A South African state-owned entity no longer conjures a picture of an organisation to be proud of but rather a dilapidated, hollowed-out shell with perpetual problems. When a country cannot bring its SOEs into line, it is somewhat naive to expect foreign investors to plug a hole in the need for capital.
Unsurprisingly, Eskom was given a qualified audit report by its external auditors SizweNtsalubaGobodo. The report states that the power utility did not have “adequate internal control systems to identify, investigate and record all information as required by the Public Finance Management Act.
Therefore, the irregular, fruitless and wasteful expenditure of R20.7-billion (2017: R4.4-billion) may not be the total amount and the identification of criminals may fizzle due to lack of evidence.
The auditors could not obtain sufficient audit evidence that appropriate disciplinary steps were taken against officials, nor that allegations of financial conduct against members of the accounting authority were investigated. How will Eskom explain the loss of some R20.7-billion to the unions in wage negotiations?
Eskom further blotted its copy book by not being able to collect all revenue due. In addition, procurement and contract management is in disarray, and there were conflicts of interest (greedy hands mixing private business interests with that of their employee). The external auditors have reported the various reportable irregularities to the Independent Regulatory Board for Auditors.
The group incurred a total comprehensive loss of R5.6-billion (2017: R6.4-billion), and the group current liabilities exceed the current assets by R20.6-billion, a decline of R20.9-billion. The “loss for the year” of R2.3-billion is meaningless, as the reserves are reduced by the amount of R5.6-billion. The external auditors further state that “a material uncertainty exists that may cast significant doubt on the group’s ability to continue as a going concern”.
Fortunately, International Financial Reporting Standards require borrowing costs in regard to plant to be capitalised, otherwise the total comprehensive loss would have been R21.1-billion.
Nevertheless, the concern with the capitalisation of borrowing costs in Eskom’s case is encapsulated in note 2.4: “Subsequent costs are capitalised only when it is probable that future economic benefits associated with the item will flow to the group and the cost of the item can be measured reliably.”
We can only wait and see if these future economic benefits will materialise. One would assume that additional interest costs resulting from labour unrest, cost overruns and inefficient construction were not capitalised.
However, this is an entity that is not currently sustainable, where future economic benefits are not a certainty and is miserably failing the going concern test. Be that as it may, R15.5-billion of interest was taken out of finance costs, thus reducing expenses, and added to the cost of plant and machinery. This gave the asset side of the balance sheet a much-needed boost, in the form of a somewhat flimsy “asset”. It is to be noted that rating agencies reduce retained earnings by the amount of capitalised interest.
From 2019, all leases will have to be brought onto the balance sheet. Eskom has not provided any information as to the expected impact.
The board does not appear to be duly perturbed by Eskom’s going concern status, and seems to have full confidence in energy regulator Nersa coming to the party, and the government’s continuous support. Perhaps if the board had “skin in the game”, they would take a more realistic view.
How bad is the situation? The International Standards of Auditing list numerous factors that should be taken into account in ascertaining whether an entity is a going concern. I have taken the liberty of amending some of these with Eskom in mind:
- Whether maturing fixed term borrowings can realistically be repaid or renewed, and whether it is feasible to continue to rely on government as a honey pot;
- Excessive reliance on short-term borrowings to finance operational costs (such as salaries);
- Difficulties in negotiating new loans or issuing further bonds;
- Negative cash flows, or where so-called near cash consists of new finance (in other words, doesn’t come from a positive operational cash flow);
- Key financial ratios indicating a negative trend; and
- Inability to monitor or collect moneys due from large debtors, such as municipalities.
Other key factors would be whether Eskom manages to improve corporate governance and implement a proper internal control system, a proper procurement system and solve the problem of the increasing cost of coal.
On that note, Eskom intends to collaborate with state-owned mining company Alexkor. I fail to see how Alexkor, situated on the diamond coast in Namibia, a floundering diamond mining company, can possibly assist in managing increasing coal costs. The board further referred to “capex investments into cost-plus mines”, and migrating from “road to rail”. Opining is easy; it is the outcome that will speak volumes.
The new board is optimistic at turning Eskom around, and repositioning it as the most trusted SOE. The 2019 interim results should indicate positive outcomes, including:
- Implementing a proper system of internal control;
- The status of employees, senior managers and executives (including close family members, partners and associated) who have any interest in contracts awarded by Eskom;
- The status of the criminal charges that have been laid against corrupt employees;
- Whether incidents of alleged irregularities, fraud and corruption have been brought to a halt;
- Whether they have managed to curb incidents of irregular, fruitless and wasteful expenditure;
- The outcome of lifestyle audits of senior management; and
- Whether there was growing investor appetite for Eskom bonds.
At this point in time, though, Eskom is in a dire situation. It lurches on, leaving ageing power stations in its wake. It will take more than an optimistic board to put an end to this crisis.
- This article was originally published by Moneyweb and is used here with permission