Guiding you through audit terminology

“Every few months there’s a stir in the media when the Auditor General releases yet another government entity’s audit report,” says Kevin Phillips

March 20, 2012

“Every few months there’s a stir in the media when the Auditor General releases yet another government entity’s audit report,” says Kevin Phillips, MD of idu Software. The reports are variously damning, with the provinces and municipalities often being the worst culprits when it comes to things like “fruitless and wasteful expenditure”.

But what do these scary-sounding terms actually mean? What is really happening to our tax money in these cases – and how much of a big deal is it?

To answer those questions, let’s first recap the purpose of an audit. The auditor’s job, whether in the private or the public sector, is to make sure that an organisation’s financial statements are a fair reflection of what actually went on during a financial year. It’s about accuracy, transparency and completeness of information.

If corrupt individuals are organised enough, they can fool the audit process for a while – but it won’t be easy. Corruption doesn’t flourish where financial information is transparent and widely available, so that many people understand the broader financial picture. On the other hand, if there’s only one person in the organisation who knows what’s going on, the risk of fraud and corruption is massively higher.

So, a regular audit serves both to uncover problems and as a useful precaution: When people know they have to satisfy an auditor at the end of the year, they are more likely to follow good practice.

With that in mind, it’s easier to understand what all those audit terms really mean. A clean audit report is what everyone wants: A confirmation that there are no material errors or omissions in the organisation’s financial statements.

That little word “material” is important, however. It doesn’t mean there are no errors or omissions at all – it just means they aren’t significant enough to be a serious concern. The “threshold of materiality” is the point at which errors or omissions become large enough to influence economic decisions in the organisation. Exactly where this threshold lies will depend on the size of the organisation’s budget: A R1m discrepancy could be a sign of major trouble in a small municipality, or a mere rounding error in a large government department. This materiality issue goes some way to explaining why there is sometimes confusion about whether an organisation’s statements really are clean or not.

The next step down from a clean audit is a “qualified audit” – the accounts contain some “material misstatements”, or there isn’t enough evidence to decide whether some amounts are accurate enough.

The words “qualified” and “unqualified” also sometimes lead to confusion, because the way they are used in audit reports is different to the way we use them in everyday speech. We want our doctors and our accountants to be qualified, i.e. we want them to have all the right training and certifications and to meet certain standards. But we don’t want audit reports to be qualified; because that means the auditor has some reservations about the figures. Hence a clean or unqualified audit is better than a qualified one.

A further step down the list is the adverse audit: The auditor finds the organisation’s financials have substantial misstatements. In other words, the amount of information that is wrong or left out is significant.

Even that is not as bad, however, as a disclaimed audit: This happens when the auditors throw up their hands and say “these statements are such a mess I can’t tell what’s going on!” or the accounts are fundamentally incorrect or false. This is a red flag precisely because of the point we made about transparency above: If nobody knows what’s going on, what could be hiding in the mess?

Within each category of audit opinion, there are three kinds of problem spending that the auditor might flag. The first is unauthorised spending: That is, spending that goes over budget or wasn’t used for the purpose intended.

Irregular expenditure is something different: Spending that was incurred “without complying with applicable laws and regulations,” according to the Auditor General’s definitions. Unauthorised spending can be down to admin errors or accidents – irregular spending might raise more concerns because it suggests that procedures aren’t being followed and there is potentially more chaos to follow.

Finally, “fruitless and wasteful expenditure” is the facepalm category: Pointless spending that could have been avoided “if reasonable care had been exercised”. Penalties and interest for late payments fall into this category.

Next time you read a sensational news story about an Auditor-General’s report on a particular department or municipality, take some time to consider the details. Is the report misunderstanding, or making a mountain out of a molehill – or are things even worse?