Audit costs to soar, not fall after new measure
Treasury says the overriding objective with three-year audits is reducing administrative cost - at least that's what they'd like trustees to believe.
In the 2018 federal budget announcement, the government revealed plans to change the annual audit requirement for self-managed superannuation funds (SMSFs) to a three-yearly requirement where SMSFs have a history of good record keeping and compliance. This measure is intended to commence on 1 July 2019 and is presumably introduced as a relief measure for the trustees after the raft of legislative compliance changes introduced in the 2017 federal budget.
The overriding objective for Treasury is to reduce the administrative audit cost burden for the trustees. At least, that is what they’d like the trustees to believe. Let’s start with some SMSF audit cost data which is published by the ATO. The total average audit fee was $694 for the 2016 year, while the median audit fee was $550. (This article contains data for financial year ending 30 June 2016 - latest available as at January 2018 from the ATO.)
According to the ATO, over the four-year period prior to the end of the 2015 financial year, SMSFs reported they were paying more for audit fees, whilst for the 2016 year, SMSFs reported paying slightly less for audit fees. For the 2016 year, 37 per cent of SMSFs paid less than $500 in median audit fees, likewise for the 2015 year, 37 per cent of SMSFs paid less than $500 in approved auditor fees, compared with 55 per cent in 2012 and 54 per cent in 2011. The conclusion can therefore be drawn that SMSF audit costs seem to be following a downward trend due to fierce competition among specialist audit firms looking to build large-scale practices.
Unfortunately, for auditors, the greatest challenge we have today is demonstrating our own value to safeguard the trillion-dollar retirement sector. Let us examine the proposed three-year audit scenario in detail and determine what future SMSF audits will really cost if these measures are enacted.
- Professional Indemnity
As part of the Future of Financial Advice (FOFA) reforms, the 'accountants' exemption' was repealed on 1 July 2016. This reform required accountants providing strategic advice on SMSFs to either hold an AFS licence or to be a representative of an AFS licensee. An accountant that is licensed to provide SMSF advice is required to provide clients with a Statement of Advice (SOA) which defines the overall superannuation/SMSF strategy. The overarching intention of the legislation was to protect the trustees’ interests through the process of articulating needs and formalising recommendations. A lesser-known fact to treasury is that advisers and auditors communicate on a regular basis when providing client advice and also during the preparation/audit of financial statements. If issues are detected during the annual audit, rectifications are sought and SOAs are amended accordingly. However, if the three-year audit cycle were to be implemented, and the auditor identifies an issue in the valuation of investments during the first year of the three-year period, adjustments will be required to the total asset values and member account balances reported by the SMSF at the end of the first year. Effectively, member balances, pension payment advice, contribution advice, Transfer Balance Accounts, Total Superannuation Balances and various other items on Financial Statements and SOAs prepared by the accountant/adviser for the first year and the subsequent two years will be based on incorrect data, and he/she may be liable to damages in case a professional indemnity claim is made by the trustees. Currently, the adviser or the accountant is not liable to opine on the accuracy of the information reported in the financial statements of the SMSF.
Not all advisers are experts at valuations and compliance issues, and not all accountants prepare true and correct unaudited financial statements. Even with the level of automation, honest mistakes are often made and incorrect advice is drafted which is easily corrected during the annual audit checks. An annual independent audit report provides significant comfort not only to an SMSF trustee but also to the adviser/accountant - should anything go wrong, or should any advice they provide be incorrect or even illegal, checks and balances within the audit system will allow amendments to be made in a timely manner. This, in turn, provides protection for advisors against professional liability claims as well as liability protection for trustees against compliance breaches at no additional cost. Some of the issues arising may not even be correctable (e.g. an overvaluation of assets in year 1 could potentially have a TRIS member drawing more than the maximum 10 per cent in subsequent years. Conversely, an undervaluation of assets could result in a retirement phase pension member drawing less than the minimum required).
If the three-year audit cycle is enacted, there will be a steady rise in professional indemnity claims and trustee breaches which will in turn increase fund administration costs for the industry in general, let alone the time value of money in defending potential liabilities for advisors and trustees. We are looking up to the American governing system, where there will be less regulation but excessive legal claims, if these measures are implemented.
- Administration software
SMSF accounting and administration work is performed on a variety of software platforms, many of which, from a compliance and data capture point of view, are not sophisticated. Year-end closures conducted on such unsophisticated systems make it very difficult to re-open a closed financial year and amend errors or mistakes, which is easily achievable if errors are detected during the audit process. These systems are not automated to capture market valuations of assets, calculations of earning rates, allocations of earnings to member accounts, tax effect and deferred tax accounting entries, maintenance of Total Superannuation Balances, Transfer Balance accounts and other calculations, which accountants have to perform and manually input into these systems. A three-year audit cycle detecting errors in the first year would make it extremely difficult for the accountant to recalculate accounts and balances in these systems.
Conversely, sophisticated accounting systems perform automatic calculations for valuations of listed assets, earning rate calculations, member earnings allocations and tax effect entries. They also maintain Member Registers, Total Superannuation Balances and Transfer Balance account registers which are updated regularly. However, these systems still require earning, buy-sell and valuation reviews from the end user for unlisted investments, property, and other asset classes in order to undertake calculations of exempt pension income. These systems calculate and allocate earnings on a daily basis which makes it even harder to re-open two preceding years and adjust major errors. The systems constantly warn the user that any changes to previous year balances will result in incorrect earning allocations for the following years, depending on the frequency and volume of pensions, contributions and earnings. In most cases, re-opening two previous years would require a re-entry of earnings, contributions and pension data to ensure correct allocations and calculations are made by the system.
The rectification time costs involved would be equally high for both sophisticated and non-sophisticated software systems.
- Resource issues
The Australian Taxation Office is ill-equipped with resources to follow up on audit contraventions. Matters are often followed up 12 months after the audit has been completed, which in most cases is 18 months to two years after the actual breach. A three-year audit cycle reporting contraventions in the fourth year may potentially be picked up by the ATO in the fifth year after the issue is reported in the fourth year. There could be time bar issues for the trustees and advisers who could potentially face penalties for time-barred breaches that cannot be reversed.
Professional bodies have conflicted priorities where they have forgotten that they are an association of professionals, created by professionals and for the professionals. CPA Australia, after years of lobbying by its members, has only recently decided to shut down its Advisory Arm. The important question is, why tinker with a system that has a 98 per cent compliance record? Only for hard-earned tax dollars to be used by policymakers to ease regulations, which will then result in the introduction of a royal commission into the inefficacies of the SMSF sector auditing standards, and even more money and resources wasted on enquiries which could have been well avoided.
ASIC has introduced an industry funding mechanism, which means that they will recover most of the regulatory surveillance costs from Registered Auditors and Advisors through a combination of levies and fees. Industry funding can only work if an industry is profitable and survives the strangulations of an over regulatory and ever-expanding government sector. Given the stance taken by both sides of politics, existing and new SMEs face a bleak future in Australia. Interestingly, who will ASIC regulate and seek funding from if the three-year audit cycle is implemented and audit firms are faced with a lack of revenue from the SMSF sector? Most auditors would leave the SMSF sector for greener pastures.
Winston Churchill once quoted that ‘Diplomacy is the art of telling people to go to hell in such a way that they ask for directions’. This is precisely what both sides of Australian politics, Treasury and the professional bodies are doing to the SMSF sector and its participants.
Naz Randeria, director, Reliance Auditing