On August 16, 2011, the PCAOB opened a 120 day comment period on the concept release in which it proposes mandatory auditor rotation. Relevant information about the matter are included in Docket 37, “Concept Release on Auditor Independence and Audit Firm Rotation.”
With two weeks left in the comment period, the only audit firm to submit a comment letter is Ernst & Young. Expect KPMG, PWC, Deloitte, McGladrey, Grant Thornton and BDO to submit their comments soon. I’m certain that each letter will be similar in message to that of Ernst & Young.,
Ernst & Young submitted its letter on November 18, about four weeks before the December 14, 2011, deadline. In general E&Y’s message is that auditors are sufficiently skeptical of management’s assertions that in general, financial reporting is a benefit to investors. Because the system works at the current time, no changes are needed. In any case, E&Y does not like the idea of mandatory rotation.
Mandatory audit firm rotation, in our view, is not a necessary or constructive means to promote
auditor skepticism. There is no evidence that we are aware of suggesting that mandatory firm rotation will improve audit quality. Moreover, there are many identifiable and known downsides to such a policy with little to no certain benefit. A mandatory audit firm rotation model would not only give rise to substantial costs and disruptions, but also would, we believe, impair audit quality, undermine sound corporate governance, and detract from the ability to maintain a robust accounting profession —all to the ultimate disadvantage of the interests of investors. We believe the mandatory retendering approach suffers from the same or even greater disadvantages.
There are five reasons why E&Y “… believe[s] mandatory firm rotation would harm corporate governance and investor interests and the ability to maintain a robust, highly skilled independent accounting profession performing high-quality audits.”
- “Negative effect on shareholders, corporate governance and audit committees.” E&Y says this would result from meddling with the duties of the audit committee.
- “Negative effect on auditor’s knowledge of the company being audited and the effectiveness of audits.” E&Y argues that long auditor tenures are beneficial, not detrimental.
- “Negative effect on public companies and the interests of their shareholders.” E&Y argues that a new auditor’s efforts would be inefficient (and therefore more costly) and less effective (thereby increasing audit failure risk).
- “Negative effect on the audit profession.” E&Y says that there would be increased costs to auditor and audit team relocation once a five-year engagement ends. In addition, the firm’s focus would shift away from delivering quality audits to a focus on marketing.
- “Effect on audit fees.” E&Y thinks audit fees are bound to increase. Since it foresees no advantages to auditor rotation, it is a negative NPV proposition.
There you have it. E&Y didn’t say anything controversial.
I can’t wait to read what the other firms have to say.
Debit and credit – – David Albrecht
I think E&Y is mostly correct in what they have said. Item 1 (negative effect on s/h, governance etc) seems a bit self serving to me. I don’t believe that the proposal is very negative in these areas, but agree that audit fees will have to go up somewhat. Item 2 is certainly true. The longer you work on a client, the more you know about it. Item 3 is correct that it would be less efficient, but I don’t think it would be less effective. Auditors have to do enough work to sign off on the opinion no matter how much it costs. Item 4 is certainly correct. If you have a large audit that falls off in year 5, but don’t get a new large audit in year 6, then you will have to lay people off and won’t neccessarily be able to re-hire them in year 7 if then you do get a big audit. It will make going into public accounting less desirable for top accounting students. And it will force accounting firms to spend more on marketing. That is probably not all bad, but it is more expensive and either has to come out of partners pockets (thus making public accounting a less desirable profession) or be passed on to clients. Item 5 is definitely true. Fees will go up. But it is not clear how much they will go up. If only a few percent, maybe its worth it. If by 10 or more percent probably not.
Ultimately, I think there best point is that there is no empirical evidence that a auditor rotation improves the quality of audits. So if there is no evidence that quality will go up, and there is a strong belief that costs will go up (though also no empirical evidence), then why force auditor rotation.
(Note: I worked in public accounting for 9 years, then in industry for 18).