Telkom Integrated Annual Report 2017

Independent
auditor’s report

TO THE SHAREHOLDERS OF TELKOM SA SOC LIMITED

Report on the Audit of the
Consolidated Financial Statements

Opinion
We have audited the consolidated and separate financial statements of Telkom SA SOC Ltd and its subsidiaries (the group) set out on pages 3 to 111, which comprise the consolidated and separate statement of financial position as at 31 March 2017, and the consolidated and separate statement of profit or loss and other comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and notes to the financial statements, including a summary of significant accounting policies and other explanatory information.

In our opinion, the consolidated and separate financial statements present fairly, in all material respects, the consolidated and separate financial position as at 31 March 2017, and its consolidated and separate financial performance and its consolidated and separate cash flows for the year then ended in accordance with International Financial Reporting Standards (IFRSs) and the requirements of the Companies Act of South Africa.

Basis for opinion
We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the auditor’s responsibilities for the audit of the consolidated and separate financial statements section of our report. We are independent of the group in accordance with the Independent Regulatory Board for Auditors Code of Professional Conduct for Registered Auditors (IRBA Code) and the International Ethics Standards Board for Accountants Code of Ethics for Professional Accountants (IESBA Code) and other independence requirements applicable to performing audit of the group. We have fulfilled our other ethical responsibilities in accordance with the IRBA Code, IESBA Code, and in accordance with other ethical requirements applicable to performing the audit of the group. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion.

Key audit matters
Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of the financial statements of the current period. These matters were addressed in the context of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion on these matters. For each matter below, our description of how our audit addressed the matter is provided in that context.

We have fulfilled the responsibilities described in the Auditor’s responsibilities for the audit of the financial statements section of our report, including in relation to these matters. Accordingly, our audit included the performance of procedures designed to respond to our assessment of the risks of material misstatement of the financial statements. The results of our audit procedures, including the procedures performed to address the matters below, provide the basis for our audit opinion on the accompanying financial statements.

	Key audit matter				How our audit addressed the matter
	Financial irregularities at subsidiary, Trudon (Pty) Ltd (Consolidated financial statements) As is disclosed in Notes 2.2.3 and 2.5 to the financial statements, during the current year a number of financial irregularities were identified in the subsidiary, Trudon (Proprietary) Limited (“Trudon”). As a result the management of Trudon commissioned forensic and criminal investigations to quantify the extent and impact of the irregularities. The nature of the irregularities primarily related to fictitious invoices received from fictitious suppliers who were controlled by the General Manager of IT at the subsidiary. The impact of these invoices resulted in restatements to Intangible assets and prepayments where these invoices had been capitalised in the past. In addition the wear and tear claimed on intangible assets and the invoices which were expensed needed to be added back for tax purposes based on Senior Counsel opinion obtained by the subsidiary. The matter was considered a key audit matter as it required our involvement (“primary team”) to assist the auditor of Trudon (“component auditor”) in determining the changes in audit strategy in response to the fraud identified and in performing procedures to recalculate the restatement determined by management of the subsidiary. The audit team was required to consider the extent of reliance on investigators or accountants hired by the subsidiary; the assessment of the validity, completeness and valuation of the remaining intangible assets; and the accuracy and completeness of the estimate of the tax restatement. Given that the tax adjustment is based on the population of fraudulent invoices and these invoices date back to 2004 there were practical challenges in identifying the completeness of these invoices. Multiple approaches and techniques were used to identify the invoices which included manual verification, the use of forensic methods (including subpoenaed information) and analysis of Trudon enterprise resource planning data.				Our audit procedures involved, amongst others, the following: The primary audit team engaged with the component audit team at more regular intervals and participated more extensively in planning and other meetings. The primary team also requested additional procedures to be performed during planning to further consider the risk of fraud and the effectiveness of entity level and transactional level controls. Risk assessments were considered and adjusted based on the result of planning activities. In respect of the restatement the primary team discussed the procedures to be performed with the component team. Procedures performed by component auditor included, amongst others: Assessing the work performed by third party forensic investigators and re-performed key procedures on a sample basis. Inspecting the underlying invoices of intangible assets and enquiring of operational management to understand these assets Assessing the completeness of the population of invoices used to determine the taxation restatement through examination of general ledger, accounts payable, and cashbook data in the ERP system with cross referencing to work performed in prior years and work performed by forensic investigators Recalculation of the restatement to intangible assets, taxation and prepayments Audit work performed in the current year was performed using significantly lower thresholds for selecting items to test. This increased testing across all areas of the financial statements Involving forensic experts to consider the extent of procedures performed
	Deferred tax assessment (Consolidated and separate financial statements) As disclosed in notes 2.3 and 17 to the financial statements, the group has significant unrecognised deferred tax assets in respect of provisions and other allowances. The recognised deferred tax asset is determined by taking into account management’s best estimate of future taxable income calculated over the period which management believes to be the most reliable estimate for purposes of IAS 12 calculations of deferred tax assets. We focused our audit attention on the matter because of the significant judgment and estimation involved in determining the period used as well as the forecasted future taxable income for the purpose of assessing the value of the deferred tax asset recognised. We focussed specifically on the following areas: Adjustments to future taxable profits relating to charges between Telkom and newly established Gyro group: There is a higher degree of uncertainty associated to these adjustments as the commercial terms of the envisaged transactions between Telkom and the Gyro group have not been concluded and are subject to further deliberations between stakeholders Adjustments to forecasted future taxable profits of the company to account for the extended roll out of planned strategic products: The impact of the products on Telkom’s future taxable income is subject to a higher degree of uncertainty as strategic decisions are still pending after which product development, pricing and regulatory considerations, amongst others, need to be finalised				Our audit procedures involved, amongst others, the following: We evaluated management’s calculation of the deferred tax balance, the future taxable income as well as the period used in the calculation in terms of IFRS. Taking into account the group's tax position, we evaluated the timing of forecasted taxable profits per the board approved 3 year business plans using our knowledge and experience of the industry and of the application of relevant tax legislation We engaged with various executives responsible for the financial, tax, legal and operational considerations on which the assumptions were based in order to assess the reasonability thereof in terms of our knowledge and understanding of the business and evidence provided by management in support of the estimates We involved our tax specialists to assess the reasonability of the tax adjustments processed to the forecast taxable income for temporary and permanent differences incorporated into the taxable profits calculation taking into account their experience reviewing Telkom’s tax computations We assessed the deferred tax asset recognised for impairment taking into account the future taxable profit calculation and actual utilisation of the deferred tax asset against the forecasts We considered alternative assumptions or outcomes relating to the commercial terms of the Gyro group transactions as well as planned products and the impact thereof on the company’s future taxable income We assessed whether the evidence obtained in performing our procedures resulted in convincing evidence in support the valuation of the deferred tax asset as required by IAS 12
	Accounting for revenue from client contracts sold as part of a significant related party transaction (Separate financial statements) The company entered into a significant related party transaction on 1 November 2016 whereby it sold its Enterprise Business as a going concern to BCX (Pty) Ltd. This included the transfer of existing contracts with clients to BCX. In terms of the agreement and the terms and conditions of the third party client contracts with cession clauses, written consent from third parties had to be obtained for the cession and delegation of client contracts to BCX to be effective. For client contracts without cession clauses, in terms of the common law position in South Africa, Telkom’s obligations under the client contracts could not be transferred from Telkom to BCX without the consent of the third party affected thereby. The process of obtaining client consent is an administratively intensive process that is likely to span over more than one financial year. Consequently the revenue from client contracts had to be accounted for as third party revenue in Telkom company with a corresponding service fee cost for the sub-contracting services delivered by BCX until such time cession and delegation of client contracts to BCX is completed and effective. We focussed our effort on this matter as it was an unusual material related party transaction; the revenue from the Enterprise contracts sold to BCX on 1 November 2016 was significant to the company’s operating revenue; and the accounting treatment required robust discussion with management to understand the terms of the sale and the terms and conditions in the third party client contracts. Refer to note 4 – Operating revenue.				We evaluated management's accounting interpretations to determine whether we agreed with the manner in which IFRS had been applied to account for the revenue from the Enterprise client contracts sold to BCX Given the complexities around intercompany transactions and the substance over legal form considerations, we involved our internal IFRS and legal specialists to analyse the agreements and other relevant information, including the limited legal due diligence undertaken by the company legal advisors on the material customer contracts relating to the Enterprise transaction We requested the related party’s external auditor to independently assess the accounting for the intercompany revenue in both the holding and subsidiary company and held extensive discussions with them during the process We included our internal IFRS and legal specialists in discussions held with the company in-house and external legal advisors on the legal form of the transaction We critically assessed the legal advice received by Telkom from management’s legal advisor on the common law principles relevant for the transaction relating to the transfer of contracts under the circumstances relevant for sale agreement

Other Information
The directors are responsible for the other information. The other information comprises the information included in the annual report as well as the directors’ report, the audit committee’s report and the company secretary’s certificate as required by the Companies Act of South Africa. The other information does not include the consolidated financial statements and our auditor’s report thereon.

Our opinion on the consolidated and separate financial statements does not cover the other information and we do not express any form of assurance conclusion thereon.

In connection with our audit of the consolidated and separate financial statements, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the consolidated and separate financial statements or our knowledge obtained in the audit, or otherwise appears to be materially misstated. If, based on the work we have performed, we conclude that there is a material misstatement of this other information; we are required to report that fact. We have nothing to report in this regard.

Responsibilities of the directors for the consolidated financial statements
The directors are responsible for the preparation and fair presentation of the consolidated and separate financial statements in accordance with International Financial Reporting Standards and the requirements of the Companies Act of South Africa, and for such internal control as the directors determine is necessary to enable the preparation of consolidated and separate financial statements that are free from material misstatement, whether due to fraud or error.

In preparing the consolidated and separate financial statements, the directors are responsible for assessing the group’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern basis of accounting unless the directors either intend to liquidate the group or to cease operations, or have no realistic alternative but to do so.

Auditor’s responsibilities for the audit of the consolidated and separate financial statements
Our objectives are to obtain reasonable assurance about whether the consolidated and separate financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these consolidated financial statements.

As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional scepticism throughout the audit. We also:

• Identify and assess the risks of material misstatement of the consolidated financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.
• Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the group’s internal control.
• Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management.
• Conclude on the appropriateness of the directors’ use of the going concern basis of accounting and based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the group’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the consolidated financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the group to cease to continue as a going concern.
• Evaluate the overall presentation, structure and content of the consolidated financial statements, including the disclosures, and whether the consolidated financial statements represent the underlying transactions and events in a manner that achieves fair presentation.
• Obtain sufficient appropriate audit evidence regarding the financial information of the entities or business activities within the group to express an opinion on the consolidated financial statements.

We are responsible for the direction, supervision and performance of the group audit. We remain solely responsible for our audit opinion.

We communicate with the directors regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit.

We also provide the directors with a statement that we have complied with relevant ethical requirements regarding independence, and to communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards.

From the matters communicated with the directors, we determine those matters that were of most significance in the audit of the consolidated financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication.

Report on other legal and regulatory requirements
In terms of the IRBA Rule published in Government Gazette Number 39475 dated 4 December 2015, we report that:

• Ernst and Young Inc. has been the auditor of Telkom SA SOC Limited client for 19 years. EY has been the appointed auditor of Telkom since 1998.
• This is the first year that Nkonki Inc. has been appointed as a joint auditor for Telkom SA SOC Limited. Nkonki was involved in the audit as subcontractor to EY for the 11 previous years, since 2006.

The engagement partners on the audit resulting in this independent auditor’s report are Delanie Lamprecht and Brian Mungofa.

Ernst & Young Inc. Director – Delanie Lamprecht Registered Auditor Chartered Accountant (SA) 1 June 2017

Nkonki Inc. Executive - Brian Mungofa Registered Auditor Chartered Accountant (SA) 1 June 2017