Arguments for and against the Ban and Rotation - Essay Example

arguments for and against the compulsory audit firm rotation and ban on audit companies for provision of non-audit services The report analyses the arguments regarding the compulsory rotation of the audit firms as well as the restriction on audit firms for carrying out advisory or other non-audit services for their client in the context of the companies listed in the London Stock exchange. Introduction After the scandals of Enron and World Call in the early 20th century which involved the audit firms as accomplices of corruption and frauds the audit firms’ role and responsibilities have come under huge question. People all over the globe have started to ponder on the pros and cons of the perspective of having an audit firm safeguard their rights where the key objective of the audit firms has become the maximization of profit, where they mostly only look to cover their own risk. The Enron and World Call scandal gave rise to a controversy where the auditors actually provided a helping hand to their audit client in carrying out and concealing fraud and other deceptive acts which resulted in huge losses to the shareholders, the employees and other related stakeholders alike. These incidents not only affected the companies but also prove to be an alarming event for the audit firms as well as the regulatory bodies to enhance their capabilities in providing a safeguard to the rights of the shareholders as well as other associated individuals. This also provided a need for the regulatory bodies to take some stringent measures in implementation of controls for appointment and rotation of auditors as well as the restriction of audit companies to be involved in provision of non-audit services to their clients which overshadows the social responsibility of the auditor and turns it in to a business perspective. Compulsory rotation of audit firm The recent incidents of corporate frauds have mobilized the regulatory bodies in the United Kingdom to establish and implement controls governing the audit of companies listed in the London Stock Exchange, which ensure that the auditors don’t stay long enough at a certain client where such a relationship is established between the two, where the auditor may disregard the social responsibility to safeguard the rights of the stakeholders. This thinking has given rise to the debate over the compulsory rotation of the audit companies to ensure that the auditors are changed after a certain period of time. arguments for the compulsion of audit firm rotation Some of the regulators governing the audit of the companies of the London Stock Exchange are of the view that the audit company rotation must be made mandatory as a step towards auditor independence. There are certain points in favor of audit rotation which have the potential of making it a good exercise. Close relationship between the client and auditor: The main causes of impaired independence, which can be cured by audit rotation, are persistent close relationship with the client, keenness to satisfy the client and fear of losing the client where any fraud related issue is identified during the audit. Fear of losing the client: If the audit company is rotated from time to time, the audit company will not have to fear for losing the client in case it highlights or reveals any fraud, deceitful acts of management or material misstatements which are actively concealed by the management. Social responsibility: The audit company will bear in mind that the audit company will have to be compulsorily rotated after a certain period, therefore the company will not look to satisfy the audit client to secure the long-term relationship with the client and the rotation will also mitigate the risk of establishment of such a relationship with the client where the audit company’s independence may get impaired. (Arel 2005) arguments against the obligation of audit form rotation Even if this fact is widely accepted by large people among the critics that the existence of a personal closeness with the management may impair the auditor’s independence, the rotation of the auditor may not aid in solving the dilemma. Lack of establishment of proper relationship required under an audit: This is because the auditors, on all levels, are required to interact with the management personnel on regularly throughout the course of the audit and these associations are a necessary part of the audit which takes place in spite of the span of the audit. Therefore, even if the auditor is rotated after a certain period, let’s say five years, during the course the audit a relationship may still be established which may impair the auditor’s impairment. Client getting fatigued with switchovers: Furthermore, with the auditors being rotated from time to time, the audit client will get fatigued by the constantly changing audit companies where it takes time for an audit company to gain an understanding of the client and establish a formal channel of communication. The audit client will feel rather comfortable while communicating with an audit firm with which it is associated for a certain period of time. Undermined effectiveness: Along with this, the effectiveness of an audit is dependent on the collective knowledge of the Audit Company and experience with the business and the complexity involved in the issues of reporting. Mandatory rotation will weaken this pool of knowledge and experience with the client and thus the effectiveness of the audit. Therefore, it remains the responsibility of the auditor to keep professional skepticism while the course of the audit to ensure independence and objectivity. (The adverse effects of compulsory audit firm rotation 2005) ban on audit firms for the provision of non-audit services Amongst from the suggestions which have come up in order to improve the audit of listed companies in the United kingdom, especially listed companies of the London stock exchange, the ban on audit firms with regards to the provision of non-audit services, such as the advisory service, has been given great importance. This is because of the fact that the companies involved in provision of non-audit services, develop greater interest in the client relationship and business perspective than that in the provision of audit services. arguments in favour of the ban It is a known fact that once there is business and money involved in the business, the social responsibility tends to mitigate. Auditor’s more concern for business rather than social responsibility: The job of an auditor is to look after the interest of the shareholder by examination of the financial statements to prove that they are free from misstatement and errors which provides a true and fair view, which has a social outlook altogether. However, if the auditor is also engaged in a business with client who derives a fee, there is a chance that the independence of the auditor might be impaired. There is a possibility that the auditor may not report any misstatements or fraudulent instances which, the auditor deems, will injure the relationship between him and the client. Since there is a possibility that client will not hire the auditor any further. Impaired independence: If the fees derived by the provision of non-audit services are significant, compared to that of the audit, some reservations may occur that the standards and guidelines may be compromised. This will make room for biasness in the relationship. (Riesenberg 2002) It is also a noticeable fact that when an auditor serves as an advisor or is engaged in establishment of controls, it is deemed that he has taken part in the business of the client therefore it is unfair to employ the auditor who has been a part of the business an auditor should be banned from providing non-audit services to the clients. arguments against the ban on provision of non-audit services Some of the experts, including the regulators take a view against a complete ban. Monopoly of audit companies: There have been arguments that a complete ban is highly unlikely because in case provision of non-audit services by the audit companies is barred, it will have a severe impact on the comparatively smaller mid-tier firms whose share in the field of auditing has already been swept away by the much bigger audit firms. Therefore, with a complete ban on the opportunity to provide non-audit services would cause a huge impact on them. (editorial 2010) Brain drain: Apart from that, the big auditing firms, which possess all the expertise, are usually employed by the bigger companies as their auditors and one amongst those may also be employed for consulting and advisory business. Therefore, if provision of non-audit services is banned, this will be a highly likely fact that pool of knowledge will remain underutilized and even though a particular company would want to obtain consultation, would be unable. conclusion It can be fairly concluded that, when proposal of a compulsory audit firm rotation and complete ban on the audit firms providing non-audit services was presented, the coordinating group took the step in the right direction when they decided against it as the two would have a rather drastic impact on the audit of listed companies of the UK. A compulsory rotation make it difficult for the big listed companies to get their accounts audited by different auditors time to time and thus requiring reestablishment of communication and relationship which is a compulsory part of any audit. A total ban on audit companies providing consultancy and advisory services is also not welcoming as if the company prefers a certain audit firm for the audit of accounts, let’s say a Big four firm, then they will have to look among much smaller firms to obtain consultancy and advisory services which they might not prefer as the pool of knowledge and expertise rests with much bigger firms. Therefore, a complete ban and compulsory rotation is not advised. Rather, a restructuring of the outlook of the audit, where a regulator appoints the auditor and a cap be placed on the fees derived from the audit and that from the advisory, is recommended. A compulsory rotation of the audit partner, as is already mandatory, can always aid the issue of impaired independence along with employment of the concept of China wall where non-audit services are provided. Works Cited Arel, Barbara, 2005. Audit firm rotation and Audit Quality. The CPA Journal. editorial, TA, 2010. Governance and independence of audit firms. the Accountant. Riesenberg, Thomas L., 2002. Non-Audit Service Restrictions of the Sarbanes-Oxley Act . The adverse effects of compulsory audit firm rotation, 2005. Commission on Financial Services and Insurance. Read More