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Mandatory audit rotation big threat to scepticism, say academics

FORCING companies to change their auditors is in danger of putting professional scepticism in jeapordy.

That’s the conclusion of a number of US academics, who published their thoughts in the American Accounting Association’s journal The Accounting Review.

According to the study, instead of elevating auditor skepticism of clients and raising audit quality, the intended “benefit disappears and even reverses when auditors rotate. Rotation and a sceptical mindset interact to the detriment of audit effort and financial reporting quality.”

Report authors, Kendall Bowlin of the University of Mississippi, Jessen Hobson of the University of Illinois at Urbana-Champaign, and David Piercey of the University of Massachusetts Amherst, said: “Rotating auditors, aware that they will not be in a long-term relationship, will… likely perceive themselves to be less competent in evaluating the honesty or dishonesty of the [corporate] manager relative to auditors who do not rotate”.

As a result, “rotating auditors would find it difficult to garner psychological support for the probability of manager dishonesty, leading them to be less likely to choose high levels of audit effort than non-rotating auditors.”

In a further bombshell, The Effects of Auditor Rotation, Professional Skepticism, and Interactions with Managers on Audit Quality report suggests that “auditors prefer low-effort and low-cost audits, but only if managers are unlikely to choose aggressive financial reporting,” ensuring that rotation will lead to “the likelihood of audit failures with negative legal, regulatory, and business implications.”

Such a dramatic reduction in accounting vigilance is not conscious but a “subtle psychological effect about which [audit] decision-makers rarely have accurate insight”.

“Standard setters, auditors, investors, and academics should consider this effect when evaluating the relative costs and benefits of a rotation mandate,” said the report authors. “Given the significant costs associated with mandatory rotation, focusing auditors on a skeptical assessment frame without requiring mandatory rotation may be a less costly way for standard-setters to improve audit quality.”

Companies in the EU will be required, starting next June, to change accounting firms (or at least put their audit out for bids) after ten years. While the US does not currently mandate rotation of firms, it insists that accounting companies rotate the engagement partner primarily responsible for a client’s audits after five years.

The study’s findings are based on a behavioural experiment in gamesmanship involving 226 US college students who competed for payoffs through decisions that parallel those made by auditors and managers in the course of corporate audits.

And as rotating auditors lack familiarity with clients that can come with tenure, the professors’ advice newly rotated auditors to be “extra vigilant in fraud planning and procedures, perhaps focusing on best practices of high-quality fraud brainstorming and on falsifying (rather than verifying) management assertions during the audit.”

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