Court judgement impacting DALRRD audit outcome and related matters: AGSA & DALRRD briefing

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Meeting Summary

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The Western Cape Provincial Parliament’s Public Accounts Committee (SCOPA) received a briefing in a virtual meeting from the provincial Department of Agriculture on a court judgment that had impacted the audit outcomes of the Department for the period from 2016/17 to 2020/21.

The Department said that over an 18-month period, it had tried to persuade the Auditor-General of South Africa (AGSA) that its findings were flawed from an accounting and legal perspective. The AGSA had refused to concede and had issued a qualified audit report in respect of the Department of Agriculture for the 2016/17 financial year, and had done so consistently in the financial years that followed. The Department had had no option but to challenge the AGSA’s findings.

The Western Cape High Court took into account that the same funding mechanism had resulted in clean audits in prior financial years. The court held that principles of reliance, accountability and rationality were fundamental constitutional principles. As far as the regulatory framework was concerned, the court confirmed that the Public Finance Management Act (PFMA) required the Accounting Standards Board (ASB) to set standards of Generally Recognised Accounting Practice (GRAP). National Treasury was not empowered to set standards of GRAP itself, a power that was clearly conferred on the ASB. The Modified Cash Standard (MCS), which was used to guide departments, did not constitute standards of GRAP – it was therefore not legally binding.

All that had been prescribed was that the Department had to account on a modified cash basis, which the Department had done. Other instruments, on which the AGSA relied, such as the new Economic Reporting Format (ERF) and the Accounting Manual for Departments, were not prescribed in law and were found not to be legally binding. The court held the Department’s payments amounted to unrequited payments, as they had received nothing of similar value in return and, therefore, constituted transfers.

The Department responded that the elements of agency were absent and that the Department had no legal relationship with the third party - beneficiaries had no rights against the Department. Insofar as the AGSA relied on the controls exercised by the Department in respect of the manner in which the funds were spent, the court held that the Department had a legal obligation to ensure that funds were properly spent, in terms of the PFMA, which did not change the relationship between the Department and the two entities (Hortgro and Casidra).

The court concluded that the MCS was not legally binding, that the AGSA had misinterpreted a National Treasury regulation, that its approach to the principal-agent relationship was incorrect in law, and that it had misdirected itself as to the legal status of various reporting standards.

Then, on 30 June 2020, National Treasury and AGSA, although not opposing the case in the Western Cape High Court as second respondent, had appealed the finding that the MCS was not legally binding and that the MCS was not reviewed and set aside. AGSA and Treasury argued that it was binding until the ASB had set implementation dates for implementing standards set by them. The AGSA was granted leave to appeal, but not National Treasury. The Western Cape government had decided to oppose the appeal. AGSA had submitted evidence of a Treasury Instruction in terms of section 76 of the PFMA that the MCS was lawful and binding (in the absence of GRAP). The Department did not oppose this new evidence submitted by the AGSA.

Members asked what the costs of the legal challenges had been, and how they would reflect on the Department’s audit report. They wanted to know if the costs were justified, or if it was money that could have been used for something else in the Department; whether Treasury had retracted the circular; what the implications could have been if the AG’s review had been upheld, and why the Department had stood its ground. The Committee asked if there had been any involvement by both the AG and Department with the Accounting Standards Board (ASB), because this was an accounting matter; and enquired if the process of putting measures in place by National Treasury had been finalised.

Meeting report

Department of Agriculture briefing
Mr Floris Huysamer, Chief Financial Officer, Western Cape Department of Agriculture, briefed the Committee on the resolutions of the Western Cape High Court and Supreme Court of Appeal judgments of 8 June 2020 and 4 October 2021, respectively.

Mr Huysamer informed the Committee that over an 18-month period, the Department had tried to persuade the Auditor General of South Africa (AGSA) that its findings were flawed from an accounting and legal perspective in terms of the above principle. The AGSA had refused to concede and had issued a qualified audit report in respect of the Department of Agriculture for the 2016/17 financial year, and had done so consistently in the financial years that followed. The Department had had no option but to challenge the AGSA’s findings and its issuing of qualified audit reports for 2016/17 and 2017/18, as well as 2018/19, 2019/20 and 2020/21, after the AGSA decided to appeal. Because AGSA was a Chapter 9 institution in terms of the constitution, the challenge had to be in a competent court of law. National Treasury (NT) had also issued a classification circular supporting the AGSA’s stance.

The Western Cape High Court took into account that the same funding mechanism had resulted in clean audits in prior financial years. The court held that principles of reliance, accountability and rationality were fundamental constitutional principles. As far as the regulatory framework was concerned, the court confirmed that the Public Finance Management Act (PFMA) required the Accounting Standards Board (ASB) to set standards of Generally Recognised Accounting Practice (GRAP). National Treasury was not empowered to set standards of GRAP itself, a power that was clearly conferred on the ASB. The Modified Cash Standard (MCS), which was used to guide departments, did not constitute standards of GRAP – it was, therefore, not legally binding.

All that had been prescribed was that the Department had to account on a modified cash basis, which the Department had done. Other instruments on which the AGSA relied, such as the new Economic Reporting Format (ERF) and the Accounting Manual for Departments were not prescribed in law and were found not to be legally binding. The court held the Department’s payments amounted to unrequited payments, as they received nothing of similar value in return and, therefore, constituted transfers. AGSA’s argument was that the transactions ought to have been classified as goods and services or capital expenditure, and that a principal-agent relationship existed between the Department and Hortgro (Deciduous Fruit Producer’s Trust (DFPT)) and Casidra. The court found that Hortgro (DFPT) and Casidra had carried out activities in collaboration with the Department, not under instruction of the Department.

Mr Huysamer reported the elements of agency were absent and that the Department had no legal relationship with the third party -- beneficiaries had no rights against the Department. Insofar as the AGSA relied on the controls exercised by the Department in respect of the manner in which the funds were spent, the court held that the Department had a legal obligation to ensure that funds were properly spent, in terms of the PFMA, which did not change the relationship between the Department and the two institutions. The court concluded that the MCS was not legally binding, that the AGSA had misinterpreted an NT regulation, that its approach to principal-agent relationship was incorrect in law, and that it had misdirected itself as to the legal status of various reporting standards. The AGSA had erred in considering irrelevant considerations and ignoring relevant ones, and in materially misdirecting itself in law and on the facts.

Then, on 30 June 2020, the NT and AGSA, although not opposing the case in the Western Cape High Court (WCHC) as second respondent, appealed the finding that the MCS was not legally binding and that the MCS was not reviewed and set aside. AGSA and NT argued that it was binding until the ASB had set implementation dates for implementing standards set by them. The AGSA was granted leave to appeal, but not NT. The Western Cape government had decided to oppose the appeal. AGSA had submitted evidence of a Treasury Instruction in terms of section 76 of the PFMA that the MCS was lawful and binding (in the absence of GRAP). The Department did not oppose this new evidence submitted by the AGSA.

Mr Huysamer stated the material misstatements for 2020/21 and the prior four annual reports were the result of an incorrect finding by the auditor, as confirmed by the two judgments. The replacement audit reports for all five years had omitted these material misstatements, indicating that there were none, and therefore there was no internal control lapse in this regard. There was no impact on the predetermined objectives of the Department in any of the years due to the dispute. National Treasury had, since the 2020/21 financial year, put processes in place to deal with disputes between the auditor and auditee, which would mostly lead to the avoidance of a recurrence.

Discussion
Ms Sharonne Adams, Corporate Executive, AGSA Western Cape, remarked the key thing was to go forward and look at the mechanisms put in place so that both parties did not find themselves in the same position. One of the things that had come from the previous judgment was to indicate the roles of the AG and this matter had been clarified in the appeal the AG had made. This was another thing that had gone in the AG’s favour.

Mr G Bosman (DA) asked what the costs of the legal challenges had been, and how they would reflect on the Department’s audit report. He wanted know if the costs were justified or if it was money that could have been used for something else in the Department.

Dr Mogale Sebopetsa, Head of Department: Western Cape Department of Agriculture, said that going to court had not been the choice of the Department. It had had no option -- that was why it had approached the courts for a different view.

Mr Huysamer said costs were around R800 000. Although the Department had a cost allocation, the money went to the national Justice Department, so it went back to the government.

Mr Ashiq Allie, Senior Audit Manager, AGSA Western Cape, said it was the Department of Agriculture that had been affected by the technical review at the time. One of the strong motivations was that it should have been classified as goods and services, because it fell under the mandate of the Department of Agriculture. The key principle was to look at whether there was a binding relationship with third parties, and the principle itself.

Mr A van der Westhuizen (DA) wanted to establish if NT had retracted the circular. What could have been the implications if the AG’s review had been upheld, and why did the Department stand its ground? What were the differences between Casidra and the Department of Agriculture on transfers? Could the Committee be assured by the AG that future audit reports of the Department would be done in a good spirit? Would a third party be involved in settling the dispute?

Dr Sebopetsa said the implications would have been that the efficiencies for supporting black farmers and drought in the province would have been affected in a big way.

Mr Huysamer said the NT had retracted the circular and adjusted certain things that were indicated in the judgments. He indicated the reason why the Department had done what it had to do it was because it understood that agriculture was a set of biological systems. Unfortunately, it did not stick to government timeframes. With the MCS, as opposed to GRAP, one starts in a year and finish within a year, and next year one starts with a new budget and business. In an accrual environment, this could be better serviced, because if it rains in April, one needed to plant in April in terms of wheat, for instance. It was difficult to stick to biological rules. That was why it was difficult for the cash environment to support agriculture. The HOD had indicated loss of efficiencies comes to the fore because of that. For example, if there was drought and one did not have the accrual environment of Casidra, at the end of the financial year, whatever money was left, had to be returned to Treasury. That meant that during this time, sheep could have been given fodder. When the new financial year starts, the money gets rolled over to the new financial year when it had been requested, so it becomes difficult for the sheep to wait for such processes.

He added there was no uniqueness in a transfer-payment environment. Casidra was in an accrual environment, and that was what was transferred. What was important was to define what a transfer was and see if people stick to the definition of “transfer”. Also, this difference of opinion had not changed their work relationship with the AG. The Department and AG were still cooperating very well, and there had been no animosity.

Mr Allie added the retraction of the circular had been considered. National Treasury was the custodian of the modified cash standards, which were applicable to both national and provincial departments. Additional guidance from the judgment had been taken into account. He noted that transfer payments were not unique only to the Department and Casidra -- it was found in other departments as well. The AG looks at consistencies and other technical considerations of the departments. There were different agreements within the different departments. The AG would then take a decision on whether this should be classified as a transfer payment or goods and services.

He said work relations with the Department had been brilliant and there was never any conflict. The disagreement had been acknowledged, and there was no hidden agenda. The AG, as a Chapter 9 institution, would continue to have an independent view, even though there would be differences of opinion. Regarding MCS and ASB, he said the MCS was specific to the national and provincial departments only. The ASB was the custodian of GRAP. The ASB and NT wanted to have national and provincial departments under GRAP as an accounting framework. However, one of the things they needed to do over the years was to check readiness and if there were sufficient systems in place in order to implement an accrual system. The GRAP system was a fully-fledged accounting system, while the Modified Cash System had elements of being reported on a cash basis. There were disclosure notes for readiness and to prepare departments to go into an accrual system. It was a hybrid system between cash and accrual to enable provincial and national departments to align to GRAP standards.

The Chairperson remarked the judgment was interesting, highly academic, and there were lots of lessons that could be learnt from it.  He asked if there had been any involvement by both the AG and the Department with the Accounting Standards Board, because this was an accounting matter. Had the process of putting measures in place by NT been finalised?

Mr Huysamer stated there was no need yet for the mechanisms. The AG’s side had more to say about it, because the Department did not need them. Even from last year up to now, the Department did not need a mechanism. There was a need to stick to the prescripts as much as possible. The Department did not make any contact with the ASB. The GRAP had not yet been implemented, because the rest of the government – national and provincial - was not on the accrual system, so it could not be on GRAP. The Department had to wait until GRAP was implemented. The ASB had written most of the GRAP prescripts. It had been implemented with the local government already.

Mr Allie said loops would be closed when it came to dispute resolutions. This matter should not have gone to the courts. There were lessons that had been taken from the judgments. Dispute resolution would be enhanced timeously in order to meet legislation timelines. A robust discussion should have taken place to solve the problem.

Mr M Xego (EFF) wanted to know which mechanisms had been put in place by NT, and what would happen if they were not effective.

Mr Allie said the process had not been fully completed to have a formalised document.

Ms Sangeeta Kallen, Unit Business Leader, AGSA Western Cape, said it was not good to ventilate accounting matters in court. The AG had reflected on this matter internally as a dispute resolution process on things it needed to consider. Timeliness was one of the important things, and there was a need to maintain impartiality and independence when it came to decision-making. There were processes in the mechanisms that were being developed internally and, once they were finalised, they would be shared with the provincial Department and Scopa so that these AG mechanisms were understood.

Treasury had dispute resolution processes in place. It was the custodian of the prescripts. The AG was independent of that decision-making. Treasury had a mechanism in place, but the AG was not party to it, and it did provide the independent perspective it had been requested by Treasury to do.

She said the AG prided itself on being impartial through its processes, and it continued to have a good relationship with the Department -- the processes were not taken personally.

Committee minutes

The Committee considered and adopted one set of minutes dated 25 May 2022.

The meeting was adjourned.
 

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