide left its traces in the South African public sector as well. South Africa is recognised as a pioneer in good governance in response to the introduction of its first inclusive framework for governance in 1994, namely the King Report on Corporate Governance in South Africa. Tshipa, Brummer, Wolmarans and Du Toit (2018:370) acknowledge that the foundation of the King Report is based on the
22 motivation to balance governance strategies that are locally relevant while meeting the international governance standards.
Governance in South Africa
Kim and Lu (2013:237) suggest that developing countries lack the resources to implement sound governance mechanisms. Waweru (2014:458), however, argues that South Africa is on the upper-income bracket of developing countries, therefore, has the resources to implement sound governance mechanisms. Clayton, Rogerson and Rampedi (2015:10) highlight that South Africa became the first country in Africa and the third internationally to embrace the importance of having an inclusive model of governance, where management does not merely account to shareholders but to all other stakeholders. Masegare and Ngoepe (2018:583) posit that although there already were good governance systems worldwide, for example, the Cadbury Committee (1992), the King l Report (1994) made a mark by being the third inclusive governance model worldwide and the first in Africa. The next section will bring a synopsis and progression of the first inclusive governance model in South Africa published by the IoDSA, the King Report on Governance South Africa.
Synopsis of the King Report on Governance in South Africa
Mans-Kemp et al. (2016:94) argue that the King l Report (1994) essentially provided guidelines on the conduct of the Johannesburg Stock Exchange (JSE) listed firms’ directors and aligned with the UKs Cadbury Report. Mans-Kemp et al. (2016:94) supported by Armstrong (2005:9) explains that the King l Report (1994) focused on the importance of a proper functioning of the board of directors, bringing an approach that integrates the different aspects of organisational management. Researchers such as Mans-Kemp et al. (2016:94), Scholtz and Smit (2015:31) agree that the King l Report (1994) stimulated awareness and attentiveness to governance issues in South Africa and provided a framework for the application of sound governance practices relevant to South Africa. Mans-Kemp et al. (2016:94) further highlight that the implementation of the King l Report (1994) is on a ‘comply or explain’ basis.
Afolabi (2015:12) explains that the King l Report (1994) was introduced in South Africa when the country was going through a major transformation in its political and economic realm. Andreasson (2011:656) poses that the King l Report (1994) anchored
23 the interests of all stakeholders into the African values of shareholders having economic benefits without neglecting the society within which it operates; the King I Report demonstrated South Africa’s commitment to sound governance to international investors.
Mans-Kemp et al. (2016:94) assert that South Africa’s political, social and economic environment and other international conditions, which to a large extent were initiated by the demands of institutional investors and stakeholder management, influenced the revision of the King l Report (1994) to the King ll Report (2002). A summary on how the different King codes address IA is covered in Table 2-1. Padayachee (2017:17) posits that these changes elicited the need for a social upgrade in the previously disadvantaged and underprivileged communities thereby calling for sound governance. Figure 2-1 illustrates that the revision of the King l Report (1994) to the King ll Report (2002) was influenced by both international and domestic pressures.
Figure 2-1: Pressures that influenced the revision of King l Report (1994) Source: Rossouw et al. (2002:298).
West (2006:436) states that the King ll was introduced in 2002 and presented guidelines on addressing stakeholder interest while not sacrificing the returns of the shareholders, the King ll Report (2002) operated on a ‘comply or explain’ basis. This code also introduced the requirement for triple bottom line reporting, which calls for reporting beyond the economic performance of any entity to include social and
24 environmental reporting. Andreason (2011:657) states that the King ll Report’s (2002) main component is the Code of Corporate Practice and Conduct, which supplies recommendations for applying sound governance to JSE listed companies, public entities falling under the PFMA of 1999 and the MFMA of 2003. Andreason (2011:657) concludes that the King ll Report (2002) applies the international best practices standards to fit in with South African local context.
The King ll Report (2002) addresses areas such as directors’ remuneration, internal control and risk management and accounting and audit and integrated sustainability reporting. The King ll Report (2002) also stipulates the role, status and scope of IA. Padayachee (2013:268) deduces that after the adoption of the King ll Report (2002), debate on the application of the code in some areas influenced the revision of the King III Report (2009) and saw the birth of the King lll report that adopted an ‘apply or explain’ approach. Nevondwe et al. (2014:265) highlights that the King lll Report (2009) applies to all entities regardless of whether they are in the private or public sector. Afolabi (2015:15) further states that the King lll principles are enforceable to entities listed with the JSE and all public entities but compliance with the code is voluntary to any other entity. Nevondwe et al. (2014:267) further concludes that due to its ‘apply or explain’ approach, the King lll Report (2009) offered some flexibility in the application of its principles. The King III Report (2009) was the first code to recommend that the IAF should adopt a risk-based approach in their audits instead of a compliance based approach. The King III Report (2009) also applauded IA as an integral internal combined assurance mechanism. The King III Report (2009) was revised in 2016 to the King IV Report (2016).
The King lV Report (2016) succeeded the King lll Report (2009) in its entirety with the aim of making its principles applicable to all organisations, including small, medium, private and public organisations. The IoDSA in the King IV Report (2016) brings a definition of governance that clarifies that governance is a concept applicable to all kinds of entities including public sector entities like municipalities. Padayachee (2017:17) deduces that the King IV Report (2016), being the most recent King code, focuses on sound leadership, sound values and gives guidelines on the establishment of governance structures in specific sectors, for example, the municipalities. The King IV Report (2016) in Part 6.2 presents principles of sound governance that applies to
