AICPA Opposed to Mandatory Audit Firm Rotation

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The PCAOB released a proposal requiring mandatory rotation of audit firms (as opposed to just audit partners) for public companies which is getting a lot of feedback in advance of the public roundtable meeting in March 2012. The PCAOB’s argument is that rotation may increase auditor independence by decreasing reliance on specific client fees. There is no requirement of any rotation for non-profit or private company sectors but many organizations look to the standards set for public companies as guidance for best practices. Many of the requirements of a public company are not feasible for exempt organizations or private companies but in the rush to embrace Sarbannes-Oxley a number of organizations instituted one of the requirements that seemed the easiest to follow: auditor rotation. In actual practice, this could do more harm than good, which is the main point behind the growing opposition to the PCAOB’s proposal.

A number of professional associations have come out in strong opposition to this proposal, including the Institute of Internal Auditors, the AICPA, the New York State Society of CPAs, and the Virginia Society of CPAs, among others. The AICPA has also submitted its opinion of opposition to audit firm rotation to the IRS.

According to WCSCPA, the IRS themselves concluded that the costs and potential problems outweighed the potential benefits for nonprofits which is why the question of audit rotation was withdrawn from the Form 990 governance questions.

The main points in opposition to mandatory audit firm rotation include the following:

From the AICPA letter to the IRS:

  • “There is a link between auditor tenure and auditor competence – studies have shown that audit failures are 3 times more likely in the first two years of an audit engagement.”
  • “Mandatory audit firm rotation can also have a perverse effect on audit quality as it reduces the audit firm’s incentive to improve quality.”
  • “the proposal is particularly ill-suited to the NPO community because, in many areas of the country, there are simply not enough audit firms with NPO experience…”
  • The costs of rotation exceed the potential benefits. Audit costs the first year include the steep learning curve.

From the AICPA letter to the PCAOB:

  • Rotation may limit institutional knowledge and industry specialization that increases during work with a client.
  • Implementing mandatory rotation may unintentionally undermine the role of the audit committee by preventing the selection and retention of the most qualified firm.
  • Research indicates “audit quality actually increases with audit firm tenure…there is a significant learning process for the auditor, i.e., an auditor needs time to get to know sufficiently well the business of the client and, consequently, audit quality tends to increase over time.”
  • “Institutional knowledge and experience are crucial to a high quality audit and increases over time.”
  • According to the Government Accountability Office, “in the first year, mandatory firm rotation could result in increased audit costs of more than 20%.”

AICPA officials have said research indicates that mandatory audit firm rotation has the unintended consequence of increasing the propensity for fraud according to Rubino & McGeehin.

From the IIA letter to the PCAOB:

  • There is no clear evidence that mandatory rotation will enhance auditor independence.
  • Audit firm rotation would inhibit the assistance that internal audit can provide to outside auditors by interfering with the development of internal and external audit synergy.

The NYSSCPA points to the fact that many firms devote years in developing their positions of leadership in their markets and “finding suitable replacements would present audit committees with undue difficulties and potentially insurmountable problems as a potential successor firms could be scarce.” The NYSSCPA also agrees with the growing consensus that the cost/benefit analysis is not in favor of rotation.

From the Hawaii Alliance of Nonprofit Organizations comes the point “it’s a myth which has no support from the research or the regulatory bodies…a good auditor is hard to find, and once they have taken the time to learn your business, which typically takes about three audit cycles, it would be foolish to switch auditors, unless you have something to hide. You wouldn’t change your legal counsel or your executive director or your CFO every three years,” says James Hasselman, CPA “the only time you should change your auditor is when you are not getting good services, [or] when your auditor does not understand your business or industry…”

Ultimately, it seems the best guidance would be to make audit decisions based on what’s right for your organization as opposed to taking on rules for a very different industry and getting random results.

About Carol Barnard

Carol Barnard has written 199 post in this blog.

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