Is the PCAOB’s Consideration of Mandatory Auditor Rotation Dead?

by Harry Emerick 19. July 2012 11:00

The Public Company Accounting Oversight Board (PCAOB or Board) issued Concept Release on Auditor Independence and Audit Firm Rotation.  The Board recently extended the comment period on the release through July 28, 2012.  Apparently the rumors of demise are greatly exaggerated.  Then again, the idea may in fact be a useful, controversial tool for the PCAOB to engage debates on other ways to improve audit quality. 

The origin of the Concept Release appears to be with the investor community and other “users” of audits who, however, are not directly involved in the audit process.  Perhaps this explains why the idea of mandatory auditor rotation is such an orphan idea with no credible studies or research supporting that it would improve audit quality and a host of opponents in both government and the private sector.

According to an article in Compliance Week, the U.S. House of Representatives’ (House) Financial Services Committee has threatened the Board with legislation to bar auditor rotation.  The House Banking Committee ordered the PCAOB Chairman to give up the idea.  The U.S. GAO has studied the idea of mandatory auditor rotation and concluded that the idea was not advisable and that it would significantly increase the cost of public company audits. 

The AICPA issued a well thought-out comment letter on the Concept Release in which they pointed to a number of arguments against mandatory auditor rotation: 

  • No credible research exists demonstrating that firm rotation would significantly improve audit quality;
  • Numerous studies indicate that audit quality increases with audit firm tenure;
  • Studies indicate fraudulent financial reporting is more likely to occur in the first three years of the auditor tenure;
  • The disadvantages would be compounded in multi-national companies in which multiple international auditor rotation requirements (currently being considered) could result in multiple audit firms using varying auditing methodologies on a single, given audit---essentially a forced audit quality nightmare;
  • Mandatory rotation undermines the role of the audit committee as the gatekeeper to select the audit firm that can perform the highest quality audit in the most efficient and effective manner;

All right – enough piling on. In the interests of engaging debates, what are some fertile ideas to improve audit quality aside from mandatory auditor rotation?  We auditors at Urish Popeck suggest:

  • More focused auditor education and CPE requirements relating to known drivers of audit quality such as independence, objectivity, professional skepticism, industry knowledge, audit methodologies, complex accounting and auditing issues and areas, workpaper and financial statement review and other quality control measures;
  • Specific CPE requirements and standards for certain industry specializations (health care, banking and other regulated industries) similar to the current yellow book standards for auditors;
  • Measures and standards to improve audit committee accounting, auditing and financial reporting competence, “360” communication and independence of Company management;
  • More emphasis and structure to the audit committee’s role in monitoring audit quality for both internal and external audits and perhaps ensuring coordination of the two without overlap;
  • Better definition to the role of the internal audit function reporting to and being the daily eyes and ears of the audit committee;
  • A requirement that absent an internal audit function, the Audit Committee have at least a minimal (at least one) full time seasoned auditing staff to serve as their daily eyes and ears;
  • Establish separate, additional, auditing and audit committee standards (clearly acknowledging a dual standard based upon the risks) for public companies that are “too big to fail”;
  • Finally, with a nod to auditor rotation, better definition to the Audit Committee’s role as the gatekeeper in hiring and firing auditors and a presumption that they evaluate changing auditors on a periodic basis (ideally long term---say every 10 years) with it being acceptable to retain the current auditors if the committee concludes the auditors continue to do quality work. 

We auditors at Urish Popeck are opposed to mandatory auditor rotation and take very seriously the challenge of delivering quality audit work tailored to our clients’ risks and needs, in an efficient and cost effective manner. With the PCAOB’s decision upcoming, please stay tuned to Urish Popeck’s blog for updates on mandatory auditor rotation or follow Urish Popeck on Twitter for breaking news. 

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Categories: Advisory

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