Tendering: a new signing

New signing It is a late winter morning in April 2006 when the board of
beleaguered music company Sanctuary Group finally makes the decision to change
auditors.

Over the last six months, the company has been through hell. Incumbent
auditor Baker Tilly has qualified its latest set of annual accounts, saying the
company understated losses by £15.6m in 2005.

The business has just raised £110m in rescue capital and takes the decision
to call in KPMG and make a fresh start. The company takes enormous flak for its
decision. It is accused of dumping its current auditor simply because the firm
gave a negative audit opinion.

It takes weeks for the furore and negative headlines to subside. Changing
auditors can be a traumatic experience.

Going through changes

Of course, not all auditor changes need to be, or indeed are, as dramatic as
the Sanctuary Group example, but any finance director or company who thinks that
changing an auditor is as simple as switching your electricity supplier is in
for a rude shock.

Changing auditors is a complex and, if anecdotal evidence is to be believed,
costly process; but if it is done correctly, the benefits can be significant;
bringing cost savings, offering better value for money and producing an audit of
higher quality and greater rigour.

Why change?

There are a number of reasons why firms should consider switching auditors.
Serge Corel, the finance director of support services giant Mondial UK,
describes what is perhaps the most important of these. ‘After a certain period
of time your relationship with your auditor can become a little bit too
comfortable. If it were compulsory to change auditors, it would force you to put
everything on the table and look at it with fresh pair of eyes,’ Corel says.

‘I think that when an auditor has worked with a company for a number of years
it does not always give it the same attention that it could, because it is
comfortable.’

Other, more practical reasons are when a business undergoes a rapid period of
growth through acquisition and doubles or triples in size over a short period of
time.

In such circumstances, it is highly likely that a firm has outgrown its
current auditor and needs to look to a firm with more experience of auditing
larger businesses.

Then there are questions of value for money. Are the services provided still
at the standard as when the auditor was first appointed? Are the fees charged
for audit still competitive with what other firms are offering?

Finance directors and audit committees need to work through all these
questions. Audit committees should be asking these questions and conducting a
formal review of their auditor at least once a year. It is where the process for
changing an auditor begins.

Starting off the tender

Once the decision has been taken to make a change, it is essential that
companies manage the process to make sure the right firm is hired. As companies,
particularly larger ones, change auditors so seldom (once every 48 years if you
are in the FTSE 100) there is no fixed formula for managing the process and
there are different schools of thought on how to proceed.

Steve Maslin, head of external professional affairs at Grant Thornton, likes
the idea of keeping the process focused and easy to manage. ‘There are so many
firms out there with all sorts of experience. A company needs to narrow its
search to where it thinks it will find the expertise and experience it
requires,’ he says.

‘Before a company makes any contact with firms it should draw up a shortlist
of firms that will meet its needs. It needs to identify firms with the technical
experience and right geographical spread for its purposes.’

Maslin suggests that a business should start tendering the audit only once a
group of three or four such firms has been identified. ‘I think it is better to
have a small group of candidates rather than contacting every single top 15 firm
when you know that some of them are not going to offer what is needed for the
audit,’ he says.

David Herbinet, head of public interest markets at Mazars, prefers to cast
the net as wide as possible. ‘I think it is best for a company to be open about
the fact that it is planning to change auditors and I would advise advertising
widely and inviting applications from all interested parties. From there you can
shortlist the best candidates and then go through a more formal assessment
before making you final choice,’ Herbinet says.

Take a test drive

Herbinet also likes the idea of testing out potential future auditors by
offering them other work. ‘I think a business can gain invaluable knowledge by
offering potential auditors work in other areas, such as tax or due diligence.
There is no better way to develop a practical feel for how you relate to a firm
and how you work together. If you go into a tender with this kind of knowledge
you are in a much better position to select the right auditor for your
business,’ Herbinet says.

Managing the transition

Once your new auditor has been chosen, the next step is the perhaps the most
challenging. When experts discuss the cost of switching auditors, it is the
transition they are referring to.

Like it our not, your outgoing auditor will have an understanding and insight
into your business that the new incumbent will take time to develop. This is
perhaps the main reason why many businesses find it easier to stick with their
current auditor, because even if the relationship is not as good as it could be
they dread going through the turmoil of a transition.

Herbinet says that one way to ease the pain of an auditor transition is to
make use of a joint audit. ‘The handover is a big thing that can create
additional cost and risk. Using a joint audit for a few months can smooth the
out the transition and facilitate a transfer of expertise,’ he says.

Quality assurance

Switching auditors has never been regarded as anything more than bringing in
a fresh pair of eyes to look over the company books at the very most.

The focus on competition and choice in the audit market, however, has
suddenly thrust auditor rotation into the forefront of the financial world’s
consciousness.

The practice is no longer regarded as merely good house-keeping, but rather
as a possible solution to concerns that the audit market at the top end,
particularly in the FTSE 350, is too concentrated.

As part of the Financial Reporting Council’s drive to enhance audit quality,
several recommendations have been made by its market participants group (MPG)
with respect to the appointment and re-appointment of auditors. This includes
improving information flow from and outgoing to an incoming auditor, using firms
from more than one audit network and disclosing contractual obligations to
appoint certain types of firm.

The MPG did not go so far as to demand compulsory auditor rotation, but the
measures outlined above are a clear attempt to make changing auditors easier and
more fluid. From being an issue that nobody paid attention too, audit rotation
is suddenly in fashion.

Top tips for auditor transition

1. ASSESS YOUR OPTIONS

Does you auditor provide value for money? Are the fees charged competitive?
Is the audit quality what you expect? Does your auditor still match your size
and growth? These questions need to be asked annually by the audit committee. If
the answers aren’t satisfactory it is time for a change.

2. IDENTIFY POTENTIAL REPLACEMENTS

This can involve advertising widely in order to select from as big a pool as
possible, or identifying a select group of firms that meet specific auditing
requirements.

3. TAKE A TEST DRIVE

Hiring potential auditors for tax or due diligence work can provide you with
an opportunity to see how you relate with a firm’s culture and staff –
invaluable knowledge to have when making a decision.

4. REPEAT STEP ONE

When you have drawn up a shortlist you should ask the new firms tendering for
the audit the exact same questions you asked of your outgoing auditor. Value for
money, fees, audit quality.

5. MANAGE THE HANDOVER

Ensure a smooth transition by setting out a clear handover timetable. Avoid
making a change during a busy time such as year end or results day. One way to
manage the transition is to have the two auditors working together over a
transition period in a joint audit set-up