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

?Does the Rotation of Auditors Improve the Quality of Auditing? Table of Contents Introduction 3 Discussion 4 Defining Audit Quality 4 The Issue thatare Addressed by ‘Rotation of Auditors’ 4 Meaning of ‘Rotation of Auditors’ 5 Advantages of ‘Rotation of Auditors’ 6 Recommendations 11 Conclusion 11 References 12 Introduction Rotation of auditors implies to the regulatory decision that audit firms will be limited on the basis of years for which they will perform audit operations for a particular entity in the corporate sector. This provision principally attempts towards ensuring that auditors are provided with better independence in their auditing operations as well as towards assuring that investors are offered with better confidence on the financial reports published following the auditing process. Rotation of auditors has also been argued to facilitate business organisations in developing better transparency in their financial reports. Moreover, auditor rotation is identified as a process assisting in better flow of information. Rotation also ascertains that the financial statements of a business organisation are reviewed frequently. In this manner, auditor rotation develops an increased accountability along with independence amid auditors. However, the policy of auditor rotation is identified to affect the audit quality to a substantial extent, as auditors with time span are aware of the risks and credibility that a business organisation is attached with. It is also ascertained that there are certain business organisations adopting the policy of auditor rotation, which are seemed to increase complexities as well as cost due to rotation during important business transactions (Whitehouse, 2013). In this regard, the essay emphasizes the audit quality and the policy of rotation of auditors. Moreover, the essay discusses about the issues that are addressed by auditors’ rotation and explains the advantages and disadvantages associated with the policy of auditors’ rotation. Discussion Defining Audit Quality In the present business scenario, financial reports of companies are deemed to be quite essential elements of identifying the performances of business organisations. In this regard, both internal as well as external auditors play effective role in the preparation of financial reports suitably (Arrunada & Paz-Ares, 1997). Contextually, audit quality has emerged as an important aspect in relation to the audited financial reports that are prepared and presented. It is therefore deemed to be the auditors’ responsibility to discover as well as identify the shortcomings in the accounting system of an organisation in order to ensure that financial reports are prepared systematically and appropriately (Velte & Stiglbauer, 2012). Correspondingly, the policy of audit quality is generally argued as based on three important factors, which include disclosure of appropriate financial statements, ascertaining that the internal control system of an organisation is efficient and provide adequate warnings in case of frauds and misrepresentations (PCAOB, 2013). The Issue that are Addressed by ‘Rotation of Auditors’ The policy of rotation of auditors is thereby adopted by business organisations with the objective of ascertaining that financial reports are prepared and disclosed appropriately ascertaining better audit quality. The policy has been adopted in order to minimise the barrier of over-familiarity that may develop amid the management of an organisation and auditors with time. In this respect, business organisations have adopted this policy in order to safeguard and protect the interests as well as confidence of investors by ensuring that quality audited financial reports are disclosed every year, representing a reliable information reflecting the current financial position of the company. The utmost objective of rotation of auditors is accordingly, to ascertain that auditing operations are performed effectively in order to enhance audit quality (PWC, 2013). In this regard, it can be comprehended that the policy of rotation of auditors has been implemented with the sole aim of ascertaining that the auditors are provided with adequate independence in their operations, so that audit quality can be improved in relation to the preparation and disclosure of financial statements. Meaning of ‘Rotation of Auditors’ Rotation of auditors is defined as a systematic process on the basis of which, accounting firms engaged in performing auditing operations are provided with the limitation on time of their services in alliance with a particular business organisation. Contextually, auditing firms are provided with time limit in relation to their term of services for auditing financial statements of a business organisation. In this respect, the auditing firms, after a predetermined period, will not be eligible in performing their auditing operations for that particular business organisation, for a specific interval of time, after which they can again form alliance and coordinate their operations accordingly. Subsequently, a business organisation should hire other auditing firm to perform their auditing operations, once the tenure limit is crossed. In this context, business organisations are required to get their auditing operations performed by different auditors and accordingly, a rotation of auditors should be developed with the aim of ascertaining that audit quality is maintained at a high degree (Cameran & et. al., 2010). Advantages of ‘Rotation of Auditors’ In this present business scenario, the policy of rotation of auditors has been adopted as an important consideration for performing auditing operations in an effective and ethical manner. The incidents of Enron and Worldcom among other business organisations, involved in disclosing misrepresented as well as fraudulent financial statements that further led to the bankruptcy of the entities, disregarding the interests of the stakeholders of the organisation to a large extent. Additionally, this measure is expected to assist in improving the professional scepticism of auditors facilitating in averting the development of a close relationship amid the management of an organisation and the auditor that may develop in the long term tenure, therefore raising the limitation of conflict of interests in performing strict auditing vigilances and ensuring maximum transparency in company financial reporting (Cameran & et. al., 2010). It is worth mentioning in this context that the policy is regarded with immense importance by the accounting policy-makers with the aim of ensuring that audit quality is maintained in the preparation of financial statements. To be noted in this regard, the policy has been adopted in many organisations under particular jurisdictions towards auditing operations. Correspondingly, it has been identified that business organisations are facilitated with different advantages rewarded with the implementation of rotation of auditors’ policy. In this regard, the foremost advantage of this policy has been the increase in the independence of auditors. In this respect, the auditors with increased independence are likely to be facilitated with the opportunity of ascertaining that financing statements are prepared with improved audit quality. The policy of auditor rotation can also potentially assure that long-term relationship amid management and auditor firms is not developed as the development of long-term relationship will lead to the formation of excessive reliance as well as dependable attitude by the management towards auditors. Subsequently, the reliable as well as dependable attitude deciphered within these participants may increase the chances of fraudulent practices in the preparation of financial statements. Contractually, the implementation of this policy will therefore force the auditors to concentrate on their auditing operations and perform their tasks with a critical sceptical approach (Ewelt-Knaier & et. al., 2012). The same notion has been argued in the report presented by MIT Sloan School of Management (2013), which implied that long term tenure develops reliable and dependable relationship amid auditors and management of business organisations and in this regard, the auditors consciously or incautiously overlook the audit processes that are essential for maintaining audit quality due to increased trust. Moreover, the auditors conduct their auditing operations with inadequate investigations and analysis under such circumstances, which is further prevented with the application of this particular policy measure (MIT Sloan School of Management, 2013). In a similar context, the report published by IFAC (2013) signified that the policy has been implemented with the provision of limiting the relationship that might develop between auditors and management that might impose an adverse influence on the audit quality standards (IFAC, 2013). The second advantage of auditor rotation policy is that it attempts to ensure the financial statements are prepared in an independent manner ensuring audit quality. In this respect, the users of financial reports will perceive that the financial reports are prepared with appropriate information creating better confidence amid the investors (Ewelt-Knaier & et. al., 2012). In this regard, the report published by EYGM Limited (2013) signified that the implementation of rotation of auditor policy will assist in the development of trust as well as confidence amid investors in relation to the financial information that are provided through the financial statements. The investors will therefore develop a perception that reliable and correct information are presented through financial statements (EYGM Limited, 2013). The third advantage offered by the policy signifies that it will increase employment opportunities for audit firms due to enhanced market competition. In this context, smaller audit firms might be provided with the opportunity of performing auditing operations in different corporate sectors (Ewelt-Knaier & et. al., 2012). According to Tagesson & et. al. (2006), increased market competition amid audit firms is to be provided with better employment opportunity. Contextually, in this competitive market conditions, audit firms will ensure that better audit quality services are offered to their clients in order to develop their competitiveness. In this respect, auditors providing audit quality services are likely to attract additional clients along with ensuring that the client company is also able to attract a larger proportion of investors assuring greater degree of reliability in its financial disclosures (Tagesson & et. al., 2006). Disadvantages of ‘Rotation of Auditors’ However, it has been recognised that there are certain disadvantages attached with the policy of rotation of auditors. The first disadvantage is that it might adversely affect the audit quality after the initial phase of hiring a new firm, which will quite likely take a considerable time period to understand the auditing requirements of the company. As the auditors are required to be rotated after certain time interval, the newly hired auditors might face difficulties in determining the technical along with business operations knowledge of the client organisation. Consequently, auditors might not be able to perform their auditing operations ensuing better audit quality since their initial phase of partnership (ICAEW, 2002). According to the report published by KPMG (2012), it was implied that the provision of the auditor rotation policy, limiting the tenure period of auditors, is likely to increase the complexity of the auditing operations as new auditors will not be able to have a comprehensive information and knowledge about the business operations, which might unfavourably affect the audit quality (Velte & Stiglbauer, 2012). Additionally, this policy is related to industry specialisation, which implies that every auditor might not be competent in performing auditing functions for every business. In this regard, business organisations performing complex operations might face substantial difficulties in obtaining such expertise (DJEI, 2000). According to Coyle (2004), the policy of auditor rotation is seemed to increase complexities for business organisations too, in acquiring competent auditors in an efficient manner further raising their operational and managerial costs. Respectively, appointment of auditors having inadequate expertise might hamper audit quality to a certain extent owing to the implementation of this policy (Coyle, 2004). Accordingly, cost is identified as another most important disadvantage in relation to the implementation of auditor rotation policy. Business organisations might face the problem of increased cost incurred in terms of the required investment to comply with the set-up expenses for new auditors and training procedures along with increased market competition augmenting audit fees. Moreover, there are instances where a business organisation might come across increased costs along with complications during auditor rotation, at times of important business transactions, which may also include mergers and acquisitions among others (Arrunada & Paz-Ares, 1997). In this regard, the report published by GAO (2003) signified that the auditor rotation policy has increased market competition, which further raised audit fees to a substantial extent. Moreover, rotation of auditors might increase complexity at times of important business transactions, which may incur additional costs in order to ascertain that financial reports are prepared within the stipulated time-period (GAO, 2003). Recommendations In this respect, business organisations, in order to ensure that financial reports are prepared with effective audit quality, should adopt auditor rotation policy. Respectively, the policy will limit the period of tenure for auditors and on the lapse of that period, new auditor should be hired. Respectively, the auditors will be offered with better independence for performing auditing operations effectively (Mostafa & Hussien, 2010). The auditors should be provided with adequate information on the basis of which, financial statements are to be prepared. The auditors should also be aware of the procedures in accordance with which, business operations are executed (Velte & Stiglbauer, 2012; GAO, 2003). Conclusion In precise, the rotation of auditor policy has been adopted as a regulatory measure by many organisations in respect to their corporate governance framework, with the aim of improving the independence of auditors, so that they are able to perform their auditing operations without intervention from the management and produce highly reliable auditing reports, ensuring better satisfaction to investors’ interests. Hence, the policy also aids in developing confidence amid investors that the financial statements presented are appropriate. Although there are certain disadvantages, which include cost and industry specialisation barriers attached with this policy, the implementation of this policy will assist in inhibiting the development of long-term relationship, which is majorly considered to be a leading factor accountable for financial frauds and misrepresentation of financial statements. References Arrunada, B. & Paz-Ares, G., 1997. Mandatory Rotation of Company Auditors: A Critical Examination. International Review of Law and Economics, Vol. 17, pp. 31-61. Cameran, M. & et. al., 2010. Does Mandatory Auditor Rotation Really Improve Audit Quality? Universidad Carlos III de Madrid. Coyle, B., 2004. Risk Awareness and Corporate Governance. Global Professional Publishing. DJEI, 2000. Auditor Independence. Chapter 12. [Online] Available at: http://www.djei.ie/publications/commerce/2000/auditing/chapter12.pdf [Accessed December 12, 2013]. GAO, 2003. Public Accounting Firms Required Study on the Potential Effects of Mandatory Audit Firm Rotation. DIANE Publishing. ICAEW, 2002. Mandatory Rotation of Audit Firms. Files. [Online] Available at: https://www.icaew.com/~/media/Files/Library/collections/ICAEW%20archive/mandatory-rotation-of-audit-firms-review-of-current-requirements-research-and-publications.pdf [Accessed December 12, 2013]. IFAC, 2013. Handbook of the Code of Ethics for Professional Accountants. Files. [Online] Available at: http://www.ifac.org/sites/default/files/publications/files/2013-IESBA-Handbook.pdf [Accessed December 12, 2013]. MIT Sloan School of Management, 2013. Mandatory Audit Partner Rotation and Audit Quality: Effect of Personal Relationships between Audit Partners. Events. [Online] Available at: http://mitsloan.mit.edu/events/asia-conference-in-accounting/pdf/Mandatory_Audit_Partner_Rotation.pdf [Accessed December 12, 2013]. Mostafa, D. & Hussien, M., 2010. The Impact of Auditor Rotation on the Audit Quality: A Field Study from Egypt. Working Paper No. 23. PCAOB, 2013. Standing Advisory Group Meeting. Discussion - Audit Quality Indicators. [Online] Available at: http://pcaobus.org/News/Events/Documents/05152013_SAGMeeting/Audit_Quality_Indicators.pdf [Accessed December 12, 2013]. PWC, 2013. Mandatory Audit Firm Rotation - Other Changes Would Be Better For Investors. Point of View. [Online] Available at: http://www.pwc.com/en_GX/gx/audit-services/publications/assets/pwc-pointofview-mandatoryrotation.pdf [Accessed December 12, 2013]. Tagesson, T. & et. al. 2006. Does Auditor Rotation Influence Audit Quality: The Contested Hypotheses tested on Swedish Data. Working Paper Series. Velte, P. & Stiglbauer, M., 2012. Impact of Auditor and Audit Firm Rotation on Accounting and Audit Quality: A Critical Analysis of the EC Regulation Draft. Conference Paper. Whitehouse, T., 2013. U.K. Panel Suggests Rotation to Improve Audit Quality. Accounting & Auditing. [Online] Available at: http://www.complianceweek.com/uk-panel-suggests-rotation-to-improve-audit-quality/article/281597/ [Accessed December 12, 2013]. Read More