Turnaround for municipal distress resolution: An audit outcomes approach

Abstract

Purpose: This research study aims to identify effective turnaround strategies that can resolve municipal financial distress by improving the audit outcomes of dysfunctional municipalities.

Motivation: As many as 64% of South African municipalities were classified as financially distressed by the National Treasury on 7 December 2022, indicating that most South African municipalities require urgent intervention. There is a knowledge gap in the existing literature on how to resolve municipal financial distress practically.

Design / Methodology / Approach: An exploratory sequential mixed methods design was utilised to identify effective turnaround strategies. An interpretative content analysis of Audit Action Plans was conducted, followed by a census of the provincial treasuries, the National Treasury and the Department of Cooperative Governance and Traditional Affairs (COGTA) in South Africa.

Main findings: The main research findings indicate that turnaround strategies associated with effective and adequate internal controls, revenue management, ethics and fraud prevention can improve municipal financial viability.

Practical implications/Managerial impact: The improved financial viability of municipalities will empower dysfunctional municipalities to resolve their own financial distress by implementing similar effective and practical turnaround strategies, thereby improving the quality of essential service delivery to local communities.

Novelty/Contribution: Improved essential service delivery directly contributes towards local economic development and job creation.

Keywords:

• municipality
• distress
• turnaround
• strategy
• audit outcomes
• audit report

1. Introduction

Ever since the dawn of democracy in South Africa in 1994, most South African municipalities have battled with financial viability and delivery of essential services to local communities after the newly elected government of national unity inherited an almost bankrupt state (Kanyane, 2014; Glasser & Wright, 2020). Continued municipal financial distress has resulted in a full-blown crisis in many South African towns and cities plagued by electricity supply disruptions, clean water shortages, inadequate housing, and a lack of sanitation (Meyer & Neethling, 2021; Nxumalo, 2022). This municipal financial crisis has various root causes, varying in severity from one municipality to the next. Low levels of infrastructure expenditure can be classified as the most significant cause of failure, as sustained low levels of infrastructure development limit the ability of municipalities to expand essential service delivery to poor, and often rural, communities. In addition, due to the lack of infrastructure development, inefficient supply chain management processes debilitate effective service delivery due to cumbersome and excessive compliance-driven procedures, which place a disproportionate administrative burden on municipalities and delays the procurement of essential goods and services. High vacancy rates in crucial positions and cadre deployment further contribute to a lack of critical skills in municipalities, worsening municipal dysfunctionality (Bureau for Economic Research, 2021). Municipal financial woes directly and negatively impact their ability to deliver essential services to their local communities (Kroukamp, 2016; Kumalo & Scheepers, 2020; Zerihun & Mashingo, 2022).

1.1. The decision-usefulness of audit reports in the context of municipal financial distress

In response to the municipal financial distress crisis, the Auditor-General of South Africa (AGSA) called for disciplined financial and performance management in South African municipalities as fruitless and wasteful expenditure resulted in a R2.1 billion loss to the fiscus for the financial year ended 30 June 2021. In addition, only 28% of all South African municipalities could prepare annual financial statements which did not contain material misstatements (Maluleke, 2021). The AGSA is mandated to perform regulatory audits at all South African municipalities, and their audit reports are the only independent, verifiable, and credible measure of the financial status and performance of municipalities. Therefore, this study aims to develop effective turnaround strategies for municipal distress resolution based on the reported audit outcomes of financially distressed municipalities.

Public sector audits can be categorised into three main types: audits of financial statements, audits of compliance with laws and legislations, and audits of reported performance information (IRBA, 2010). Financial audits determine whether the auditee’s financial information is reasonably presented following the financial reporting and regulatory framework. Audits of reported performance information focus on evaluating the usefulness and reliability of reported municipal performance information against predetermined objectives, as prescribed by the Municipal Systems Act 32 of 2000 (Nombembe, 2013). Compliance auditing is performed by assessing whether activities, financial transactions and information are, in all material respects, in compliance with the authorities which govern the audited entity (INTOSAI, 2022). Public sector audit reports, therefore, contain audit opinions on the financial statements, the achievement of performance targets and strategic objectives, and the level of compliance with laws and regulations at municipalities. Consequently, public sector external audit reports are utilised to assess and evaluate how a municipality has performed holistically, considering all significant operational, financial, and administrative processes as prescribed by regulations in the Municipal Finance Management Act (MFMA) 56 of 2003 and other regulations (RSA, 2003). Regulatory audits provide the public with assurance that their municipality has either been governed in the public’s best interest or not and can be utilised to hold local municipalities accountable for how public funds have been spent (Eichhorn et al., 2016; Salle, 2020).

After a regulatory audit has been concluded, the external auditors discuss reported audit findings and recommendations with the management team of their auditee, as prescribed by the International Auditing Standards. Audit reports enable effective decision-making in all spheres of government and are crucial for improving accountability and governance (Lamoreaux et al., 2015; Fung et al., 2016). Audit opinions should spark strategic and operational management ideas, which would facilitate effective decision-making and improve service delivery to local communities, as management reports often include independent recommendations on how to improve the efficiency and effectiveness of internal controls and operations (Gildenhuis & Janse van Rensburg, 2017; Mahaček et al., 2017). Nonetheless, the decision-usefulness of audit opinions is compromised when supporting audit evidence reflects inaccurate and unreliable financial information in the financial statements and annual reports, which may indicate impending financial risk and distress (Gomez II et al., 2020). A qualified, disclaimed, or adverse audit opinion destroys trust that municipal financial statements and performance are reliable and credible (Moalla, 2017). In contrast, unqualified audit opinions will provide decision-makers and oversight bodies with reasonable assurance that the financial information is a fair reflection of the financial status and performance of the municipality during a financial year. Therefore, municipal oversight bodies and management are empowered by audit report disclosures to mitigate financial and operational risks and draft strategic plans for the future, which will aid the municipality with risk mitigation and strengthen governance (Gomez II et al., 2020).

Audit opinions are used as signals of impending potential financial challenges at auditees. Audit opinions may signal warning signs relating to the mismanagement of assets, over-indebtedness, financial unsustainability, and the excessive cost structure of a municipality (Cherny, 2014). Audit reports inform decision-makers about the municipality’s ability to be financially sustainable and remain a going concern in instances where a going concern emphasis of matter paragraph is absent from the audit report (Fischer et al., 2016; Istrate et al., 2020). Modified audit opinions may increase the risk of future litigation and are directly correlated with financial distress (Moalla, 2017). There is also a direct relationship between ineffective governance structures and regressions in audit outcomes of municipalities (Motubatse et al., 2017; Funk & Owen, 2020).

Subsequently, the auditee’s management team develops an Audit Action Plan to strategise on how remedial action will be implemented to strengthen their internal control environments based on audit findings and recommendations. Municipalities must address audit findings raised by the AGSA by compiling Audit Action Plans as prescribed by section 131 of the MFMA (RSA, 2003). National Treasury and oversight bodies, such as municipal audit committees, use Audit Action Plans to monitor the progress made by municipalities in resolving their audit findings and expediting turnaround interventions (National Treasury, 2022b). Audit Action Plans are used to improve municipal accountability and allocate responsibility for the execution of each audit finding to a specific municipal official. Priorities for the resolution of audit findings are also disclosed in Audit Action Plans. National Treasury concluded that Audit Action Plans should be drafted to assist dysfunctional municipalities to “move from crisis, through recovery, to sustained improvement in audit outcomes” (National Treasury, 2022b, p. 6). Audit Action Plans should be implemented to strengthen auditees’ internal control environments and mitigate risks. If Audit Action Plans are only partially implemented, there will be a residual risk that the financial and performance reports may contain errors and omissions (Chartered Institute of Internal Auditors, 2020). Shohihah et al. (2018) warned sternly that audit findings and recommendations would have no value or meaning if auditees do not implement Audit Action Plans.

1.2. Problem statement and objective

Financially distressed municipalities struggle to adequately deliver essential services to their respective communities and execute their constitutional mandate, as reflected in poor municipal audit outcomes. This study aims to improve the sad narrative of the prolonged dysfunctional state of most South African municipalities. The implementation of effective turnaround strategies will empower municipalities to improve their audit outcomes. Consequently, municipal service delivery to citizens will also improve, and taxpayers’ money will be spent in a disciplined manner. The rest of the study is set out as follows. Section 2 provides an overview of the existing academic literature regarding the determinants of municipal financial distress and turnaround strategies. Section 3 deals with the research design, and Section 4 highlights the study’s empirical research findings. The study closes with a conclusion, containing an acknowledgement of the limitations of this study and recommendations for future research.

2. Literature review

2.1. Determinants of financial distress

Financial distress occurs worldwide in municipalities of all sizes and is usually caused by financial mismanagement, ineptitude, and unethical behaviour (Swisher, 2016; Buendía-Carrillo et al., 2020). In South Africa, municipal financial distress occurs when:

… a municipality, as a result of a crisis in its financial affairs, is in serious or persistent material breach of its obligations to provide basic services or to meet its financial commitments, or admits that it is unable to meet its obligations or financial commitments. (RSA, 2003, p. 134)

Municipal financial distress, therefore, refers to the inability of municipalities to pay creditors on time or a failure to provide residents with access to adequate essential services such as water, electricity, refuse removal, and sanitation. Municipal financial distress hurts local communities and may result in significant financial losses for municipal creditors and suppliers if their bills are not settled promptly. In South Africa, municipal financial distress is synonymous with regressions in audit outcomes. A regression of municipal audit outcomes cannot be attributed to a single factor or determinant, which can be isolated and blamed for modified audit opinions. A regression in audit outcomes is a complex and multi-faceted product of various factors ranging from ineffective leadership, insufficient risk management practices and inadequate financial management (Motubatse et al., 2018). Factors contributing to financial distress are diverse and interactive (Swisher, 2016; Cohen et al., 2017). Therefore, all municipal stakeholders must identify and evaluate the root causes of financial distress so that they can put safeguards in place to protect themselves against potential losses (Habib et al., 2020). The following root causes of municipal financial distress have been identified in the academic literature:

• Records management: In developing economies, financial reporting is crucial in demonstrating accountability to the public in using taxpayers’ money in the execution of service delivery mandates and ensuring that annual financial statements conform to accounting standards (Brown, 2018; Shuraki et al., 2021). Records management is a vital component of financial reporting as sufficient appropriate evidence is required to enable external auditors to express an opinion on the reliability and accuracy of financial reports (Mosweu & Ngoepe, 2021). External auditors cannot discover financial misstatements if supporting transaction documentation is unavailable. The external auditors may therefore experience a limitation of scope on their ability to execute their audit procedures and, consequently, a disclaimed audit opinion will be issued (Tidrick, 2017; Dung & Tuan, 2019). The National Treasury has flagged disclaimed audit opinions as a determinant of municipal financial distress, as stipulated in section 138 of the MFMA (RSA, 2003).

• Asset management: Municipal infrastructure development forms the foundation for local economic development. Infrastructure development can be successfully utilised to create jobs and reduce poverty and inequality in local communities (Vitri & Herman, 2019; Yang & Cen, 2020; Choi, 2021). The lack of infrastructure development in South Africa is concerning, especially in rural municipalities. Limited municipal infrastructure expenditure further curtails local economic development and job creation (Makhathini et al., 2020). In addition, inadequate infrastructure development and maintenance result in communities lacking access to proper roads, electricity, sanitation, and water supplies (Nyawo & Mashau, 2019). It is estimated that 60% of municipal infrastructure assets have a residual useful life of less than ten years and will have to be replaced soon (Bikam & Chakwizira, 2021). Therefore, South African municipal infrastructure assets are characterised by deterioration, old age, and high maintenance costs. In addition, infrastructure development and maintenance delays are further impacted by corruption, weak project management and implementation, and unreliable planning of infrastructure development projects (Dithebe et al., 2019). Consequently, the Minister of Cooperative Governance and Traditional Affairs (COGTA) flagged the failure to develop and maintain municipal infrastructure as a root cause of financial distress (COGTA, 2018).

• Budget management: Central governments, municipal oversight bodies, citizens, and political opponents frown upon both large municipal operating profits and significant deficits (Cohen et al., 2019). Large surpluses may indicate that the municipality did not spend enough money on improving essential service delivery objectives, whereas large deficits may indicate a lack of fiscal discipline. Municipalities with political competition tend to report net profit as close to zero as possible due to increased efficiency in the allocation of public resources as a result of enhanced accountability and citizen activism (Ferreira et al., 2020). However, chronic operating deficits will result in municipal failure and financial distress. Therefore, significant and repetitive operating deficits are material determinants of financial distress (Yang, 2019; McDonald III & Maher, 2020). As per the MFMA, South African municipalities are classified as being financially distressed if the actual expenditure of the municipality has exceeded the sum of its actual revenue for at least two consecutive financial years or the municipality had an operating deficit in excess of 5% of revenue, which is indicative of a significant operating deficit (National Treasury, 2021). If the municipality reported smaller operating deficits (less than 5% of revenue) in two consecutive financial years, then the municipality should also be classified as financially distressed.

• Consequences management: Most dysfunctional and distressed municipalities do not attempt to execute and enforce consequences management in cases where municipal officials act unethically (Kroukamp, 2016). Disciplinary action in financial misconduct cases should, however, be swift, transparent, proportionately just and fair, and should not be used to coerce public servants to act in a politicised manner (Werbner, 2014; Enwereji & Uwizeyimana, 2019; Onyango, 2019). In practice, though, consequences management tends to target vulnerable employees, junior employees and employees supporting a different political party rather than senior managers, and as such, the fairness and effectiveness of consequences management may be in jeopardy (Mason, 2014; Lindeman et al., 2017; Al-Haidar, 2018). The lack of consequences management at an executive management level may enhance the public’s perception that their government is failing to address fraud and corruption (Mafunisa, 2014). Accordingly, fraud and corruption have been indicated by the AGSA as the root cause of material irregularities; therefore, a lack of consequences management is also a determinant of municipal financial distress (AGSA, 2022a).

• Credible annual financial statements: Section 126(1)(a) of the MFMA stipulates that municipalities should submit annual financial statements to AGSA within two months after their financial year-end, which is on 30 June annually (RSA, 2003). The late submission of annual financial statements after the legislated submission deadline is highly correlated to increased audit findings raised by external auditors, which can indicate an incompetent municipal management team and a weak internal control environment (Cagle et al., 2017). South African municipalities struggle to draft credible and reliable annual financial statements independently within the legislated deadlines. In response, the South African National Treasury issued a Local Government Financial Management Grant to provide funding and support municipalities in the preparation and timely submission of annual financial statements. The grant conditions indicate that this conditional grant should be utilised to provide technical accounting support to municipal officials (Minister of Finance, 2021). The National Treasury has flagged the late submission of credible annual financial statements as a determinant of municipal financial distress, as stipulated in section 138 of the MFMA (RSA, 2003).

• Debt management: As per section 138 of the MFMA, a municipality will be flagged as financially distressed if it has failed to make payments as and when due or has defaulted on financial obligations for financial reasons (RSA, 2003). Bastida et al. (2019) concluded that the level of indebtedness of a municipality is the main reason for debt default risk. Municipal default risk directly relates to the municipality’s ability to continue as a going concern and influence the going concern audit opinion as expressed in audit reports (Tihar et al., 2021).

• Ethics and fraud prevention: The urge to enrich oneself through dishonesty means makes fraud and corruption a persistent phenomenon in society, regardless of the political system utilised (INTOSAI, 2016). A causal relationship exists between local government corruption and service delivery satisfaction. As corruption decreases, public satisfaction with municipal service delivery increases. As corruption increases, public satisfaction with local municipalities diminishes, as does the quality of essential service delivery (Habibov et al., 2019). Consequently, priority number one, as per COGTA’s strategic plan for the year ended 2019, stipulated that municipalities should respond vigorously to immediate crises of fraud and corruption by promoting ethical behaviour and implementing fraud prevention plans (Gordhan, 2015). The Minister of COGTA, therefore, declared failure to enforce ethics and fraud prevention plans as an indicator of municipal financial distress (COGTA, 2018).

• Expenditure management: The effectiveness of municipal expenditure management is usually evaluated by the creditors’ payment period. This indicator shows the average number of days taken for municipal creditors to be paid. If the municipality exceeds 30 days, which is legislated by South African law, then the municipality has not managed its working capital appropriately to ensure that suppliers are paid on time. A creditors’ payment period of more than 30 days usually indicates cash constraints and cash flow problems, which may lead to possible going concern difficulties (AGSA, 2022b). When municipalities cannot settle creditors’ claims in the short term, the credibility and sustainability of the municipality will be questioned due to increased default risk. Late suppliers’ payments may also indicate significant internal control weaknesses within the accounting departments of these municipalities (Guo et al., 2019; Yendrawati & Ghaisani, 2020).

• Governance and oversight: Overall public trust in local municipalities is garnered through good governance, which encompasses transparency, accountability and municipal responsiveness to the service delivery demands of residents (Hartanto & Siregar, 2021). Creating people-centred municipalities is noble and demands servant leadership. Servant leadership must ensure municipalities place residents first when providing essential services (Makwembere & Garidzirai, 2021). By contrast, the rampant mismanagement of public funds, corruption, and fruitless and wasteful expenditure at financially distressed municipalities indicate that municipal leadership in South Africa is perceived to be a step ladder towards personal enrichment, which is in stark contrast to good governance principles (Makole, 2022). Accordingly, COGTA indicated that failure to build resilient local government institutions with regard to good governance is a determinant of municipal financial distress (COGTA, 2018).

• Human resource management: There is a direct correlation between the duration of the employment term of the Chief Financial Officer and Municipal Manager and the audit outcomes of a municipality (Local Government Sector Education and Training Authority, 2019). It is worrisome to note that these municipal officials usually occupy these positions for less than two years, resulting in high staff turnover and vacancy rates (Janse van Rensburg & Ramutsheli, 2015). These key management positions serve as gatekeepers of financial and internal control, and associated vacancies may result in increased tender irregularities as management control diminishes (Mantzaris, 2017; Mhelembe & Mafini, 2019). Resultantly, the AGSA specifically evaluates the loss of key management without appointing suitable replacements when they assess the municipal management’s assessment of going concern (AGSA, 2022b).

• Internal controls: The AGSA often criticises financially distressed municipalities in their audit reports for having weak internal control environments and the inability to implement remedial action based on audit findings (AGSA, 2019). In addition, significant internal control deficiencies, which resulted in modified audit opinions and audit report non-compliance findings, will also be listed in the audit reports of public sector auditees (IRBA, 2019; AGSA, 2022c). Accordingly, inadequate and ineffective internal controls are indicated as determinants of municipal financial distress.

• Performance information: The main strategic aim of audits of reported performance information is to evaluate whether public sector organisations report reliable and useful performance information based on their pre-determined objectives within a given timeframe and within the allocated budget (Mosimege & Masiya, 2022). As a result, the Public Audit Act 25 of 2004 requires the AGSA to “report information relating to the performance of the auditee against performance objectives” (RSA, 2004, p. 22). Municipalities’ financial woes directly impact their ability to deliver essential services to their local communities (Kroukamp, 2016; Kumalo & Scheepers, 2020; Zerihun & Mashingo, 2022). Therefore, audit report qualifications associated with audits of pre-determined objectives indicate municipal financial distress.

• Procurement and contract management: During the 2021 financial year, financially distressed municipalities had cumulative irregular expenditure of R6.3 billion due to non-compliance with laws and regulations in ensuring that tender processes are fair and cost-effective. As at 15 April 2022, the AGSA had identified 149 material irregularities (MIs) in municipalities, with a minimum estimated financial loss of R3.9 billion (AGSA, 2022a). Most of these MIs are caused by municipalities incurring interest and penalties due to them not paying their suppliers, such as Eskom, Water Boards, construction companies and other suppliers, promptly. The second leading cause of MIs relates to non-compliance with procurement processes. Procurement irregularities often relate to municipalities procuring overpriced goods and services or where the goods and services are of poor quality and not in line with underlying procurement contracts (AGSA, 2022a). Fundamentally, MIs are caused by systemic governance failures and weak internal control environments in municipalities and result in financial distress and repetitive disclaimed audit opinions.

• Revenue management: Nowadays, it is common practice for individual residents and customers not to settle their accounts when due, which may jeopardise the financial sustainability of a municipality (Onar et al., 2018). Therefore, the efficiency of a municipality’s revenue collection systems and processes is indicative of the long-term financial viability of the municipality. Stats SA reported that debt owed to South Africa’s 257 municipalities totalled R72,4 billion in the 2018 financial year, which also renders municipalities unable to pay their own creditors due to ineffective revenue collection (Stats SA, 2018). The AGSA uses two indicators to measure the effectiveness of municipal revenue collection in assessing a municipality’s ability to continue as a going concern: the municipality’s average debtors’ collection period and the bad debts provision as a percentage of total debtors (AGSA, 2022b). Numerous South African municipalities are not financially viable due to uncollectable debtors; hence, low revenue collection is a determinant of municipal financial distress (Enwereji & Kadama, 2018).

• Strategic management and leadership: Managerial and political leadership is poor in most distressed municipalities, resulting in indecisiveness and an inability to execute election promises made to local residents (Steytler & Ayele, 2014; Moshikaro & Pencelliah, 2016; Enwereji & Uwizeyimana, 2019). Councillors do not always understand their responsibilities, resulting in paralysis and an inability to execute tasks (Meamela & Van Hoof, 2008; Gqamane & Taylor, 2013). Most municipalities lack strategic management and leadership, as prescribed by the King IV code. Municipal financial distress is an indictment of the entire local government accountability ecosystem, characterised by service delivery failures and causing substantial harm to local communities and the municipalities themselves, as evidenced by the MIs reported by the AGSA (AGSA, 2022d).

Considering the dysfunctional state of most of South Africa’s municipalities, it is pivotal for South African citizens, municipal councils and oversight bodies to find effective turnaround strategies to resolve financial distress by targeting the root causes of the problem.

2.2. Turnaround strategies

The construction of an effective turnaround plan to resolve financial distress is a highly complex process (Xu et al., 2022). Consequently, turnaround management teams usually incorporate an integrated canvas of various turnaround strategies to achieve distress resolution (Bhattacharyya & Malik, 2020; Carreira et al., 2022). Municipal turnaround managers, administrators, and oversight bodies may therefore opt to use a combination of various turnaround strategies to achieve distress resolution. An overview of turnaround strategies is provided below:

• Strategic responses for financial distress resolution: Executive management restructuring is often indicated as an essential prerequisite for financial distress resolution and turnaround to prevent organisational failure and collapse (Kumalo & Scheepers, 2020). When the old, trusted strategies for managing operations are required to undergo drastic changes, it is often difficult for the incumbent executive management teams to change their methods and introduce rapid, radical reforms to achieve distress resolution (Sudarsanam & Lai, 2001). Consequently, financial distress and dysfunctionality usually involve involuntary senior management changes and restructurings shortly after adopting a turnaround plan (Radjen, 2015). In South Africa, democratically elected municipal councils have the authority to restructure management teams by appointing new municipal managers and dismissing incumbent municipal managers based on misconduct or failure to execute their fiduciary duties with due care. Municipal councils can also suspend municipal managers pending disciplinary investigations and hearings by following good governance principles (Steytler, 2005). Nevertheless, municipal management restructurings are synonymous with complex debates regarding the technical merit of changing municipal management teams and the political control and support for local elected officials (Wang & Crosby, 2019; Nickels et al., 2020).

• Financial responses for financial distress resolution: Financial restructuring strategies aim to improve profitability and efficiency, and include substantial changes in organisations’ debt and equity financing structures to avoid bankruptcy (Akbar et al., 2022). Focus areas for financial responses to financial distress usually revolve around accelerating revenue growth and debtors’ collection, introducing new technology to improve operations, and strengthening strategic client relationships by building partnerships with stakeholders (Kulkarni et al., 2021). In South Africa, financially distressed municipalities can obtain debt relief as Part 3 of Chapter 13 of the MFMA, which provides a stay of legal proceedings against the financially distressed municipality by suspending financial obligations (Glasser & Wright, 2020). Creditors often prefer a proactive approach to distress resolution, as opposed to a reactive intervention, for financially distressed municipalities, and therefore, financial restructuring should be conducted as soon as a municipal decline is detected (Gao et al., 2016). Financial responses to financial distress resolution include debt reduction, budget and expense control, revenue enhancement strategies, and asset control.

• Operational responses for financial distress resolution: Operational inefficiencies, such as non-transparent systems, duplication of processes and procedures, insufficient segregation of duties, and inadequate internal controls may stifle the operational effectiveness of any entity. Optimising and re-engineering operational processes will result in operational efficiency, improved sustainability, and rapid performance improvement (EY, 2023; PwC, 2023). As such, Hammer and Champy (1993) defined the operational responses to distress resolution as a process of re-inventing organisations and their business processes to reduce operational costs. A radical operational redesign will improve service delivery performance, reduce costs, and ensure services are executed quickly (Hammer & Champy, 1993). The South African Cities Network (2021, n.p.) indicated that the weakest link in service delivery is public procurement processes, which is the “link between drawing up plans and realising those plans in real substantive outcomes for citizens”. It is recommended that Audit Action Plans include plans to improve internal public procurement controls to ensure that public procurement processes comply with legislation and are just and fair. In addition, municipalities should implement performance management systems (PMS) for employees. These empower municipal managers and employees to stipulate the service delivery objectives of municipalities so that residents and municipal stakeholders are familiar with each municipality’s strategy. The PMS will define specific and measurable key performance indicators that municipalities and their employees aim to achieve within each financial year (Ndasana & Umejesi, 2022).

The effectiveness of municipal turnaround strategies, which are utilised to resolve financial distress, hinges on the ability of the municipality to identify all its financial distress determinants. These financial distress determinants are adequately reflected as audit outcomes in the audit reports on municipalities. All municipalities are required to draft Audit Action Plans to resolve their audit findings. As such, Audit Action Plans can be used effectively to plan and implement remedial action to resolve audit findings, which should result in improved audit outcomes and enhance financial viability. Furthermore, it is recommended that Audit Action Plans should include strategic, operational, and financial turnaround strategies to resolve financial distress and improve audit outcomes.

3. Research design: Exploratory mixed methods design

This exploratory study followed a mixed methods approach consisting of an interpretive content analysis of the audit reports and Audit Action Plans of municipalities that have achieved improved audit outcomes. The research findings from this interpretative content analysis were confirmed through quantitative census responses from the National Treasury, each of the provincial treasuries and the Department of Cooperative Governance and Traditional Affairs, which are all mandated by the South African Constitution to monitor and support municipalities from a financial and administrative governance perspective, and to intervene in cases of financial distress (RSA, 1996). Findings from the interpretive content analysis of audit reports and Audit Action Plans were then synthesised and analysed based on quantitative survey responses from the National Treasury, provincial treasuries, and COGTA through methodological triangulation. In this way, successful turnaround strategies for municipal distress resolution were identified by integrating multiple research methods to address this complex and multi-faceted research problem.

3.1. Data collection and analysis for the interpretative content analysis

On 15 May 2018, the Minister of COGTA announced a list of 87 municipalities officially declared financially distressed (COGTA, 2018). These 87 municipalities constitute the population selected for this study. A content analysis of subsequent audit reports and Audit Action Plans was conducted for three years after these municipalities were declared financially distressed by the State to establish whether these municipalities could resolve their financial distress by implementing turnaround strategies. The audit reports and Audit Action Plans of these 87 financially distressed municipalities were evaluated from the financial year ended 30 June 2018 to the financial year ended 30 June 2021. The municipal audit outcomes for the financial year ended 30 June 2022 were excluded from this study as these audit outcomes were not officially released by the AGSA as at 30 May 2023, which was the cut-off date of this study. Audit and annual reports for the financial years ended 30 June 2018, 30 June 2019, and 30 June 2020 were obtained from the National Treasury’s MFMA database¹ for the financially distressed municipalities selected as part of this study. Annual reports and audit reports for the financial year ended 30 June 2021 were obtained from the National Treasury’s GoMuni portal.² The public can access both the MFMA database and the GoMuni portal.

If the audit opinion as expressed by the AGSA in the financial year ended 30 June 2018 was disclaimed, but in the financial year ended 30 June 2021 it had improved to an adverse, qualified, unqualified with findings, or unqualified with no findings (also known as a clean audit) opinion, then the financially distressed municipality would be classified as having ‘improved‘. Likewise, if the audit opinion expressed by the AGSA in the financial year ended 30 June 2018 was adverse, but in the financial year ended 30 June 2021 it had improved to a qualified, unqualified with findings, or unqualified with no findings opinion, then an improvement would have been noted as well. Furthermore, if the audit opinion expressed by the AGSA in the financial year ended 30 June 2018 was qualified, but in the financial year ended 30 June 2021 it had improved to an unqualified with findings, or unqualified with no findings opinion, then the municipality would also have improved. Finally, if the audit opinion expressed by the AGSA in the financial year ended 30 June 2018 was an unqualified with findings audit opinion, but in the financial year ended 30 June 2021 it had improved to an unqualified with no findings opinion, then the municipality would also have improved. The classification of improved municipal audit opinions is based on the definitions and guidelines of modified audit opinions as per the AGSA’s Public Audit Manual of 2022.

An interpretive content analysis was only performed for the municipalities that improved their audit outcomes, as reported by the AGSA, and published their annual report. Of the 87 municipalities classified as financially distressed by the Minister of COGTA in 2018, only 24 municipalities improved their audit outcomes and published their annual reports. Turnaround strategies are disclosed in the annual reports of municipalities as part of the Audit Action Plans. Turnaround strategies were only identified for audit report findings which were resolved by 30 June 2021, representing the end of the 2021 financial year for municipalities. Audit report findings were classified as being resolved if a particular audit report finding or qualification paragraph was observed in a particular municipality’s audit report for the financial year ended 30 June 2018, and the same audit report finding or qualification paragraph did not re-occur in the same municipality’s audit report for the financial year ended 30 June 2021. Subsequently, a thematic evaluation of municipal turnaround strategies identified in the literature review (refer to section 2) was utilised to analyse turnaround strategies as disclosed in the Audit Action Plans, which are included and disclosed in annual reports. The Audit Action Plans, as disclosed in annual reports, were then coded based on the identified turnaround strategies in ATLAS.ti. Coding was performed to obtain a detailed description of the turnaround strategies utilised by municipalities to improve their audit outcomes, utilising ATLAS.ti.

The authors performed a first round of manual coding as part of the content analysis of the Audit Action Plans for municipalities. Subsequently, ATLAS.ti’s artificial intelligence (AI) auto-coding was utilised to ensure that all turnaround strategies were included in the research and that no turnaround strategy was missed due to manual coding errors. The machine learning capabilities of ATLAS.ti were used to identify any other potential turnaround strategies by using the automated Regular Expression Search function for words relating to ‘turnaround’, ‘turn-around’, ‘strategy’, ‘strategies’, ‘remedial action’ and ‘distress resolution’. In this manner, a complete and comprehensive list of successful turnaround strategies was obtained from the Audit Action Plans as disclosed in the annual reports of financially distressed municipalities.

3.2. Data collection and analysis for the quantitative census

Quantitative questionnaires were administered to the municipal oversight branches of the treasuries and COGTA to explore their perspectives on turnaround strategies resulting in financial distress resolution. The importance of quantitative surveys using questionnaires in auditing research is specifically stressed and utilised to focus on and capture the views of stakeholders in auditing and oversight functions (Marx, 2008; Harber, 2018). The questionnaire consisted of open- and close-ended questions, which respondents were requested to answer. A set of fixed alternative options for answers were provided for the close-ended questions, whereas the respondents could respond as they wished in answering the open-ended exploratory questions. Questions included in the census mainly related to five-point Likert scale questions with the options of ‘strongly agree’, ‘agree’, ‘neutral’, ‘disagree’, and ‘strongly disagree’, with ‘1’ representing ‘strongly agree’ and ‘5’ representing ‘strongly disagree’. The directionality of the Likert scale questions was increasingly negative, from ‘strongly agree’ to ‘strongly disagree’. Research respondents were also provided with the option to indicate other effective turnaround strategies based on their experience, which were not identified in the content analysis or the literature review, in the comments section provided after each Likert scale question posed, to ensure that as many effective turnaround strategies as possible were identified. All questions included in the questionnaire were informed by the literature review and related to specific turnaround strategies for financially distressed municipalities.

This study’s purposeful and specific census included all nine provincial treasuries, the National Treasury and COGTA. Therefore, all municipal oversight branches of the provincial treasuries, the National Treasury and COGTA, which have a legislative mandate to evaluate and monitor municipalities in South Africa, were included in this census. Specific respondents were selected to extract information-rich feedback and opinions regarding effective turnaround strategies for financially distressed municipalities. Representative delegates were selected based on the names of officials listed as responsible for municipal oversight in MFMA Circulars 113, 114 and 124. MFMA circulars are official national and public communications issued by the National Treasury of South Africa; the public officials listed in these circulars thus have a delegated mandate to represent their respective treasuries. All officials representing the National Treasury, COGTA, and provincial treasuries who participated in this census are sufficiently senior with appropriate qualifications and work experience and are appointed as either Directors or Deputy Directors. All respondents invited to participate in this study submitted their questionnaires, representing a 100% response rate.

3.3. Methodological triangulation

The objective of methodological triangulation is to synthesise the results from the interpretive content analysis with the research results from the census. This is done to validate and complement the qualitative content analysis research findings with the research results from the quantitative questionnaires in this exploratory study to identify effective turnaround strategies which result in municipal financial distress resolution. Accordingly, triangulation is presented for each turnaround strategy identified in the literature review, which was subsequently tested in the interpretive content analysis and the quantitative census.

Table 1. Triangulation of the research results from the content analysis with the census results.

	CONTENT ANALYSIS				QUESTIONNAIRE		COMBINED
Turnaround strategy	Number of improved municipalities (n = 24)	% Municipalities utilising this strategy	Number of references in Audit Action Plans (n = 750)	Rank out of 15 strategies	Effectiveness based on the mean values^1	Rank out of 15 strategies	Overall rank	Overall combined opinion
Adequate Records Management	20	83%	63	4	1,64	13	9	Effective
Asset Management	18	75%	59	5	1,27	5	4	Effective
Budget Management	15	63%	32	13	1,27	5	11	Effective
Consequences Management	14	58%	37	10	1,18	2	5	Effective
Credible Annual Financial Statements	13	54%	20	14	1,55	12	14	Effective
Debt Management	7	29%	10	15	1,82	14	15	Effective
Ethics & Fraud Prevention	20	83%	52	6	1,18	2	3	Effective
Expenditure Management	12	50%	38	9	1,36	8	10	Effective
Governance and Oversight	21	88%	102	2	1,45	10	6	Effective
Human Resource Management	21	88%	67	3	1,91	15	12	Effective
Internal Controls	22	92%	122	1	1,18	2	1	Effective
Performance Information	16	67%	35	11	1,45	10	13	Effective
Procurement & Contract Management	16	67%	39	7	1,36	8	7	Effective
Revenue Management	14	58%	39	7	1,09	1	2	Effective
Strategic Management	15	63%	35	11	1,27	5	8	Effective

¹Means were calculated based on the following scales: 1 = Strongly agree; 2 = Agree; 3 = Neutral; 4 = Disagree and 5 = Strongly disagree

4. Findings and discussions

This study focuses on identifying effective turnaround strategies for municipal financial distress resolution based on turnaround strategies disclosed in Audit Action Plans of municipalities that achieved improved audit outcomes. Audit Action Plans are prescribed in section 131 of the MFMA. These strategies have been developed for the treasuries, COGTA, audit committees, municipal councillors, and all relevant oversight bodies to alleviate financial distress and improve audit outcomes. Accordingly, the interpretive content analysis results were synthesised with the quantitative census results to culminate in recommended processes and procedures which should be prioritised during a financial crisis. The top 10 most effective turnaround strategies for municipal financial distress resolution are critically analysed below.

4.1. Priority 1: Implement effective and adequate internal controls

The implementation of effective and adequate internal controls as a turnaround strategy aims to ensure that municipalities reduce the likelihood and impact of adverse events through robust risk management processes and risk assessments, which inform control activities (IAASB, 2019). Internal controls are designed to assist municipalities in determining whether policies and standard operating procedures are being executed appropriately and enable municipalities to evaluate whether risk exposures are adequately mitigated by evaluating internal controls and monitoring activities. To resolve audit report findings, 22 out of 24 municipalities (92%) that improved their audit outcomes for the financial year ended 30 June 2021 attributed their success to adequate and effective internal controls. In this regard, 122 references were noted regarding adequate and effective internal controls in municipalities’ Audit Action Plans that achieved improved audit outcomes. A total of 22 municipalities, classified as financially distressed on 15 May 2018, managed to improve their audit outcomes as a direct result of implementing adequate and effective internal controls, which translated into a cumulative total of 138 audit report qualification paragraphs being resolved.

Table 2. Census responses relating to internal controls.

Audit Action Plan responses as identified in the content analysis	Number of responses received					Total	Mean
	(1) Strongly agree	(2) Agree	(3) Neutral	(4) Disagree	(5) Strongly disagree
The overall effectiveness of internal controls	9	2	0	0	0	11	1,18
Each divisional manager is responsible for safeguarding assets in their division	10	1	0	0	0	11	1,09
Utilise accurate work-in-progress registers to account for infrastructure projects under construction	9	2	0	0	0	11	1,18
Use independent accounting consultants to update fixed asset registers	3	2	3	1	2	11	2,73
CFO approves adjusting journal entries	6	5	0	0	0	11	1,45
Limit irregular expenditure by ensuring that the procurement of goods and services is conducted as per SCM prescripts	9	2	0	0	0	11	1,18
SCM managers review transactions to ensure that transactions are correctly recorded	5	3	1	2	0	11	2,00
Expenditure managers review payments to ensure that all payments have been appropriately recorded	8	2	0	1	0	11	1,45
Implement segregation of duties	8	3	0	0	0	11	1,27
Municipal managers should review irregular expenditure registers, and the CFOs should ensure that irregular expenditure are adequately disclosed	7	2	0	1	1	11	1,82
Conduct internal audits	8	3	0	0	0	11	1,27
The municipal council should approve tariffs	7	3	1	0	0	11	1,45
Use independent valuers to review objections against property values in the valuation roll	4	3	4	0	0	11	2,00
Revenue accountants use the revenue transaction summary reports to balance receipts to cash counts and bank deposits	4	4	2	1	0	11	2,00

Most respondents either strongly agreed or agreed that the turnaround strategies disclosed in the Audit Action Plans of municipalities that achieved improved audit outcomes are effective, with means for each strategy reflected as between one and two, except for ‘Use independent accounting consultants to update fixed asset registers’. The respondents are sceptical about whether the appointment of external accounting and auditing consultants is a sustainable solution for financial distress resolution. The respondents indicated that critical skills are often not adequately transferred between external consultants and municipal officials, which renders these municipalities unable to implement effective and adequate internal controls themselves without being dependent on costly external consultants in the long term.

4.2. Priority 2: Effective revenue management

The implementation of effective revenue management as a turnaround strategy aims to ensure that municipalities increase their revenue, enabling them to resolve their financial distress. Revenue empowers municipalities to deliver essential services to residents; hence, effective revenue collection is critical for municipalities (Mgonja & Poncian, 2019). To resolve audit report findings, 14 out of 24 municipalities (58%) that improved their audit outcomes for the financial year ended 30 June 2021 attributed their success to having effective revenue management strategies to account for revenue as stipulated by accounting standards and to collecting revenue when due. In this regard, 39 references were noted regarding effective revenue management in municipalities’ Audit Action Plans that achieved improved audit outcomes. A total of 14 municipalities, classified as financially distressed on 15 May 2018, managed to improve their audit outcomes as a direct result of implementing effective revenue management, which translated into a cumulative total of 32 audit report qualification paragraphs being resolved.

Table 3. Census responses relating to effective revenue management.

Audit Action Plan responses as identified in the content analysis	Number of responses received					Total	Mean
	(1) Strongly agree	(2) Agree	(3) Neutral	(4) Disagree	(5) Strongly disagree
The overall effectiveness of revenue management	10	1	0	0	0	11	1,09
Compliance with GRAP through processes of multiple reviews	7	2	1	1	0	11	1,64
Adequate records management processes	7	2	1	1	0	11	1,64
Reviewing all debit entries in revenue accounts and the debtors’ age analysis	5	4	1	1	0	11	1,82
Verifying that all registered indigent residents are truly unemployed and unable to pay for essential services	10	1	0	0	0	11	1,09
Using professional debt collectors to collect overdue accounts	5	4	1	1	0	11	1,82
Using provincial treasuries to collect the inter-government debt	5	4	1	1	0	11	1,82
Offering residents early settlement discounts to avoid bad debts	6	4	1	0	0	11	1,55
The municipal councils approve property rates, indigent status, credit control, and debt management policies	8	2	1	0	0	11	1,36

All respondents either strongly agreed or agreed that municipalities should verify that all registered indigent residents are truly unemployed and unable to pay for essential services. The verification of the indigent register is crucial as some residents apply for indigent status to obtain free and discounted essential services even if they are not poor, resulting in municipal revenue being reduced unnecessarily and unfairly. Furthermore, the means for all other revenue-related turnaround strategies identified in the Audit Action Plans for municipalities that achieved improved audit outcomes were between one and two, indicating a high level of consistency in the responses received from the respondents.

4.3. Priority 3: Ethics and fraud prevention

The objective of ethics and fraud prevention as a turnaround strategy is to ensure that municipalities do not become vulnerable to procurement irregularities, employment and appointment irregularities and the embezzlement of funds, which all have a direct and negative impact on service delivery (Dzansi et al., 2016; Ngumbela, 2021; Kaizer, 2022). Municipalities are more susceptible to fraud and corruption if these entities have weak internal control environments, limited fraud awareness campaigns, high staff turnover rates, use numerous commercial banks and have no or little consequences management (National Treasury, 2023). To mitigate the risk of fraud and corruption, 20 out of 24 municipalities (83%) that improved their audit outcomes for the financial year ended 30 June 2021 attributed their success to ethics and fraud prevention strategies. In this regard, 52 references were noted regarding ethics and fraud prevention strategies in municipalities’ Audit Action Plans that achieved improved audit outcomes. A total of 20 municipalities, classified as financially distressed on 15 May 2018, managed to improve their audit outcomes as a direct result of implementing ethics and fraud prevention strategies, which translated into a cumulative total of 33 audit report qualification paragraphs being resolved.

Table 4. Census responses relating to ethics and fraud prevention.

Audit Action Plan responses as identified in the content analysis	Number of responses received					Total	Mean
	(1) Strongly agree	(2) Agree	(3) Neutral	(4) Disagree	(5) Strongly disagree
The overall effectiveness of ethics and fraud prevention	9	2	0	0	0	11	1,18
Displaying fraud and anti-corruption banners at all events	5	5	0	0	1	11	1,82
Asking municipal managers, internal auditors, and risk managers to identify fraud risks	6	4	1	0	0	11	1,55
Evaluating the fraud prevention and response plans	7	4	0	0	0	11	1,36
Drafting internal audit plans in response to fraud risks	7	4	0	0	0	11	1,36
Promoting an ethical culture	10	1	0	0	0	11	1,09
Ongoing staff training on fraud and corruption prevention	7	3	1	0	0	11	1,45
Providing physical security measures at municipal buildings	4	3	4	0	0	11	2,00
Employee vetting procedures before appointments are made	7	3	1	0	0	11	1,45
Investigating all instances of alleged fraud and corruption	8	3	0	0	0	11	1,27
Taking disciplinary action against employees found guilty of fraud and corruption	9	2	0	0	0	11	1,18
Councillors, mayoral committee members and municipal managers all declared and disclosed their financial interests	6	5	0	0	0	11	1,45
Subscribing to fraud and corruption hotlines	6	3	1	1	0	11	1,73

All respondents either agreed or strongly agreed that promoting an ethical organisational culture, conducting investigations for all instances of alleged fraud and enforcing disciplinary action where warranted will improve ethics and prevent fraud. The respondents indicated that all ethics and fraud prevention strategies, as reflected in the Audit Action Plans of municipalities, are effective as the mean values for all these strategies were equal to or less than two.

4.4. Priority 4: Effective asset management

Section 63(2)(a) and 63(2)(c) of the MFMA require that municipalities take reasonable steps to maintain their management, accounting and information systems to account for assets (RSA, 2003). Furthermore, a system of internal controls should be in place, including an asset register (National Treasury, 2017). The MFMA’s definition of asset management focuses on infrastructure assets and includes receivables, investments and loans to directors, prescribed officers and companies within these municipalities. In this regard, 18 out of 24 municipalities (75%) that improved their audit outcomes for the financial year ended 30 June 2021 attributed their success to enhanced asset management. Effective asset management is frequently referenced in the Audit Action Plans of municipalities, which have achieved improved audit outcomes, and 59 references were noted to effective asset management in the Audit Action Plans of municipalities that achieved improved audit outcomes. A total of 18 municipalities, classified as financially distressed on 15 May 2018, managed to improve their audit outcomes as a direct result of effective asset management, which translated into a cumulative total of 50 audit report qualification paragraphs being resolved.

Table 5 indicates that all respondents agreed that asset management could be improved by adequately budgeting for asset repair and maintenance, implementing infrastructure maintenance plans, having accurate fixed asset registers, segregation of duties, and monitoring asset utilisation to reduce maintenance costs. The mean values for all asset management turnaround strategies were between one and two, except for three relating to appointing an independent auctioneer to curb theft, appointing external asset management consultants, and ensuring that assets are received within 24 hours of purchase. The respondents had mixed opinions about the effectiveness of these three turnaround strategies; therefore, the mean values for these turnaround strategies were between 2.7 and 3.5. Despite this, several treasuries actively encourage financially distressed municipalities to take ownership of their asset management processes and records instead of outsourcing this crucial function to external consultants and auctioneers. The treasuries have issued strong warnings to municipalities about the ineffective use of financial consultants since 2016.

Table 5. Census responses relating to effective asset management.

Audit Action Plan responses as identified in the content analysis	Number of responses received					Total	Mean
	(1) Strongly agree	(2) Agree	(3) Neutral	(4) Disagree	(5) Strongly disagree
The overall effectiveness of asset management	8	3	0	0	0	11	1,27
Integrating budgeting and reporting of assets with the IDP	6	3	1	0	1	11	1,82
Budgeting for the repair and maintenance of assets	8	3	0	0	0	11	1,27
Implementing maintenance plans	10	1	0	0	0	11	1,09
Accurate fixed asset registers	9	2	0	0	0	11	1,18
The physical safeguarding of assets	8	1	1	1	0	11	1,55
Segregation of duties regarding the custody of assets	6	5	0	0	0	11	1,45
Monitoring of asset utilisation to reduce maintenance costs	6	5	0	0	0	11	1,45
Drafting a disposal of assets policy	7	3	1	0	0	11	1,45
Ensuring that new assets are received within 24 hours after purchase	2	1	7	0	1	11	2,73
Appointing an independent auctioneer to curb theft	2	2	5	0	2	11	2,82
Appointing external asset management consultants	2	0	3	3	3	11	3,45
Establishing an asset loss control committee	5	5	1	0	0	11	1,64

4.5. Priority 5: Consequences management and disciplinary action

The objective of consequences management as a turnaround strategy is to strengthen accountability in municipalities. Consequences management relates to the practical processes and procedures implemented in municipalities to limit instances of financial misconduct as described in section 171 of the MFMA (National Treasury, 2022a). The MFMA prescribes that municipal councils should investigate all instances of unauthorised, irregular, fruitless and wasteful expenditure and that these expenditures should be recovered from the persons responsible for them (RSA, 2003). Out of 24 municipalities that improved their audit outcomes for the financial year ended 30 June 2021, 14 (58%) attributed their success to effective consequences management and discipline, and 37 references were noted regarding effective consequences management in the Audit Action Plans of municipalities that achieved improved audit outcomes. A total of 14 municipalities, classified as financially distressed on 15 May 2018, managed to improve their audit outcomes as a direct result of effective consequences management, which translated into a cumulative total of 28 audit report qualification paragraphs being resolved.

Table 6 indicates that all respondents believe that recovering financial losses due to irregular, unauthorised, fruitless and wasteful expenditure from the employees found responsible for these expenditures; conducting disciplinary hearings for all employees allegedly responsible for irregular, unauthorised, fruitless and wasteful expenditure and financial misconduct; and reporting all suspected criminal offences relating to financial misconduct to the South African Police Service (SAPS) are effective turnaround strategies for financially distressed municipalities. The mean values for all consequences management turnaround strategies were between one and two, indicating a high consistency in respondents’ responses.

Table 6. Census responses relating to consequences management.

Audit Action Plan responses as identified in the content analysis	Number of responses received					Total	Mean
	(1) Strongly agree	(2) Agree	(3) Neutral	(4) Disagree	(5) Strongly disagree
The overall effectiveness of consequences management	9	2	0	0	0	11	1,18
Implementing a SCM compliance checklist	5	5	0	0	1	11	1,82
Investigating all instances of irregular, unauthorised, fruitless and wasteful expenditure	8	2	0	0	1	11	1,55
Ensuring that investigators are independent and suitably qualified	7	2	2	0	0	11	1,55
Reporting all instances of irregular, unauthorised, fruitless and wasteful expenditure to the Municipal Council and implementing council resolutions	8	2	1	0	0	11	1,36
Recovering financial losses due to irregular, unauthorised, fruitless and wasteful expenditure from the employees who were found to be responsible for unwanted expenditures	9	2	0	0	0	11	1,18
Conducting disciplinary hearings for all employees allegedly responsible for irregular, unauthorised, fruitless and wasteful expenditure and financial misconduct	7	4	0	0	0	11	1,36
Reporting all suspected criminal offences relating to financial misconduct to the Police	10	1	0	0	0	11	1,09
Requesting audit committees to provide oversight and monitor instances of alleged financial misconduct	7	1	1	2	0	11	1,82

4.6. Priority 6: Governance and oversight

Effective governance and oversight as a turnaround strategy aims to ensure that municipalities are responsive and accountable to the essential services needs of local communities (Eneqvist et al., 2022). Local governments are obliged to report and justify decisions regarding the manner in which public funds are being spent on service delivery objectives to their residents and oversight committees. To resolve transversal audit report findings relating to poor governance and oversight, 21 out of 24 municipalities (88%) that improved their audit outcomes for the financial year ended 30 June 2021 attributed their success to effective governance and oversight, and 102 references were noted regarding effective governance and oversight in municipalities’ Audit Action Plans that achieved improved audit outcomes. A total of 21 municipalities, classified as financially distressed on 15 May 2018, managed to improve their audit outcomes as a direct result of implementing effective governance and oversight strategies, which translated into a cumulative total of 100 audit report qualification paragraphs being resolved.

Table 7. Census responses relating to governance and oversight.

Audit Action Plan responses as identified in the content analysis	Number of responses received					Total	Mean
	(1) Strongly agree	(2) Agree	(3) Neutral	(4) Disagree	(5) Strongly disagree
The overall effectiveness of governance and oversight	7	3	1	0	0	11	1,45
Establishing effective audit committees, risk management committees and MPAC committees	11	0	0	0	0	11	1,00
Utilising a stakeholder-inclusive approach for decision-making	6	4	0	1	0	11	1,64
Applying the Batho Pele and King IV principles	7	3	0	1	0	11	1,55
Enhancing effective leadership by focusing on critical success factors	8	3	0	0	0	11	1,27
Conducting internal audits	7	3	1	0	0	11	1,45
Limiting SCM irregularities	6	5	0	0	0	11	1,45
Monitoring Municipal Infrastructure Grant expenditure	4	4	1	1	1	11	2,18
The municipal councils approve policies and standard operating procedures	7	1	3	0	0	11	1,64

All respondents strongly agreed that establishing effective audit, risk management, and municipal public accounts committees would improve audit outcomes and financial distress resolution. In addition, all respondents agreed or strongly agreed that enhancing effective leadership by focusing on critical success factors and reducing procurement irregularities would result in financial distress resolution. The mean values of all governance and oversight turnaround strategies, as reflected in Audit Action Plans, were mostly between one and two, indicating that these strategies are deemed effective.

4.7. Priority 7: Procurement and contract management

Implementing fair procurement and contract management processes as a turnaround strategy aims to ensure municipalities comply with laws and regulations and avoid irregular, unauthorised, fruitless and wasteful expenditure while procuring quality goods and services at reasonable market-related prices. To resolve audit report findings, 16 out of 24 municipalities (67%) that improved their audit outcomes for the financial year ended 30 June 2021 attributed their success to having fair procurement and contract management processes, and 39 references were noted regarding fair procurement and contract management processes in municipalities’ Audit Action Plans that achieved improved audit outcomes. A total of 16 municipalities, classified as financially distressed on 15 May 2018, managed to improve their audit outcomes as a direct result of implementing fair procurement and contract management processes, which translated into a cumulative total of 38 audit report qualification paragraphs being resolved.

Table 8. Census responses relating to procurement and contract management.

Audit Action Plan responses as identified in the content analysis	Number of responses received					Total	Mean
	(1) Strongly agree	(2) Agree	(3) Neutral	(4) Disagree	(5) Strongly disagree
The overall effectiveness of procurement and contract management	8	2	1	0	0	11	1,36
Maintaining an audit trail of all contracts and quotes submitted as part of the procurement process	9	2	0	0	0	11	1,18
Requesting potential bidders to submit a declaration on whether the State employed them	5	5	1	0	0	11	1,64
Ensuring that all potential bidders in consideration are tax compliant	8	3	0	0	0	11	1,27
Ensuring that the procurement of goods and services does not exceed market-related prices.	10	1	0	0	0	11	1,09
Use SCM compliance checklists	9	2	0	0	0	11	1,18
Reviewing all deviations for compliance, recording in the deviation register, tabling at municipal council meetings, and disclosing in annual financial statements	11	0	0	0	0	11	1,00
Training all SCM officials as well as bid specification, bid evaluation and adjudication members	11	0	0	0	0	11	1,00

All respondents strongly agreed that municipalities should firstly ensure that all deviations are reviewed for compliance, recorded in the deviation register, tabled at municipal council meetings, and disclosed in annual financial statements and then, secondly, train all supply chain officials as well as bid specification, bid evaluation and adjudication members on procurement compliance practices. Most respondents either strongly agreed or agreed that the turnaround strategies disclosed in the Audit Action Plans of municipalities that achieved improved audit outcomes are effective, with means for each strategy reflected as between one and two concerning procurement and contract management.

4.8. Priority 8: Strategic management and leadership

Implementing strategic management and leadership plans as a turnaround strategy aims to ensure municipalities have service delivery strategic objectives and can execute their strategies. To resolve audit report findings, 15 out of 24 municipalities (63%) that improved their audit outcomes for the financial year ended 30 June 2021 attributed their success to having strategic management and leadership plans to deliver essential services to their communities. In this regard, 35 references were noted regarding strategic management and leadership in municipalities’ Audit Action Plans that achieved improved audit outcomes. A total of 15 municipalities, classified as financially distressed on 15 May 2018, managed to improve their audit outcomes as a direct result of strategic management and leadership, which translated into a cumulative total of 38 audit report qualification paragraphs being resolved.

Table 9. Census responses relating to strategic management and leadership.

Audit Action Plan responses as identified in the content analysis	Number of responses received					Total	Mean
	(1) Strongly agree	(2) Agree	(3) Neutral	(4) Disagree	(5) Strongly disagree
The overall effectiveness of strategic management and leadership	9	1	1	0	0	11	1,27
Achieving political stability and ensure stability amongst senior key personnel	10	1	0	0	0	11	1,09
Establishing a Special Economic Zone as part of local economic development initiatives	4	4	3	0	0	11	1,91
Having robust community engagements	8	3	0	0	0	11	1,27
Ensuring that performance targets are well-defined, specific, and measurable	8	3	0	0	0	11	1,27
Placing municipalities under section 139 administration	2	1	6	2	0	11	2,73

All respondents strongly agreed or agreed with the effectiveness of the turnaround strategies as disclosed in the Audit Action Plans of municipalities that achieved improved audit outcomes except for ‘Establishing a Special Economic Zone as part of local economic development initiatives’ and ‘Placing municipalities under section 139 administration’. The respondents had opposing views regarding the effectiveness of section 139 administration. Section 139 administration authorises official intervention from the provincial or national government and tends to be unsuccessful. Section 139 administration usually lasts for an extended period if the municipalities under administration have incapable councillors; the proposed turnaround plans are ineffective; performance monitoring is neglected; and due to poor change management practices (Mello, 2018). In addition, not all financially distressed municipalities can opt to become Special Economic Zones, as approved by the South African parliament, as stipulated in section 20 of the Special Economic Zones Act 16 of 2014.

4.9. Priority 9: Adequate records management

The objective of adequate records management is to keep source documents and informative financial data readily accessible to enable optimal decision-making. Poor records management not only results in disclaimed audit opinions but may hinder the ability of municipalities to deliver essential services to local communities (Touray, 2021). In this regard, 20 out of 24 municipalities (83%) that improved their audit outcomes for the financial year ended 30 June 2021 attributed their success to enhanced records management. The significant impact of adequate records management on audit outcomes is evidenced by the 63 references to records management in the Audit Action Plans of municipalities, which achieved improved audit outcomes. These 63 references to adequate records management contributed to 20 municipalities reporting improved audit outcomes and, consequently, 75 audit report qualification paragraphs were resolved due to adequate records management.

Table 10 indicates that most respondents agreed that records management could be enhanced by implementing Generally Recognised Accounting Practice (GRAP) compliant fixed asset registers and establishing credible and reliable conditional grant registers. In addition, most respondents agreed that reviewing the valuation rolls for accuracy and completeness and reviewing billings reports would further enhance records management. The effectiveness of these strategies is confirmed by mean values of between one and two for all proposed turnaround strategies relating to records management, apart from prepaid metering systems. Even though prepaid meters have been credited with improving the cash flow at various municipalities through improved revenue collection, many municipalities struggle to detect or prevent illegal prepaid charging tokens from being sold in the market or prepaid meters being tampered with illegally, which results in revenue erosion (Mupeti, 2022). Resultantly some treasuries responded neutrally to the increased use of prepaid metering systems as a turnaround strategy.

Table 10. Census responses relating to adequate records management.

Audit Action Plan responses as identified in the content analysis	Number of responses received					Total	Mean
	(1) Strongly agree	(2) Agree	(3) Neutral	(4) Disagree	(5) Strongly disagree
The overall effectiveness of adequate records management	6	3	2	0	0	11	1,64
GRAP compliant fixed asset registers	6	4	1	0	0	11	1,55
Prepaid metering systems	5	1	4	1	0	11	2,09
Reviewing market values of properties in the valuation roll	5	2	3	1	0	11	2,00
Confirming the completeness of properties in the valuation roll	5	4	2	0	0	11	1,73
Reviewing monthly billing reports	4	4	3	0	0	11	1,91
Register of traffic fine books	5	2	3	1	0	11	2,00
Conditional grants registers	5	5	1	0	0	11	1,64

4.10. Priority 10: Expenditure management and fiscal discipline

Effective expenditure management as a turnaround strategy aims to ensure that payments and withdrawals from the municipality’s bank accounts are approved by the accounting officer, chief financial officer or a properly delegated official as prescribed by section 11(1) of the MFMA (RSA, 2003). Furthermore, municipalities should take reasonable care to ensure they maintain a management, accounting, and information system that recognises expenditure when it is incurred, accounts for creditors, and payments made as prescribed by section 65(2)(b) of the MFMA (RSA, 2003). To resolve audit report findings relating to poor expenditure management, 12 out of 24 municipalities (50%) that improved their audit outcomes for the financial year ended 30 June 2021 attributed their success to effective expenditure management, and 38 references were noted regarding effective expenditure management in municipalities’ Audit Action Plans that achieved improved audit outcomes. A total of 12 municipalities, classified as financially distressed on 15 May 2018, managed to improve their audit outcomes as a direct result of the implementation of expenditure management strategies, which translated into a cumulative total of 32 audit report qualification paragraphs being resolved.

Table 11. Census responses relating to effective expenditure management.

Audit Action Plan responses as identified in the content analysis	Number of responses received					Total	Mean
	(1) Strongly agree	(2) Agree	(3) Neutral	(4) Disagree	(5) Strongly disagree
The overall effectiveness of expenditure management	8	2	1	0	0	11	1,36
Utilising conditional grants only for their intended purposes	9	2	0	0	0	11	1,18
Reviewing of the grants registers	6	5	0	0	0	11	1,45
Recalculating unspent grant liabilities	4	6	1	0	0	11	1,73
Complying with SCM management rules	9	2	0	0	0	11	1,18
Confirming that payments from bank accounts are authorised	7	3	1	0	0	11	1,45
Conducting an internal audit of expenditure	7	4	0	0	0	11	1,36
Cutting back on wastage by recruiting competent and skilled employees	8	3	0	0	0	11	1,27

All respondents strongly agreed or agreed with the turnaround plans stipulated in the Audit Action Plans of municipalities that reported improved audit outcomes, except for ‘Confirming that payments from bank accounts are authorised’ and ‘Recalculating unspent grant liabilities’, where one treasury responded neutrally. Resultantly, the means for the turnaround strategies linked to expenditure management were close to one, indicating mainly ‘strongly agree’ responses.

5. Summative findings

Municipal financial distress occurs when municipalities fail to deliver essential services to the local communities or honour their financial obligations, reflected as regressions in audit outcomes reported by the AGSA. In South Africa, the regression of municipal audit outcomes cannot be attributed to a single factor or determinant. The regression in audit outcomes is a complex and multi-faceted product of various factors ranging from failed and flawed leadership, inadequate and ineffective internal controls, insufficient revenue collection and a weak ethical culture to poor asset management practices. As a result, effective and targeted turnaround strategies were developed to mitigate the determinants of financial distress.

An exploratory mixed methods design was used to identify and develop effective municipal turnaround strategies. Firstly, turnaround strategies utilised by municipalities that have achieved improved audit outcomes were identified through conducting an interpretative content analysis of municipal Audit Action Plans as disclosed in annual reports. Secondly, a quantitative census was conducted through online questionnaires. Questionnaire responses regarding the effectiveness of various turnaround strategies were obtained from all municipal oversight branches within the provincial treasuries, National Treasury and COGTA, which all have a constitutional legislative mandate to monitor and support municipalities regarding financial and administrative governance. The research findings from the interpretive content analysis and the quantitative questionnaire responses were then synthesised through methodological triangulation.

First and foremost, municipalities that improved their audit outcomes managed to become more financially sustainable by focusing on implementing effective and adequate internal controls. The importance of adequate and effective internal controls regarding safeguarding municipal assets was stressed, and municipalities should prioritise the implementation of credible asset registers. Asset verifications should also be conducted throughout the year to ensure that asset registers are constantly updated. Furthermore, divisional managers should be held accountable for the assets allocated to their divisions to ensure that assets are adequately maintained and in a working condition. Progress made in the construction of infrastructure assets should also be carefully monitored and, in this regard, municipalities must maintain credible work-in-progress registers. Once infrastructure projects have been certified as complete by engineers, architects, and project managers, then these assets should be capitalised to the fixed asset registers to ensure compliance with accounting standards.

Secondly, improved municipalities further aimed to improve their revenue streams. These municipalities succeeded by ensuring that their indigent registers are updated and that indigent residents who claim free basic services (such as water and electricity) genuinely experience poverty and lack the necessary means to pay for essential services. These municipalities also ensured that accurate meter readings were obtained for all water and electricity meters in their municipal boundaries to make sure that residents received accurate monthly accounts for the municipal services that they utilised. Residents were also enticed to settle their municipal bills promptly through the introduction of early settlement discounts. Improved municipalities also charged interest on all overdue municipal accounts.

Following revenue enhancement strategies, improved municipalities prioritised fostering an ethical organisational culture built on honesty, integrity, and due care. These municipalities actively promote ethical values and the implementation of fraud prevention strategies. Accordingly, improved municipalities use procurement and contract management compliance checklists to ensure their procurement processes are fair and compliant with legislation. These municipalities actively promoted an ethical organisational culture and prioritised whistleblower protection. Cases of alleged financial misconduct were independently investigated, and disciplinary action was taken against guilty employees. Alleged fraud and corruption cases were reported to the SAPS. It is highly recommended that financially distressed municipalities implement turnaround strategies, as identified in the top 10 priorities discussed in this study, to improve their audit outcomes and resolve their financial distress.

6. Conclusion and areas for further research

This research study highlights the importance of promptly implementing effective turnaround strategies to resolve municipal financial distress, as municipal financial distress directly impacts essential service delivery and the lives and livelihoods of local communities. Audit outcomes can be used successfully to determine the extent of the financial and operational problems that dysfunctional and financially distressed municipalities face (‘depth of the rot’). Furthermore, audit outcomes can also serve as an independent barometer to gauge the effectiveness of subsequent Audit Action Plans drafted in response to audit findings. Resultantly, effective turnaround strategies were crafted by the researchers based on the remedial actions as disclosed in the Audit Action Plans of municipalities that have achieved improved audit outcomes in this study. The effectiveness of these turnaround strategies was also confirmed by census responses received from the provincial and national treasuries and COGTA.

The practical implementation of these effective turnaround strategies can alleviate time constraints and costs during a municipal financial crisis by assisting the municipal management teams, councils, oversight bodies, the treasuries, section 139 administrators and COGTA in implementing proven and tested turnaround strategies to alleviate financial distress quickly. In addition, these turnaround strategies can also contribute to the day-to-day operational management of a municipality if they are used as a management tool to prevent a municipality in the first place from becoming financially distressed incrementally, over a prolonged period of time. Moreover, these turnaround strategies can serve as checklists for any municipality to improve the effectiveness and adequacy of their control activities, which may result in improved audit outcomes and even a reduction in external audit fees.

This study does have some limitations as it only focused on South African municipalities classified as financially distressed in 2018 and that achieved improved audit outcomes in 2021. The audit outcomes for municipalities for the 2022 financial year had not been issued to the public as at 30 May 2023, which is the cut-off date of this study, and have therefore been excluded from the research results. Consequently, the research findings will only be valid and reliable as long as the determinants of municipal financial distress remain the same. It is envisaged that the determinants of financial distress may change over time, which will have an associated impact on the effectiveness of turnaround strategies.

This exploratory research study has significantly contributed to the existing body of knowledge regarding municipal financial distress resolution in identifying effective turnaround strategies to improve municipal audit outcomes and financial viability. The significant direct benefits of turnaround research, which include the early identification of financial distress determinants, may assist declining municipalities in improving their financial affairs before they become dysfunctional and financially distressed. Furthermore, the practical application of effective turnaround strategies can lead to improved audit outcomes, an associated reduction in external audit fees, and an improved understanding of the practical challenges cash-strapped municipalities incur while attempting to execute their service delivery mandate.

Acknowledgments

This article is derived from the following Doctoral thesis:

McKenzie, M. (2023). A framework for municipal distress resolution based on audit outcomes (Doctoral thesis, University of Johannesburg, South Africa).

The research proposal and questionnaires were submitted to the University of Johannesburg’s School of Accounting’s Research Ethics Committee, which awarded an ethical clearance certificate to conduct the study.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 The MFMA database can be accessed at http://mfma.treasury.gov.za.

2 This portal can be accessed at https://lg.treasury.gov.za/ibi_apps/signin.Audit.