DoD, DMV, Armscor & Castle Control Board audit outcomes

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Defence and Military Veterans

24 November 2020
Chairperson: Mr V Xaba (ANC)
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Meeting Summary

2019/20 Annual Reports

The Committee met with Auditor-General South Africa (AGSA) for a briefing on the 2019/20audit outcomes for the Defence portfolio. Department of Defence (DoD) obtained qualified audit with findings;  Department of Military Veterans (DMV) and Cape Castle Board (CCB) maintained its unqualified audit with findings; Armscor had improved and obtained a clean audit.

The Committee expressed concern with the Departments of Defence and Military Veterans whose management has clearly failed to enhance risk management and internal controls nor investigated irregular expenditure emanating from supply chain management with the required urgency. The Committee noted this is a serious indictment on the Department and its accounting officers.

Members expressed concern at the number and sums involved in legal claims against DOD which are in court and a possible danger to its financial well-being if the claims are successful. Members asked AGSA if the Department has tools in place to monitor the progress of its audit action plan.

The Committee noted that if DoD had paid amounts due at year end for the lease of an unoccupied building, it would have overspent its budget by R108m in unauthorised expenditure. This had to be paid out of the 2020/21 budget. DoD controls a R55 billion budget but is still exhibiting weak internal controls. The 2019/20 irregular expenditure was R3.3 billion and R2.8 billion for 2018/19 that needed investigation.

Meeting report

The Chairperson noted this year's revised programme to accommodate the late arrival of the Annual Reports due to COVID-19. This was necessary so the Committee could consider the Annual Reports and adopt its Defence Budgetary Review and Recommendations Report (BRRR) next week.

Defence Audit Outcomes for 2019/20: Auditor-General South Africa (AGSA)
Ms Mbali Tsotetsi, Deputy Business Executive, AGSA, noted that its audit reports assisted the Portfolio Committee in its oversight role of assessing the performance of the entities in the Defence portfolio.

• DoD obtained qualified audit with findings. This was due to the lack of completeness about the irregular expenditure identified in the current year whilst the prior year irregular expenditure had not been addressed. indings on lack of legislation compliance were reported. DoD audit was qualified due to:
- Sufficient, appropriate audit evidence could not be obtained on goods and services and investments relating to sensitive projects. This inherent limitation of scope is due to the sensitivity of the environment and the circumstances under which these transactions are incurred and recorded.
- Irregular expenditure recorded was incomplete due to inadequate systems to prevent, detect, record it.

• Department of Military Veterans (DMV) maintained its unqualified audit with findings. This was mainly due to its audit action plan to address prior year findings not being effective as management did not review and monitor compliance with legislation and the performance report was not reliable

• Armscor has improved on its outcomes and obtained a clean audit.

• Cape Castle Board (CCB) maintained its unqualified audit with findings on legislation compliance. CCB achieved an unqualified opinion only because it corrected all misstatements identified during the audit.

Top five non-compliance areas
-Quality of financial statements (CCB and DOD)
-Prevention of irregular and fruitless and wasteful expenditure (DOD and DMV)
-Payments to suppliers not made within 30 days (DOD and DMV)
-Sufficient and appropriate evidence for consequence management could not be obtained (DOD and DMV)
-Non-compliance with procurement and contract management processes (DOD)

Cape Castle Board financial health
The effects of Covid-19 had a negative impact on CCB revenue-generating capability due to it being in the events and tourism sphere. Cash flow forecasts did not show that CCB will be able to generate income due to the cancellation of events and closure of the site to tourists. CCB applied to DOD for relief funding in April 2020 and R3 million emergency funding was approved by the Minister of Defence and Military Veterans.

Departments of Defence (DoD) financial health
DOD has been affected by budget cuts which impact on its ability to afford the compensation of employees’ expenditure. Claims against the department increased by 25% from R4.3 billion to R5.4 billion. If DOD were to lose the claims, it could significantly affect cash flow. At year end DOD had payables of R114.2m, which exceeded the R5.88m surplus by R108.55m which constituted unauthorised expenditure.

Department Military Veterans (DMV) financial health
Claims against the DMV constitute 88.5% of next year’s budget and there is an excessive amount of accruals from the current year that must be paid out of next year’s budget allocation. This may result in DMV being unable to achieve all planned service delivery requirements for 2021/22 especially taking the 2020/21 R137m budget cut into account.

Fruitless and wasteful expenditure incurred
The majority of the disclosed fruitless and wasteful expenditure was caused by leased property not utilised by DoD whilst they continued to pay for the property resulting in fruitless expenditure of R12m.

Irregular expenditure incurred
The majority of the irregular expenditure is due to the increase in compensation of employees without the necessary authority in DoD environment amounting to R2.6 billion (prior year was R2.9 billion). Irregular expenditure incurred in the Defence portfolio due to not following prescribed procurement processes remains a concern, particularly in the DoD.

AGSA Recommendations to the Defence Department and entities and Portfolio Committee
- Implement consequence management by performing investigations, monitor status of investigations and ensure action is taken when investigations have been finalised.
- Implement audit action plan to address audit findings raised.
- Committee monitor the implementation and progress of the audit action plan during oversight.
- Committee monitor actions taken against irregular and fruitless and wasteful expenditure transgressors.

Discussion
Mr S Marais (DA) thanked AGSA for the comprehensive report but just like previous years, it seemed the quality of management and accountability from the Department of Defence (DoD) has not changed much. That could be part of the reason they have big funding issues with National Treasury. The people to be held responsible is the Chief of SANDF (CSANDF) and the DoD Chief Financial Officer. It is refreshing Armscor has a clean audit but did the AGSA look into the bonuses paid by the entity? It looks like Armscor always pays bonuses. How do they account to AGSA on the bonuses they paid such as the previous year? Bonuses were also paid to their ex CEO around September/October 2018 but was paid till the end of the financial year because that was the only way he could qualify to be a paid bonus. Is this bonus paid to him justified? DoD This Committee has many concerns about DoD such as the material misstatements. What happens in such a case? Do they have to report it somewhere? Is it just reported in this presentation for the Committee to monitor? Something needs to be done urgently and it is a serial transgressor due to lack of accountability and consequence management. Is it adequate to request monitoring alone by management and the Portfolio Committee? Does AGSA carry out its audit function in establishing if an entity is a going concern? On the legal claims and the possible danger of these being successful, has AGSA looked at the legal costs involved to defend those claims? In some cases the legal costs to defend itself against the claim might be equivalent to the claim itself.

Ms A Mthembu (ANC) congratulated Armscor for improving to reach a clean audit. Getting a clean audit involves having a robust team work and Armscor has thrown down the gauntlet to other entities. She noted the R19m in fruitless and wasteful expenditure and R90.8m irregular expenditure but said that it is good to know there is a action plan to deal with that. Armscor was encouraged to reduce these irregularities and to have a concrete plan to avoid it from happening again.

Ms A Beukes (ANC) thanked AGSA but asked for its opinion on lack of audit evidence for goods and services procured for sensitive projects. Is it a case of missing documents, absence of documents or the unavailability of officials to assist with the evidence? There are increasing claims against the department which is influencing its cash flow. Could AGSA establish the status of these claims? She noted there are still problems in all areas of internal controls. Does the department have tools or is there a process and time frames to monitor the impact of the recovery plans? What is the view of AGSA on the quality of the financial statements? Is there a capacity problem or lack of ability to prepare those statements properly?

AGSA response
Mr Lourens van Vuuren, Business Executive, AGSA, replied about accounting for bonuses. An entity would have to make provision on its financial framework for bonuses if they plan to pay these. There should be a policy to determine under what circumstances the entity will pay bonuses and it will link to its performance management system as that will determine who will be entitled to a bonus. One of the key considerations before an authority approves a bonus is the financial means. They will have have to determine if funds are available in the budget to pay the bonus. In the case of Armscor, they would have made a provision in their budget and financial statements for those bonuses. The services for those bonuses have been delivered in that financial year. This is why in terms of accounting principles the bonus provision has been made in the financial year the bonus was paid. In a nutshell, the ultimate authority to pay or not to pay a bonus rests with the financial authority. In this case that will be the Armscor board. On the bonus paid to the former CEO of Armscor; AGSA has no specific details about that payment but it would have been regulated by the policies of the entity and the employment contract between the former CEO and Armscor.

In terms of the Portfolio Committee oversight functions, it could call in the accounting officer to present its annual report and talk about its audit outcomes and then exercise its oversight by asking relevant questions and ensuring management has the audit action plan in place. The Committee should also follow up with the accounting officer whether consequence management is applied within the entity because the PFMA makes provision for consequence management to be applicable. It is critical the Committee follows up where there is irregular expenditure or transgression of laws or regulations.

AGSA found that not enough consequence management is taking place in DoD. On DoD as a going concern, the presentation dealt with DoD financials noting that every year there is not enough money to pay salaries. Its payroll budget has always been exceeded for number of years leading to significant irregular expenditure. This effectively means the department has financial constraints and that could have negative effect on their projects. At some point there might not be enough funds available to continue with projects in the manner planned. It is important for the Committee to look at that to ensure the department does not suffer any losses.

On the value of the CFO and internal audit, the CFO is defined in the fiscal regulations as someone to support the accounting officer in the execution of duties. In the case of the DoD, supply chain management is not currently under the control and direction of the CFO while Treasury’s PFMA requires it should be. Looking at where irregular expenditure emanates from in the Defence Department, it is from the supply chain management area and this should be addressed. Internal audit has a serious role to play because its work is also risk based.

Irregular expenditure should be a focus area for internal audit throughout the year. The Committee should consider engaging with the DoD Audit Committee chairperson who is directly responsible for the control of the internal audit to gain more insight into the work carried out by internal audit and their progress towards finalising its audit action plan. AGSA has noted that not all the planned items in the internal audit plan has been executed and reason they provided was capacity constraints.

On the medicines procured from Cuba in March 2020, Mr van Vuuren replied that this has been audited by AGSA and if there are findings to be reported, it will be included in the final Special Audit report on COVID-19 procurement to be tabled in Parliament soon. AGSA works with the Fusion Centre and in cases it deems necessary, those role players will be informed.

On the accuracy of the financial statements, currently besides the qualifications on sensitive projects, the other qualification deals with irregular expenditure. What is important is this qualification was dealt with for the first time in the previous 2018/19 audit. DoD management had been requested to go back to the various supply chain management transactions, review it and identify the irregularities and disclose these in the financial statements. Management has however not done that for 2018/19 and it also has not improved on its controls and irregular expenditure has again been identified in 2019/20 to the extent that AGSA believes that irregular expenditure has led to material mistakes. The Secretary of Defence will have to review the two years of supply chain transactions to identify the irregular expenditure, disclose it and take the necessary actions in terms of the PFMA including consequence management.

Ms Tsotetsi, AGSA, replied on whether there is a monitoring tool DoD uses to assess progress on the action audit plan. AGSA is not aware of the tools used by management but the DoD CFO does report on the implementation of the audit action plan in the Audit Committee meetings. That is done on a quarterly basis but it remains the responsibility of the accounting officer as well to ensure that the status report matches what is happening on the ground.

On the status of the legal claims disclosed in note 18 in the financial statements, these matters are still in court and the department is defending those matters because they feel they have a chance to win against those claims. One of those cases has been going for a number of years and is not yet finalised. The department has obviously incurred legal fees on those cases but there are significant amounts involved and they defend against them. They are reported as potential outflows in the financial report. In the event it loses, the amount of those claims is worth R5.4 billion.

Follow-up questions and answers
Mr M Shelembe (DA) asked if AGSA can proffer some solutions on the difficulties encountered by National Treasury in dealing with DoD. There is the case of R2.6 billion unauthorised expenditure spent by DoD for compensation of employees without the necessary authorisation. What could be a possible solution about this? This is bound to continue into the next financial year. Is it the right time for DoD to consider changing its budgets for staff compensation and capital expenditure? Could AGSA propose a possible solution to this problem? National Treasury does not seem to be considering the DoD proposal to allocate more funds to it for employee compensation.

The Chairperson commended CCB for achieving a clean audit and he hoped it can sustain this trajectory. AGSA stated that if DoD had paid amounts due at year end, it would have overspent its budget by R108m and that would have constituted unauthorised expenditure. As result of not paying the R108m in 2019/20 financial year, it means it will have to be paid out of the 2020/21 budget. This means the DoD 2020/21 budget is already reduced by R108m – the Committee takes note of that. The Committee also notes that both the DoD and DMV management are not responding with the required urgency to the call to address risk and improve internal controls. It is a poor reflection on DoD performance which controls over R55 billion but it still exhibiting these weak internal controls. The 2019/20 irregular expenditure is R3.3 billion and R2.8 billion for 2018/19. Total accumulated and unresolved irregular expenditure that has not been investigated is R7.9 billion. That is a serious indictment. This inaction is concerning.

Mr van Vuuren replied about the financial health of the department saying that the AGSA mandate does not extend beyond reporting on financial health risks. Once AGSA reports on that, it is then in the hands of the accounting officer and National Treasury to deal with the budget allocations and priorities. It is true that with the pandemic there was re-prioritisation of most of DoD and DMV budgets that could in the short or longer term impact on its entities.

On supply chain management and risk management, there are various models that can be applied. Treasury Regulation 3.2.1 states: "The accounting officer must ensure that a risk assessment is conducted regularly to identify emerging risks of the institution. A risk management strategy, which must include a fraud prevention plan, must be used to direct internal audit effort and priority, and to determine the skills required of managers and staff to improve controls and to manage these risks. The strategy must be clearly communicated to all officials to ensure that the risk management is incorporated into the language and culture of the institution." These are the risk management principles that accounting officers must follow.  

Ms Tsotetsi replied that the DoD accounting officer not taking action was a material irregularity of the performance management contract and it was reported on in the AGSA audit report. The accounting officer took no action when the officer was informed of the recommendations that need to be implemented. It is important for this Committee to follow-up during oversight meetings of DoD on the progress made to implement those recommendations.

On the unoccupied office buildings that resulted in a material irregularity, this must be investigated by the accounting officer. It is important that when the Committee meets with DoD, they follow-up on the progress of this flagged material financial loss of R108m resulting from payments made for those unoccupied buildings.

The Chairperson referred to the fruitless and wasteful expenditure and said DoD had signed a lease for R12 million per year for unoccupied office buildings. The R108m paid to the landlord for unoccupied buildings was accumulated over a number of years. How long had this office been unoccupied and paid for? DoD has incurred repeat audit findings on this but they are not being investigated.

Ms Tsotetsi answered that the offices were rented in 2015/16 and have remained unoccupied ever since. In 2019/20, DoD started occupying part of the building at a rental cost of R12m per annum. Prior to that DOD incurred R96m in rental costs whilst the building was unoccupied.  Added together, R108m is reported as a material financial loss which must be investigated.

The Chairperson said they can take some comfort that the building is now fully occupied late in 2020/21 to avoid further irregularity. He thanked AGSA for sharpening the Committee’s oversight. AGSA had lived up to expectations and further interactions will take place with it from time to time. When will the final PPE procurement audit report be released? The DoD PPE procurement audit report released in September had no findings and those of other departments were all preliminary reports.

Mr van Vuuren replied that AGSA is planning to table its second Special Audit report next week. He suggested that once tabled, an engagement should take place with the Committee on the report’s contents as it relates to DoD.

The Chairperson thanked AGSA for the presentation and for a fruitful interaction.

The meeting was adjoined.

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