Mandatory rotation of audit firms - ICAEW

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Mandatory rotation of audit firmsKey themes and argumentsThe results of the governmental reviews and academic research has shown that there are a numberof key themes and arguments, both for and against, mandatory rotation. These are predominantlyconcerned with the expected impact of mandatory rotation on:• Auditor objectivity and independence(i)(ii)(iii)rotation as a means of enhancing independencethe perception of objectivity and independenceauditor rotation and opinion shopping• Quality of audit work(i)(ii)(iii)(iv)rigour of the audit processincidence of audit failurescumulative knowledgeinvestment by audit firms• Cost of audits(i)(ii)(iii)competition in the audit industry‘first time through’ audit costscost of management time• Other practical considerations(i)(ii)(iii)audits of specialised industriesimpact on freedom of choicenatural occurrence of rotationConclusionsThe review of research and publications has indicated that there is a significant amount of opinionand conjecture compared to the empirical evidence and studies that exist. It should also be notedthat the research and studies in many cases had been performed or written in excess of 15 yearsago and that the extent of more recent material is limited. The most recent empirical studies arethose performed in Spain and Italy referred to above.The research carried out shows that there are arguments for and against mandatory rotation. Theperceived benefits of mandatory rotation can be summarised as (i) an improvement in audit qualitydue to the avoidance of over-familiarity with the client and its management and the opportunity fora fresh approach to the audit, (ii) a better perception of auditor independence, and (iii) the benefitsof competition. On the other hand, it is generally recognised that there are (i) additional start-upcosts affecting both the auditor and client, (ii) adverse effects on the quality of the audit due to a2
Mandatory rotation of audit firmslack of familiarity in the first and early years of the audit, (iii) a lack of incentive if the audit isabout to change hands and (iv) the signals that may be given out currently when there is a changeof auditor will be lost.As indicated above, the recent reviews in Australia and the Republic of Ireland concluded that, inbalancing the arguments, the costs of mandatory rotation outweighed the benefits. The SDAUniversita Bocconi paper suggests mechanisms for focusing on single partners, rather than onaudit firms through partner rotation, the role of the second partner, ‘peer review’ and controlscarried out by the ‘vigilance authority’, proposals that are largely, if not wholly, in place in theUK.Other considerationsAreas not considered in this paper but which are, or may be, relevant to reaching a conclusionabout the need for mandatory rotation include:• the frequency of rotation eg three years, five years or longer and, for example, the likelihoodthat the shorter the period the higher the costs of the audit and client management time.• whether there is, at least in the short term, the possibility or probability of a lack of choicewhen appointing a new firm eg (i) acting as an expert witness may rule out one or more firmsfrom being appointed and (ii) the auditor of a client’s competitor may rule that firm out fromseeking appointment.• whether problems such as those in the previous bullet point would be exacerbated if a firmcould not be re-appointed for a number of years.• the impact of any other steps which have been mooted, such as the banning of the provision ofnon-audit services to audit clients – for example, a firm providing non-audit services might notbe able or might not wish to give up that work and therefore rule itself out as a potentialauditor.• whether the issues that rotation is perceived as addressing will be better dealt with by proposalsconcerning the role of non-executive directors and audit committees.3
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Mandatory rotation of audit firms - ICAEW

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