Let's put the focus on the correct quality
The PCAOB is receiving comments on its proposal to require auditor rotation. Most of the comments are against auditor rotation. Written by corporate executives, CFOs, audit committees and auditors, the claim is made that a change in auditor will result in lower quality audits for at least three years.
Three years is selected because it is alleged that it will take at least that long for a new audit firm to get up to speed (that’s an insult to the successor audit firm). And, if the company had previously employed the best auditor, then being forced to change auditor will result in a permanent decrease in audit quality.
As a small investor, I am insulted. The issue is not about audit quality. It is about the quality of the audit opinion. It is almost a certainty that in most cases, a change in auditor will result in a higher quality opinion. At least, it it won’t produce a lower quality opinion.
How is that? Currently, the large audit firms that audit the largest public companies have little credibility to produce believable, trustworthy and valuable audit opinions. A sizable number of investors don’t even read the opinion, passing over it because so many audit scandals have destroyed faith in the auditor. And many more investors find the audit opinion to have hardly any information content, and hence, hardly any value.
I would expect a large audit firm to produce a high quality audit. Let’s say that the fee for a large audit totals $40 million USD. If 80% is spent on labor and related expenses, then I would hope that $32 million USD would be sufficient to test everything that needs to be tested.
However, in today’s world of big audit, there is frequently a disconnect between data from the audit and the opinion that is eventually rendered.
And audit opinion quality has too often sucked. Big time. How could it get any worse?
That’s what auditor rotation is all about. And if big audit and big business are successful in beating down this reform movement in all its symbolic glory, then big audit and big business will have won a battle but lost the war. It is a significant possibility that defeating investors on this issue will drive them permanently from the market. Then we all will be losers.
Debit and credit – - David Albrecht
David,
This is not a simple issue to be sure, but I find your assertions unconvincing. You seem to suggest that auditor rotation alone will produce higher quality opinions, while not improving the quality of the audit itself. In other words, you focus entirely on the opinion, not on any results of the audit.
Let me suggest another viewpoint. A good audit, done with deep understanding by the audit firm of the client, and with a relationship of respect between client and auditor, will produce changes in the client. Some of those changes may even affect the granting of the opinion.
Those kinds of changes don’t come about from a distant auditor-client relationship that consists solely of dry, tick-box processes executed by strangers. In fact, that kind of relationship often serves to encourage less candor, not more, between auditor and client.
To focus only on the opinion, and to ignore any changes in underlying management and accounting processes that might have come about by the audit itself, is to view audits in a narrow way.
Is the point to grade on the curve, and point out the X% of companies who failed a test? Or is it to get all companies to comply with a standard of performance?
If the FDA found 100% compliance in food processing plants, would that mean the surveys were tainted? Or might it mean that we had achieved a consistent level of quality? I think you have to at least consider the latter interpretation.