The Public Company Accounting Oversight Board recently held a series of three roundtables on Mandatory Auditor Rotation. PCAOB believes that questions persist about whether more can and should be done to enhance auditor independence, objectivity and professional skepticism. Proposals are being considered both within and outside the U.S. for measures such as regulation of engagement tenders, mandatory rotation, dual firm audits and “audit-only” firms.
PCAOB believes that the recent global financial crisis has tested the credibility of the audit in the public mind and that mandatory audit rotation will help ensure the Board’s goals of protecting investors and enhancing audit quality.
- Because the accounting firm is a for-profit enterprise that is paid by the company being audited, auditor independence remains subject to a significant inherent risk. Unlike many other professionals, an auditor must struggle against letting the pressures of client service interfere with his or her duty to serve the public.
- The Board has conducted annual inspections of the largest audit firms for eight years. Based on these inspections and other oversight activities, the board believes that auditors still, at times, “fail to display the necessary independence in mental attitude”.
- During these inspections, the board found that several hundred cases involved what they determined to be audit failures: “investors were relying on an opinion on the financial statements that, when issued, was not supported by sufficient appropriate evidence.”
Note: When the Board’s inspectors find audit failures, they focus firms on the need for corrective action, which in some cases has resulted in issuers restating previously issued financial statements. The Board also seeks to understand any quality control defects that underlie the audit failures it finds. Through the quality control remediation process, the Board’s findings have led to numerous and significant improvements in firm audit methodologies, processes and related quality control systems.
Critics maintain that the legislation would impose significant costs on companies without providing clear benefits and could in fact harm audit quality. Companies in a Business Roundtable Survey that had changed audit firms within the past ten years estimated that the cost of changing auditors, including additional management time and company resources, ranged from $500,000 to over $5 million.
Other objections include:
- Mandatory auditor rotation legislation would undermine the audit committee’s fundamental role of engaging, overseeing, and terminating the company’s auditor, as required by the Sarbanes-Oxley Act of 2002.
- A change in auditors would be against the company’s best interests. Mandatory rotation could require an audit committee to engage a new audit firm even when it has determined that the company’s existing firm is best able serve the company and its shareholders.
- It could take four or more years following a change in auditors for the new auditor to become sufficiently acclimated to the company’s financial reporting practices and operations. Audit quality could suffer as the new auditors and existing internal auditing staffs allocate time and resources to the transition instead of the audit.
- All of the companies responding to the survey noted that they engage one of the Big Four audit firms for auditing services. However, the Big Four firms are not interchangeable and for many large, international companies, only one of them may even be capable of adequately addressing its particular auditing needs. These companies would have difficulty finding a replacement audit firm with an absence of independence issues, sufficient geographic presence, and the necessary expertise they would need.
Business Roundtable, an association of chief executive officers of leading U.S. companies, believes that “substantial improvement in audit quality has occurred since the enactment of the Sarbanes-Oxley Act, due in part to the Board’s inspection program and regulatory efforts. Included among these efforts are the several important standards adopted by the Board in recent years.” See note above.
While proponents of mandatory audit firm rotation claim that it would make auditors more objective, critics believe that the legislation is a drastic measure that would not provide any meaningful benefits.