From the September 2011 issue of Treasury & Risk magazine

A New Spin for Audit?

Accounting regulator considers requiring public companies to switch audit firms regularly to allay a ‘lack of skepticism.’

Public Company Accounting Oversight Board Chairman James Doty blasted the accounting industry in June for a continued “disturbing lack of skepticism” in audits of public companies. Citing cases where the PCAOB found auditors permitting the backdating of major contracts and the altering of a company’s rules to help it avoid retracting an earnings announcement, Doty said the PCAOB would consider mandatory audit firm rotation. Congress looked at requiring companies to change auditors regularly—something that perhaps only one or two Fortune 500 companies do voluntarily—in the wake of Enron and WorldCom. After heavy lobbying by the accounting industry, only the rotation of partners and staff was required.

The Securities and Exchange Commission now says audit partners and concurring partners on public company audits must rotate every five years and not return to that client for five years. Team members can work on one client for seven years, but then must be off that job for two.

But Doty says PCAOB reviews continue to find “examples of seemingly unrestrained enthusiasm” among auditors.

Should the rules be tightened? Richard Hatfield, a professor at the University of Alabama, says there is little to be gained by moving from partner rotation to firm rotation. A study of the two options that he did with two other academics shows “there is growing familiarity between auditor and client over time. But the benefits of rotating firms over rotating auditors were insignificant, so firm rotation may be overkill,” Hatfield says. “It takes two to three years to get up to speed as a new partner, and maybe a year longer for a new audit firm, so the costs can outweigh the benefits.”

Steven Bainbridge, a law professor at UCLA, disagrees. “The current rule is inadequate,” he says. “Even if you rotate the auditor and break the personal relationship, you still have the institutional relationship.” It’s too easy for audit firms to lose their independence because they are allowed to perform other, non-audit services for audit clients, such as tax services, he says.

Hatfield and Bainbridge agree, though, that no change in the rules is likely any time soon.  

“The PCAOB is going to raise this issue,” Hatfield says, “but my guess is firm rotation is not going to happen.”

The limited number of big firms is one problem, Bainbridge says. “You’d have to build up the second tier of accounting firms so they could compete,” he says. “But also, given the current politics in Washington, especially in the House, there’s no way such a measure would go through.”

 

To read about the growing responsibilities of internal auditors, see Expanding Beyond SOX.

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