Partner rotation: tactical substitute

Listed companies in the UK are facing up to the implications of audit partner
rotation – the fact that their friendly senior auditor suddenly has to move on.
The Auditing Practices Board’s ethical standard (ES3), specifies that the audit
engagement partner must rotate every five years.

Gradually, but with increasing frequency since December 2004 when ES3 became
effective, audit partner rotation has been impacting on listed companies, whose
audit committees now need to plan ahead for these transitions. For non-listed
companies, where the relationship between auditor and company is often much
closer, the rotation periods are longer, but the issue can be just as critical.

Try-outs

As the first rotation cycle evolved, it became clear that there were
challenges to be addressed on both sides to make it work smoothly and
effectively.

Companies have generally found the process to be effective, welcoming a fresh
approach, new insight and ideas. But, at the same time, companies want to retain
knowledge of their legacy decisions when their audit partner rotates out. In
addition they want stability around advice and policies.

Problems have occurred when clients have not felt engaged in the process and
therefore feel they have not ‘chosen’ their new partner, or where issues they
felt had been dealt with were either revisited or overturned. In the worst case,
badly planned rotations have led to further partner changes and even re-tenders.

To avoid disruption, it is therefore important that a proper handover is
achieved and clients are given an opportunity to ensure that the chemistry will
work.

There is no one-size-fits-all process and the range of approaches depends on
the size of the company and the importance it places on the audit.

In one company, it was just two months before the year-end that the CFO, the
audit committee chair and the CEO made their decision after interviewing one of
two potential candidates.

In another case, the audit committee chair and the CFO interviewed two
candidates and made their decision a full six months before year-end, leaving
plenty of time for a proper handover between the outgoing and incoming partners.

Talking tactics

Audit firms seeking to meet the needs of large clients are identifying in
advance those partners for rotation with relevant sector, industry, and large
client handling experience; all skills which, for a large audit, may already
exist within the team.

Leading audit firms recognise the need for a matching exercise so that the
new partners earmarked to rotate in to an audit have just as good a relationship
with key individuals in the client company.

Partner rotation is being planned years ahead, giving companies the
opportunity to interview and get to know the new partners, with a clearly staged
and planned handover embedded in the process. As an example of this long-term
planning, partners can be removed from an audit team for two years before coming
back to lead the engagement.

An APB survey indicates that smaller companies are taking little account of
audit partner rotation, but for a small company the issue could arise rapidly if
a decision is made to seek a stock market listing. Suddenly the rotation period
diminishes from ten to five years, and although there is a two year extension
available in these circumstances, it can still be a shock for a company in the
midst of listing requirements to be told its trusted adviser is going to have to
change.

Companies and their auditors are still in the first cycle of audit partner
rotation, and there is a risk that companies under-estimate the impact of a
badly managed transition. But leading companies and their auditors are
developing best practice which addresses the issues, offering an agreed process
to smooth the transition.

Tim Gordon, is managing partner, Ernst & Young London Assurance