What are the implications of BEE on the going concern assumption for companies?

This question was asked by a first year trainee accountant from Port Elizabeth. This got me thinking about the far reaching implications of the trickle down effect of BEE on the economy. The way that the BEE legislation is crafted is that it does not force anyone to contribute to BEE. The Broad-based BEE Act in section 10 however provides that every organ of state and public entity must take into account and as far as is reasonably possible apply any relevant code of good practice issued in terms of this Act in: determining qualification criteria for the issuing of licences, concessions or other authorisations in terms of any law; and developing and implementing a preferential procurement policy, amongst other requirements. This is the section in the Act that makes BEE a business imperative because it uses the economic leverage that government has in procurement, licensing, and granting of any concessions to drive BEE forward. The way that the trickle down effect works is that a public sector entity will say that if companies want to conduct business with it they need to show the contribution they have made to Broad-based BEE, which includes how much they have bought from black companies and those companies that contribute meaningfully to Broad-based BEE. These first tier suppliers then need to see how much their suppliers buy from BEE companies in order for them to get affirmative procurement points on their BEE scorecard. The chain goes down to numerous tiers until it affects all companies within the economy. All companies that operate within the South African economy are affected by this trickle down effect. The impact of this trickle down effect is that when one values companies using, for example, the discounted cash flow model or any other model that requires forecasting of earnings, BEE is a factor that needs to be taken into account. Companies that do not contribute to BEE will see their future cash flows decreasing, which leads to a lesser value to be attributed to the company as a whole. Furthermore when assessing the discounting factor of the company, contributions to BEE are important to factor into the risk analysis because any contribution will count towards decreasing the companys business risk. Contributions to Broad-based BEE allow companies to at least maintain their current business or at best increase their business especially if they are ahead of their competitors. The reality is that the economic leverage exercised by the government has ensured that even valuations of companies in South Africa will be influenced to a greater extent by BEE. Clearly then BEE is an issue that needs to be considered when evaluating the going concern assumptions of companies. The going concern assumption states that a company is assumed to be a going concern in the foreseeable future. This foreseeable future can range from one year to three years. This assumption is influenced by the financial and operational factors that affect the companys sustainability going forward. If the different factors indicate that the sustainability of the company is in question then the auditors will have to qualify their audit report depending on the gravity of the factors considered. The implication for the company is that they may have to write down the value of their assets

to net realizable value which would decrease their profits in a substantial manner depending on the level of assets held. This may also have some tax implications especially for VAT if they decided to sell off their business not as a going concern, because certain exemptions may fall away. Some of the high risk factors that would highlight going concern issues are: The company engaging in fronting practices and entering into unsustainable BEE deals. This may cause the company to be black-listed which would negatively affect their future business. No reputable company will want to take a risk by having economic dealings with a front. The company has no BEE contributions whatsoever and there are no plans in place or no intention to contribute to BEE. The key medium risk factor may be that the companys BEE is lagging way behind its competitors and is therefore likely to lose business. This risk can be mitigated by the fact that sustainable transformation takes time and as long as the company is showing good progress towards meeting the targets as set out in the codes and charters then they will be able to weather the storm. Auditors will not be able to sidestep taking BEE into account when evaluating the going concern assumption of companies they audit because in the South African economic environment BEE is a business imperative that can make or break companies fortunes and sustainability.