Mandatory rotation of audit firms - ICAEW

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Mandatory rotation of audit firmsThe key empirical study quantifying the increase in cost was performed by Ridyard and Bolle(1991) in which a survey of European audit firms revealed that start-up costs were estimated at15% of all costs for a new client in which the audit firm had industry experience and 25% whenthe audit firm had no industry experience.All these first time through costs are initially incurred by the audit firm, but many researchers orcommentators believe that it is likely that these costs would result in higher audit fees over thelonger term.4.3.3 Cost of management timeAs well as the explicit additional costs incurred by audit firms likely leading to an increase in auditfees, certain researchers also have considered the implicit cost of the management time employedin selecting new auditors and familiarising them with the company’s business, operations andsystems.Not only does the auditor change process incur costs as outlined above, it is also argued to behighly disruptive to business operations.Empirical evidence of this increased cost to management is limited and these assertions are largelybased upon an understanding of the audit change process. However the research by SDAUniversita Bocconi found that the client has an increased burden on ‘managers, personnel andinternal auditors’ in supplying necessary information about ‘corporate governance, internal controlsystems, organisational structure, market relations and so on’. This concern over increased costs tomanagement has also been expressed in a significant number of publications including the RamsayReport (2001), AICPA Statement of Position Regarding Mandatory Rotation of Audit Firms(1992) and review of ‘Economic Consequences of Mandatory Rotation’ by Arrunada and Paz-Ares(1995).Further, the awareness of businesses of the disruption caused by auditor change are objectivelyshown in a questionnaire based research by Beattie and Fearnley (1995) in which 35% ofbusinesses considering change due to dissatisfaction with fees did not change auditors to avoiddisruption.4.4 Other practical considerations4.4.1 Audits of specialised industriesSpecialised industries have been argued to be especially vulnerable to a reduction in audit qualitydue to mandatory rotation (Petty and Cuganesan, 1996). This is due to the fact that only a smallnumber of audit firms may have partners and staff with specialised knowledge of these industriesand a business may be forced to rotate to an auditor without this specialism.Arrunada and Paz-Ares (1995) have further developed this argument by pointing out that auditfirms will have little incentive to invest in specialised industries with few clients, as they will notbe able to capture an adequate portion of the market to recover the investment. The authorsunderline the significance of this point by quoting empirical studies that confirm the value ofspecialised experience (Ashton, 1991; Eichenseher and Danos, 1981).The issue of lack of investment in specialised industries is being investigated as part of theongoing research at the University of Bocconi in Italy (2002).20
Mandatory rotation of audit firms4.4.2 Impact on freedom of choiceAlthough not necessarily an independence issue or a quality issue, there is a view that mandatoryrotation would deny the client the opportunity to select their own auditors (Irish Review Group(2001), The Ramsay report (2001))4.4.3 Natural occurrence of rotationThe AICPA 1992 Statement of Position pointed out that a review of the executive management ofthe largest 100 industrial concerns listed in the 1991 Fortune 500 and of the 50 largest bankholding companies at 31 December 1990, showed that turnover of staff was high enough tocontinually renew the auditor-management relationship is continually renewed even withoutauditor rotation.21
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Mandatory rotation of audit firms - ICAEW

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