Auditor rotation- new balls please

The key findings of the Financial Director survey show the UK’s FDs are emphatically in favour of seeing their auditors rotated on a mandatory basis in the wake of the collapse of Enron.

Almost 800 FDs responded to the survey with 57% – a clear majority – arguing that auditors should be compelled to change every four to seven years.

Despite that principled view barely a third of the FDs believed that regulators here or in the USA will take the necessary action to bring about the change. More than half believe that ‘best practice’ will be the driver of change.

Enron on the minds of FDs
Results show that the scandal surrounding Enron and its auditors Andersen has weighed heavily on the minds of FDs, who have also indicated scepticism about the audit process in previous FD surveys.

There were strong reactions among the FDs, who responded on a no name basis. One said: ‘I think that there is an increasing risk that all listed companies will be forced to rotate. Every five years is probably the best period. The main drawback will be in year five, as any firm will be sensitive to a new firm coming in and being critical. An audit in that year will probably be hell!’

Not all were convinced of the argument for mandatory rotation.

‘You probably need to rotate the audit partner, rather than the audit firm, every four years to ensure a new viewpoint is introduced on a regular basis. This happened to us recently and was refreshing,’ said one.

Another added: ‘I do not know whether Andersen failed to operate the right level of skill and care when auditing the books of Enron, but I see no case for introducing draconian measures that force rotation of auditors. It would offer no guarantee that another Enron could not happen.’

But the survey result showed that there is much less appetite for a ban on non-audit work being given to the group auditors, with almost two-thirds opposing the idea, and just over one- third supporting it.

Again, reactions were passionate. ‘I believe it is an insult to the intelligence of management to suggest they cannot select advisers on their own criteria,’ one respondent told the survey.

On the other hand there were FDs who were strongly in favour of a separation of the two kinds of work. ‘I believe in auditor independence and any consultancy or tax engagement can destroy this independence,’ said one while another said he would ‘draw a distinction between tax work, which is acceptable, and large consulting contracts, which are not’.

Reduction in non-audit work
However, more than half expect best practice to result in a reduction in the amount of non-audit work awarded to auditors.

‘The age of using audit as a loss leader for value-added services is over. In future, investors will want to see real scrutiny of company accounts and those companies which are not seen to be providing it will suffer.’

Those who answered the survey were quite clear that many of the questions in the survey deserved different answers, according to whether publicly-quoted companies or owner-managed businesses were under discussion.

‘The whole idea of auditor independence is of much greater importance when they are reporting to shareholders who do not form part of the management team. When auditing private companies, cross-selling of consultancy work etc. can bring benefits without the same risks that lack of auditor independence could bring to a public company.’

FDs were also asked whether auditors should do more to ensure there is no fraud or other irregularity in the company accounts. The results show they are evenly split as to whether they should pay more for such a service.

Fraud is an issue for directors
In a typical comment on the role of auditors, one FD said: ‘At the end of the day, company directors are responsible for preparation. Ensuring no material fraud is contained in the accounts is an issue for the directors. The auditor is not the main problem here,’

Others felt fee arrangements should ensure auditors bear some element of risk and ‘take responsibility for their errors’.

Some wanted a ‘back to basics’ approach from auditors.

‘Auditors used to check that things were right. Now they look at trends and pretend to be business advisers. They should get back to basics,’ said one.

Views also edged towards the downright sceptical.

Companies, according to one FD, ‘do not get good value for money from their audits. Auditors spend far too long form-filling to ensure their PI (insurance) requirements are met. Critical systems reviews are rare – often audit staff are so inexperienced they wouldn’t spot a fraud if it bit them. The pressure on audit managers is too great to bring an audit home “within fee budget” that they cannot spend quality time with the client. I would be happy to pay higher audit fees if I felt I was getting value added.’

More criticism was piled on the audit process. ‘The speed with which auditors sign-off after the year-end indicates to me that they are relying heavily on representations. I can’t be alone in thinking that use of the phrases “off balance-sheet” and “special purpose entity” state the users’ intention to mislead.’

To evaluate the impact of the scandal on Andersen, FDs were asked whether the Enron affair would affect their choice of auditor were they to put their audit out to tender. Andersen may take some comfort from the fact that, even with the press still laden with the scandal, more than 40% would be prepared to give Andersen the benefit of the doubt. Nevertheless, more than three-quarters of respondents expect Andersen’s corporate clients here and in the US to seriously consider switching firms.

Some FDs see the scandal as an assurance that Andersen will now have to provide good work. ‘Using Andersen at the moment would be like taking a flight immediately after 11 September: because of heightened security it made it much safer. The whole firm will be so aware of the Enron problem that they are very unlikely to allow any questionable transactions,’ said one supportive FD.

The Enron effect
Others said Enron had blighted Andersen’s opportunities.

Comments were rife with pessimism. ‘We are on the point of moving to a Big Five firm across Europe but we excluded Andersen from the list. The publicity did not help their cause.’

‘It is difficult to see how Andersen’s reputation can be saved and it will lose some business as a result,’ said another.

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