Does the Rotation of Auditors Improve the Quality of Auditing - Essay Example

? Does the rotation of auditors improve the quality of auditing? Introduction: Recent corporate failures, global economic crisis and the recent global banking crisis have made many governments around the world to introduce auditor’s rotation as mandatory, mainly to achieve auditor’s independence and to increase the external audit’s ambit and quality, to minimise their market concentration and to minimise the peril of fraud. Further, it is expected that the mandatory auditor rotation will result in higher audit quality, results in auditor’s independence, a downturn in audit costs and to lessen big audit firms market concentration. It is to be noted, in the recent past, Italy, India and Brazil have made the auditor rotation as mandatory whereas Canada and Spain have revoked their earlier decision, whether to make auditor rotation as mandatory. Australia is collecting more empirical data on the subject to make a decision to make it mandatory or not. India recently envisaged that audit partner should be rotated compulsorily and there should be atleast 50% rotation of the audit team compulsorily. For listed companies, auditor rotation is made compulsory in Portugal on an explain or comply basis. Public companies in Slovenia are given a choice to choose either to rotate partner or audit firm rotation once in five years. Audit partner rotation instead of audit firm rotation is made mandatory by countries like Netherlands, Germany and UK. Administrators in Germany, US and UK are of the view that possible advantages of compulsory rotation of auditors do not overshadow its perils and costs. (Ewelt-Knauer, Gold & Pott 2012:5) The research study will analyse in detail whether the rotation of auditors improves the quality of auditing or not with available literature evidence on the subject. What is the problem? The main issue is whether mandatory auditor rotation will result in enhancing the auditor’s independence or not and does the rotation of auditors improve the quality of auditing? How are you going to answer it? For answering the research question, this research essay will make use of secondary research evidence available on the subject like information available in the books, journals, previous empirical studies, etc. Coherent development of arguments: According to Lee Metcalf report, it was a great concern that big audit firms lacked independence, which has created doubt about their certification of financial data to public and investors. Further, long association of an auditor and a company may result in aligning with company’s management and hence, the independence of such an auditor has become really doubtful. Thus, Metcalf report recommended to the Congress of USA to introduce mandatory auditor rotation to minimise the corporate frauds. (PCAOB 2011:10). What is audit quality? Some study suggests that there is a direct association between audit quality and audit tenure. According to Simon & France (1988), long run audit tenures enhance the audit quality, mainly because of auditee-specific knowledge benefited by the auditors over the time. Daly, Hamilton and Strokes (2003) investigated whether audit partner rotation is linked with transformation in audit quality and found that a partner change or rotation is not poignantly linked with a change in the audit opinion released. Further, rotation of a partner does not result in more chances to issue a qualified audit report. Thus, this study report suggests either the rotation of the firm or a partner does not have required audit quality advantages that supporters vehemently argue. (Campbell & Houghton 2005:78). Vanstraelen (2000) found that long-term audit tenures resulted in high audit quality. Deis & Giroux (1992) found that long run audit tenure lessens the adherence with GAAS. Copley & Doucet (1993) found the audit tenure, and the audit firm association has a direct effect on audit quality. Knapp (1991) exposed that audit committee members observed that long audit tenure erodes audit report quality and their independence. Dopuch, King and Schwartz (2001) exposed that statutory auditor rotation requirements lessened auditor’s enthusiasm to issue prejudiced reports in favour of company. Hussey & Lan (2001) found that the requirement that auditor is to be appointed on a yearly basis did enhance the auditor’s independence. (Miettinen 2008:35). What is the issue that the ‘rotation of auditors’ is addressing? Rotation of auditors will enhance the auditor independence as the audit firms are not compelled or fascinated by compromises, personal relationship with the management of the company. A new auditor will bring a fresh set of visions and has the chance to ring the alarm that accounting rules have been bypassed or overlooked by the earlier audit firm. According to Tan (1995), a new auditor is able to recognise issues, vary their judgments and can raise issues up for deliberations when they are not personally perpetrated to a prior conclusion. (Ball et al, 2012) What is meant by the ‘rotation of auditors’? Compulsory audit firm rotation was regarded by many legislators around the world after Enrol scandal as a mean to enhance independence of the auditor. The Sarbanes –Oxley Act (SOX) in USA requires audit partners’ rotation instead of an audit firm to minimise the corporate frauds. Jennings et al. (2006) offer corroboration that the expected auditor independence is achieved by rotation of audit firms and results in vibrant corporate governance. (Jennings et al 2006:253). What are the advantages? The main advantage of auditor rotation is the attainment of auditor independence, which will result in higher audit quality. A long association of an auditor may result in close relationship between client and auditor, probably resulting in inadequate audit procedures and excessive banking upon stagnant audit schedules and more reliance on earlier year financial results. It is advocated that by shortening the auditor duration with a company, auditor will be compelled to pay more attention to the fiscal details and be more realistic in their audit approach. Many past empirical studies have proved that wherever there is auditor rotation is in force, there will be more auditor independence. Some analytical studies have corroborated that there exist positive impact on independence of the auditor wherever there is auditor rotation, particularly in cases where big audit firms have large market share and when there a requirement for expert audit services. Supporters argue that rotation of auditors enhances the overall impacts on audit quality by minimising the quantum of audit failures, and enhancing the dependability of financial data. Supporters argue that investors are ready to bear the extra cost to be incurred due to auditor rotation, if it will end up high quality of audit reports. The statutory auditor rotation will help the smaller audit firms or entry level auditors to have the chance to get audit of the best companies. What are the disadvantages? The short engagement of an auditor may slow down the smooth relationship between management and auditor. As the auditors are frequently required to regain their start-up costs, they might be more compassionate with the company’s management and may not like to give a negative opinion on the client as contrasted to an audit firm which has a long term association with the company. One empirical study reveals that clients with the short-run auditor term are of the opinion that they can pressurise their stand in case of a divergence of opinion. There is a concern that statutory audit rotation may increase the peril of audit failure since auditors are not able to foster a very deep knowledge about their client as they would need more time to comprehend it. Moreover, it is criticised that audit firms need to spend additional set-up costs as a new auditor has to comprehend the business model of his client. Further, in case of auditor rotation, it may increase the audit expenses of a company up to 20%. Many past empirical studies have suggested that short-run audit services may also usher negative impacts on auditor independence, especially in the terminal periods of their appointment. Some empirical studies have found that the tenure is not at all concerned with the audit quality and that the audit quality is especially down in the initial years of auditor appointment, corroborating that statutory auditor rotation could have negative impacts. The chance of issuing a non-qualified audit report is closely associated with the tenure of auditor-client bond. Further, the past experience from South Korea and Italy advocate that auditor rotation might result in lesser market competition rather than aggressive competition in the market. Is there academic evidence for its advantages or disadvantages? There is a convincing corroboration in academic research that rotation of auditor will prejudice the expertise of an auditor. The concept paper released by the Public Company Accounting Oversight Board (PCAOB) demonstrates that the auditor is most susceptible to detect frauds, particularly in new assignments. St.Pieree and Anderson (1984) also concurred the above. Meyers et al (2003) study demonstrated that eminence of accounting data is linked with an increase in years of audit tenure. As per Craswell et al. (1995), statutory auditor rotation could destabilise enlargement of expertise and may destabilise the quality of the audit. (Jamal 2010). Conclusion: According to Ball et al (2010), rotation of audit firms does not advance independence of auditors. This is because as the auditor is being appointed by audit committees where there is an intensive involvement of management in deciding the constituents of such audit committees. The probable advantages of rotation of auditors appear likely to be overweighed by the impairment linked with the auditor appointment process. More lowballing and opinion shopping is being achieved by the rotation of auditors as it prejudices the audit quality and on its reliance. Rotation of auditors really disheartens acknowledgement of audit proficiency. As the audit committee is itself is being appointed by the management, enhancing the audit quality through auditor rotation may not result in desired result of enhancing auditor independence. Thus, auditor rotation cannot be viable panaceas for the ailment of corporate frauds but to have more stringent accounting standards, which will definitely improve the reliability of financial reports which in-turn enhance the audit quality. (Ball et al 2010). It is to be noted that the quality of the audit is assessed by the independence of the audit and auditor rotation may achieve the auditor independence but it cannot be said that auditor rotation alone can assure auditor independence, and there are other factors, which influence auditor’s independence like their excellence in accounting education , eminence of accounting standards , expertise and experience of auditors , the composition of audit committees , the structure of corporate governance and audit environments. Thus, endeavours to cherish some of these preferred qualities of audit often degrade others, thereby making a faultless audit a utopian dream. Therefore, public policy should be designed in such a manner to ensure the best audit quality and not to preoccupy on any detachment of the essentials of the audit quality. Thus, the available corroboration helps to conclude that despite its obvious glamour, making auditor rotation as mandatory would be definitely a bad accounting policy. Such recommendation may destabilise the independence of the auditor, can deteriorate expertise of auditors and destabilise the corporate governance process itself. (Jamal 2012). List of References Ball TC , Glover J , Jarnal K , Kassan R , Kouri K, Paterson B, Radhakrishnan S & Sunder Shyam. (2012). Audit Firm Rotation: A Joint Academic and Practitioner Perspective. [online] available from http://faculty.som.yale.edu/shyamsunder/Research/Accounting%20and%20Control/Presentations%20and%20Working%20Papers/AuditFirmRotation/Audit_Firm_Rotation_%20Dec30_Jamal.pdf [accessed 24 October 2013] Campbell, T & Houghton, KA. (2005). Ethics and Auditing. Sydney: EPress. Ewelt-Knauer, Gold & Pott.(2012). What We Know About Mandatory Audit Firm Rotation? [online] available from < http://icas.org.uk/mafr/>[accessed 24 October 2013] Jamal, K. (2012) Reviewing Rotation. [online] available from [accessed 24 October 2013] Jennings, M M, Pany, K J & Reckers, P M J (2006) Strong Corporate Governance and Audit Firm Rotation: Effects on Judges’ Independence Perceptions. Accounting Horizons 20, (3) 253-270. PCAOB (2011) PCAOB Concept release on auditor independence and audit firm rotation [online] available from [accessed 24 October 2013] Miettinen, J. (2008). The Effect of Audit Quality on the Relationship Between Audit Committee. Vassa: University of Vaasa Publication. 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