Manifesto: should we rotate the auditors?

Ted Awty

Last year it was foot-and-mouth, last month the railways. The current preoccupation of the pundits is the Enron debacle. Top of their instant solutions list for this one is the old chestnut of mandatory rotation of auditors.

Firms that get too close to their clients eventually lose their independence, objectivity and scepticism and become complacent, they say. They argue rotation stimulates the auditor’s courage and independence, because there are no expectations of a long-term relationship.

However superficially attractive, this question has been addressed and rejected many times across Europe.

Introducing new auditors is costly to the client, as the team builds detailed knowledge of the client, its business and the key issues in its financial statements.

The accumulated cumulative knowledge and experience of long-term complex issues Ñ exactly where the auditor’s expertise is needed most is lost on rotation.The process of selection is time-consuming and costly, for all involved. In some industries, with a small number of corporates, rotation can discourage auditors from specialising to the required depth thus limiting the choice of available alternatives.

But these corporate-based arguments miss the most fundamental point. It is the attitude of independence, objectivity and professional scepticism of individuals in the audit team, not the firm itself, which determines the conduct of the audit and quality of opinion. These individuals provide the accumulated organisational knowledge of a client and its industry. Regular introduction of fresh people to the relationship through the rotation of audit partners, managers and staff, provides a better solution than swapping among a small pool of firms.

Review of the audit relationship is the duty of the client’s audit committee. This will expose any impairment of the audit team’s independence or concerns over the underlying quality which would call for a change in auditors. If lessons are to be drawn from the small number of recent high-profile corporate failures, there are far more important issues than auditor rotation. These include the duties of directors, independent regulation and peer review of audit firms, the complexity of financial reporting and the ‘rules versus principles’ debate between US GAAP and IASs.

As ever, a superficially attractive solution reveals more disadvantages than advantages. Mandatory rotation is not thesilver bullet to deal with all concerns surrounding auditor independence. Good hard thinking is required from all stakeholders involved in the audit process.

Ted Awty is the head of audit at KPMG
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Peter WilliamsOf all the problems facing the auditing profession at the moment, the idea of rotation of audit of major listed companies doesnåt strike me as the biggest threat.

Indeed it is tempting to urge auditors to welcome the idea of a thoroughly independent inquiry to see if such a move will deal with many of the perceived problems of independence.

Have those calling for or contemplating rotation thought through all the implications? For a start, rotation happens now. The only difference is rotation is currently market or client-led, whereas presumably in the world of mandatory rotation someone like Sir Howard Davies at the Financial Services Authority or Harvey Pitt at the Securities and Exchange Commission will have the switching power.

If the shape of the profession remains unaltered, then the audit of the worldås largest companies will remain in the hands of the Big Five. If that is the case then it strikes me that passing audit around between them will achieve very little and rotation will quickly degenerate into buggins turn.

The biggest problem is that as the audit passes from PwC to KPMG to Ernst & Young and so on, the critics of the profession who are presently advocating rotation will soon feel they have not achieved their aim.

Once used to the idea, such planned switching may even suit the audit firms. Forward planning will become easier: every few years you’re out. Except this is no game of The Weakest Link.

Instead of the walk of shame it’s a walk into the next plum audit assignment. The fierce rivalry that exists between firms at the moment could well subside, surely not a welcome side effect to those who criticise the big firms.

To the outsider there may well be a logic in wanting to introduce greater competition into the world of auditing the world’s biggest companies. They shouldn’t mistake rotation for competition.

If they want greater competition, they have to think of some ways in which new players could enter a market where barriers are set high. But that is a completely different idea from a game of musical chairs where none of the chairs is ever taken away. In other words, auditors should not get in a spin about the idea of rotation.

Peter Williams is a freelance writer
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