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

? DOES THE ROTATION OF AUDITORS IMPROVE THE QUALITY OF AUDITING? By of the of the of the School State 10 December 2013 What is audit quality? Globalization has enabled financial and economic growth of corporations within economies and across borders. It has also challenged numerous businesses, in the event of economic crisis by translating into high systemic risks and financial instabilities. Over the past, numerous corporations collapsed because they worked on wrong assumptions that failed to fully reflect the condition of their finances. Auditing had never been influential and applicable as it is today. Each corporation feels the need to examine its accounts from time to time, and especially when change is about to occur, so that it can determine their correctness and fairness, as well as detect of any irregularity. Auditing is broad and can be conducted for systems, data, and finances which are of great concern in this context. Auditing can be described as an examination and verification of accounting data with an aim of establish the correctness and reliability of the accounting reports and statements (Shirin, 2009). However, numerous controversies exist over establishing a standard against which actual audit performances can be measured. Therefore, organizations may have difficulties in assessing the effectiveness and quality of their audit, even if it serves the purpose. Audit quality has been described by Fearnley et al as the “market assessed joint probability that a given auditor will both discover a breach in the client’s accounting system and report the breach” (2011, p. 2007). Organization’s committees and shareholders need enhanced audit quality for the sake of delivering appropriate organization audit results and opinions. Firm rotation of auditors has been campaigned for and applied in some countries as a way of improving audit quality. The issue of audit quality that auditors’ rotation attempts to address There are several factors that affect the quality of audit. Nowadays, clients want to be confident of the financial reports they get, to make future projections of the business. Internationally, various initiatives have been proposed to establish a standard or enforce some consistencies across borders, in how the auditors ought to accomplish the audit objective, and what financial statements clients should expect (ICAEW, 2010). The number of recently reported financial failures in organizations call for more accountability and undertaking of effective measures for countries, firms, and audit practitioners, whom are all affected in case of any unexpected undesirable effect after auditing. There have been cases of firms experiencing frauds and even bankruptcy after a repetitive auditing by specific auditors, while auditors are sometimes prevented from delivering certain quality audit results due to differences in countries’ regulations, economic incentives, their ability, and expertise. Considering the perceived audit failures, there is an urge for audit effectiveness and efficiency to enhance clients’ confidence in the quality of audit reports. This remains the greatest problem in quality control. Rotation of auditors is one of the strategies recommended, but still debatable over its success in promoting audit quality. Rotation of auditors The concept of auditors’ rotation is related to job rotation of employees, but unlike the later, which is intended to enhance motivation, the former has clear based objectives to impact on the quality of audits. Due to the established failure and fraud cases when a former auditor has been reemployed for a longer term by a specific client, companies avoid hiring similar auditing firms for a subsequent number of years to conduct their audits. The issue surfaced since the 90s and proposes that audit firms serve as client auditors for a certain period, then replaced by others. AICPA requirement proposes seven years of an auditor firm or auditor service, after which rotation occurs separating the former audit client from the auditor (GAO, 2002). Following the Enron scandal, examiners of the case concluded that the forged relationships between the management of companies being audited and the auditors who have had longer tenure with them led to a poor quality audit. To put clear the essence of auditor rotation, Gul states that “shorter auditor tenure enhances auditor independence because it would enable auditors to resist management pressure and exercise greater objectivity” (2002, p. 105).There are several raised controversies over the specified time period to enforce rotation. Issues on making audit rotation mandatory Internationally and within countries, audit regulators and practitioners feel the need for audit firm rotation. Governments are currently working on making it mandatory, despite the high level of public and key concerned organizations’ disagreement. Although the governments have conflicting issues when it comes to setting auditing laws in their countries, international auditing bodies have set a template and nations like United states have gone ahead to form mandatory audit rotation (MAR) and establishing it in law. The MAR rule holds that companies’ auditors can only provide the service for a set limited time frame, after which they are replaced with a possibility of enhancing investors’ assurance and auditors’ independence (Cameran, et al, n.d.). Many countries adopted it before with different periods ranging from five to nine years, but had to abandon it for the numerous costs and its unclear effectiveness in improving audit quality. Until the last decade, numerous countries have embarked on the issue, to save the nations and corporations from the threats arising that may reap them their long accumulated benefits. Italy stands out to be the only consistent country that applied the rule back in the 80s, and has been used as a template to investigate the effects of the rule. By legalizing or using mandatory rule, rotation of auditors can be achieved. Regulations and countries’ stand International regulatory on audit rotation At the international level, Sarbanes Oxley Act of 2002 (SOA), as promulgated by the Americans favours and requires the mandatory audit rotation. The Act goes ahead to govern the responsibility of auditors and even amend the prohibited non audit services. SOX Act enabled SEC to adopt the prohibition certain partners (auditors) from an auditing firm to perform auditing for a similar client for a period of 5 or 7 successive years (Chadbourne & Parker LLP, 2003). Working towards increasing audit quality and auditor’s independence, various shareholders in organizations (the board and committees) were affected, invoking changes in the composition of the Audit committee and delegating powers to the board to set the auditing standards. Sarbanes Oxley Act was approved by the U.S. congress in early 2000s, following a series of successive companies’ accounting irregularities. It promoted the change in the federal securities laws and influenced the interaction of external auditors with companies. Other countries had developed their own internal regulations in auditing and auditors’ regulation, while others have applied a similar approach as that of the U.S. For example, Australia currently uses a combination of legislative provisions in Corporation Acts to require a rotation for an audit partner after 5 year tenure of in a listed company (Ottaway, n.d.). The U.K. on the other hand has no regulatory framework that forces auditors’ rotation after a defined period. However, for public listed companies, “the audit engagement partner cannot act for more than seven years and cannot return to that role for a further five years,” which are similar actions of SEC (ICAEW, 2002, p. 1). The U.K. has experienced intense debates on adoption of MAR rule in the course of 2013, but despite the their current system that affect listed companies as earlier mentioned, and European Union’s recommendation of auditors rotation after seven years tenure, the degree of resistance in the U.K. is still high. When you focus on the mode of the society over the issue, there is a move lobbying against the MAR regulatory option from the EU and U.S. regulators and U.K.’s competitive commission. Factors affecting the rotation of Auditors Financial power: From the companies’ perspective, the financial condition of a client that needs the audit may affect the auditor selection decision. Hence the financial capacities of companies will be used determine the expertise they would acquire, based on the next auditor they would hire. Those with higher power will acquire reputable auditors, while those with low limited financial power would switch to less reputable auditors, whose ability in the field may be partially effective. Countries that support auditors’ rotation, but without a defined period after which rotation can be enforced, the longer the auditors’ tenure in organization, the weaker auditors’ independence could be, and hence demand for their rotation. Level of competition: Some auditors would deliver results that are pleasing or not to the company. Based on this, the company committees or user may develop a perception that may affect the judgment of the auditors’ works, and the term they would offer the service. There is a high tendency that clients would replace auditors with more reputable ones, if users of the generated audit report developed a negative perception on auditing partner’s independence (Suyono et al, 2013). Besides the issue of auditors rotation that affects audit quality, there are auditor’s skills and knowledge, experience of auditors in auditing a specific industry, control enforced over the audit process in companies, and companies’ resource allocation to auditing task that have been studied to have some form of influence in the audit quality. Advantages of rotation of auditors Supports auditors independence: Auditors have an objective that requires appropriate critique and assessment of the financial statements of companies. This can be made efficient without influences of parties with certain interests, who may manipulate the auditors to sacrifice the required auditor’s independence and opinion, just to further their agendas. . It would be quite difficult for auditors to be impaired and compelled by judgement, compromising forces, and their established relationships with the companies’ officials (who have certain interest); thereby promoting auditors’ objectivity (Ball et al, n.d.). Rotation makes sure that an auditor would only have a temporally period with the firm or client, therefore eliminating the long period of engagement that may open up opportunities for auditors to compromise, and provide inappropriate audit records, due to the pressures and attractive incentives that come along their way while in work. Improves investors’ confidence: When a company goes bankrupt, the investors are highly affected and their capitals are drained as the companies fail. Past audit failures have made investors to question the quality of auditing performed in the companies, and the credibilities of the auditors in relation to the duration they offer the service to the companies. Rotation of auditors becomes a necessary tool to them, because as it attempts to increase auditors’ independence, objectivity, and audit quality, and investors feel more confident with the delivered report. Meaning they can take measure to make improvements and corrections as to where they direct their assets in future. Other advantages are in detecting omissions and irregularities made in the past. Different successive auditors examining a client’s financial data can capture frauds and identify where wrong opinions were delivered and report material misstatements. Auditors would then strive to perform their task objectively, because they are avoiding issues of litigations and loss of reputation upon irregularities that would be detected by fresh looks (Bhika and Francis, 2012). Disadvantages of rotation of auditors Reduces auditors’ expertise: When an auditor performs a task with one client, and is reemployed by the client for a longer period, he develops cumulative knowledge in the business. Rotation would result to loss of the built knowledge and familiarity with the client’s business that may consume an extra time for the next auditors to gather in preparation for auditing. Auditors and auditing firms may have fewer opportunities to specialize their auditing service in a specific industry. Working in various companies may imply reduced expertise and talent in specific majored sectors. This general concept has been used to elaborate the chances of audit failure in the absence of client knowledge and business familiarity. Issue of complex audit compliance: Since rotation of auditors would promote auditing services across the borders, there could be a conflict in regulations governing auditing, due to lack of a standard reference. Hence, audit compliance with the numerous international corporations would be more complex with the different requirements of audit rotation (Institute of Chartered Accountants of Australia, 2013). Loss of time, disruptive changes, and costs: It would take extra time and financial resources to search and hire the best choice of auditors a firm needs. Clients may have to let go of the best auditors, who are reputable and with satisfactory knowledge and expertise, which could be difficult to access again through rotation plan. Transition comes with an extra cost and responsibilities to the companies’ committees. Does rotation of auditors improve the quality of auditing? To justify the aforementioned impacts of auditors’ rotation, research conducted by Harris found that implementing MAR rules in audit markets enhanced their quality. Another research led by Targesson in the group only established weak reasons to support the fact that rotation influences audit quality. GAO has in the past also failed to establish the benefits of mandatory rotation of auditors. This illustrates the complexity of determining audit quality and that further evidence is required to support or refute the societies’ perceived opinions. Conclusion Rotation of auditors has got both its benefits and drawbacks upon application. It is obvious that many factors contribute and affect audit quality, where rotation of auditors is one of them. Rotation is argued to be one initiative, but quite weak in impacting on the quality of audit. The numerous costs outweigh rotation (in particular MAR rule) than the expected benefits to the involved parties. The assumption that rotation of auditors improves audit quality hence remains unclear with numerous investigations failing to prove it, but ascertain that it enhances auditors’ independence, which is essential in improving the quality of an audit. Reference List Ball, T. C., Glover, J., Jamal, K., Kassam, R., Kouri, K., Paterson, D. B., Radhakrishnan, S. and Sunder, S. Audit Firm Rotation: A joint Academic and Practitioner Perspective. [online] Available at: [Accessed 11 December 2013]. Bhika, R. and Francis, A. 2012. Will Rotating Accounting firms enhance audit quality? [online] Available at: [Accessed 11 December 2013]. Cameran, M., Prencipe, A. and Trombetta, M. Does Mandatory Auditor Rotation Really Improve Audit Quality? [online]Available at: [Accessed 11 December 2013]. Chadbourne & Parker LLP. 2003. Client Alert: Sec Adopts Final Rule on Auditor Independence. [online]Available at: [Accessed 10 December 2013].  Fearnley, S., Beattie, V. and Hines, T. 2011. Reaching Key Financial Reporting Decisions: How Directors and Auditors Interact. West Sussex: John Wiley & Sons. GAO. 2002. Protecting the public interest selected governance, regulatory oversight, Auditing, Accounting, and Financial Reporting Issues. Collingdale, PA: Diane Publishing. Gul, F. A. 2007. 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