BERNARD AGULHAS AND ANÉ CHURCH: Small business: the unseen sector

A few years ago, a report from the International Finance Corp (IFC) indicated that SMMEs in South Africa contribute about 35% to GDP and constitute more than 90% of all formalised businesses, employing 50%-60% of the country’s workforce. These are striking statistics — but the IFC notably referred to these enterprises as “the unseen sector”. 

It seems, however, that instead of paving the way for these enterprises to grow, regulation makes business and entrepreneurship increasingly difficult. Regardless of good intentions, regulations can be discouraging for entrepreneurs and small businesses. The extensive paperwork, compliance costs and administrative burden can create barriers to entry and smother much-needed innovation and economic growth. 

Take body corporates, for example. Even if they only have two members and 36 transactions a year, they’re required to undergo an (expensive) external audit in terms of the Sectional Titles Scheme Management Act regulations. 

The Companies Act regulations, which introduced the public interest (PI) score as a determinant of whether a company should undergo an audit or a review, have remained unchanged for more than a decade. They differentiate between smaller and large corporations, and the PI score recognises the appropriate level of accountability based on public interest.

Only, the way the PI score is determined hasn’t kept pace with inflation, so it now requires expensive audits on SMEs that wouldn’t have been close to a mandatory audit 10 years ago. 

One wonders if these challenges are sufficiently aired at the forums where standards and regulations are set, and if these SMEs are adequately represented. Do the decisionmakers truly understand the impact on these businesses?

The audit and accounting industry 

While business seems to suffer high regulation, the accounting profession has somewhat of an imbalance.

The title “auditor” is often used to cover anyone who works with finances, books and tax affairs. The reality is that not all “auditors” are regulated and need to conform to the same standards. Those who undertake external audits of financial statements are subject to stringent rules, codes and standards, as well as close monitoring by the audit regulator, with whom they must be registered. The catch is that other services they provide are, in some circumstances, also regulated. These include independent reviews and financial statement compilation services that any Tom, Dick and Harry can perform.

It is not a requirement to have one’s financial statements independently compiled. This enables Tom and Dick to deliver services similar to members of professional accountancy bodies — without affiliation to such a body. 

Harry may indeed be a member of a professional body, as this is one of the requirements to perform an independent review. He subscribes to a code of ethics and may get into trouble if he doesn’t adhere to the code. But this can only happen if someone reports him to his membership body. These bodies don’t regulate their members or check the quality of their work unless someone blows the whistle.

Back to the “registered auditors”. In addition to continuous monitoring, they have to respond to ever-changing demands. For example, they have had to implement substantial changes in the past two years to comply with global quality management standards.

Large firms usually have technical departments that provide the necessary training and update audit programmes to reflect these changes. In small firms, these duties are divided between the three or four partners who need to find the time to understand and implement the necessary changes.   

Some time ago, section 90 of the Companies Act (prohibiting the same firm from performing an audit and the compilation of financial statements) significantly affected the businesses of smaller firms — and their auditors. The companies mandated to be audited purely because the PI score didn’t stay up to date with economic developments needed to get a different service provider for their non-audit services.

In short, being regulated comes at a cost — one that smaller registered audit firms need to somehow absorb. Because if they pass these costs to their clients, it puts them at a competitive disadvantage, and Tom, Dick and Harry are in business. 

The challenge is in finding a way to balance regulations with the practicalities of running a business. There are, at least, glimpses of hope, with the accounting profession pushing for amendments to the PI score, and the International Auditing & Assurance Standards Board’s draft audit standard for less complex entities.

There doesn’t appear to be a silver bullet. For the moment, we can only take comfort in a global commitment to respond to demands for more equality, fairness and a voice for the less advantaged. And when that materialises, everyone will participate in a society in which they can take advantage of opportunities more equally, and regulation will apply to those who trespass, seen and unseen.   

* Agulhas is the former audit regulator and an adjunct professor in auditing at the University of the Free State. Church is a lecturer in auditing and corporate governance at UFS