Auditor Rotation and Its Requirements - Essay Example

Audit Contents Contents 2 Introduction 3 Auditor Rotation and its requirements 4 In case of internal auditor and audit committee 4 In case of external auditor 5 Arguments supporting MAFR 5 Arguments against mandatory firm rotation 7 Effects of mandatory firm rotation on profession 8 Additional aspects influencing independence of auditors 8 Conclusion 9 10 References 11 Introduction Audit is the process of validating and verifying the objective evidences that have been reported by a company in their financial statements and annual reports. The audits of different companies are done with the aim of assessing the compliance of the business processes and financial reporting of a company to the internationally recognized accounting standards and reporting standards. The audit process in the modern world is a multi-tier process which is carried out by both the external and internal auditors. The external auditors are generally a separate auditing company while the internal auditors are a team of people from the company itself who are responsible for conducting the internal audit of the company. The audits are aimed at evaluating and establishing the compliance, effectiveness and validity of the financial reporting and accounting activities of a company. Recently a new concept has been introduced in the audit industry known as Mandatory Audit Firm Rotation (MAFR). It was proposed as an obligatory practice in audit by the European Commission with the aim to reduce any discrepancies in the auditing processes and ensure better standards and quality in the audits. The MAFR is a process in which a company has to change its external auditing firm in every five years. Earlier, it was possible for a company to maintain the same external auditors for 48 years. However, after the introduction of the MAFR, it would be mandatory for a company to change its auditors after the completion of five years of audit by an external auditor. Auditor Rotation and its requirements MAFR has emerged as a significant concept in the international audit processes. The corporate scams and events like the Great Financial Crisis of 2008, has brought about many questions on the effectiveness of the existing international audit practices. One of the reasons behind major corporate frauds like the Enron scam is identified to be discrepancies in the auditing systems (Mohamed, 2010). As such, much focus is given on evaluating the advantages and disadvantages of adopting MAFR in a company operating in the modern business world. In case of internal auditor and audit committee The system of MAFR is expected to make the internal audit processes more efficient and streamlined. The proponents of MAFR are of the view that the new system is likely to improve the scopes for ethical standards and compliance in the activities of the internal auditors. Also, it is expected that MAFR will enhance the quality of audits. Since, in this system, the auditors will be changed in every five years, long term relationships between the internal and the external auditors will not be established (Moody, Pany and Reckers, 2006). This would enhance auditor independence and subsequently reduce the chances of misrepresentation of information for personal or business benefits. MAFR is expected to improve the ethical considerations and internal control in the auditing processes (Manry, 2008). The auditors of a company are required to follow five basic principles which are confidentiality, objectivity, integrity, ethical behaviour and professional confidence. These five principles are integrity, objectivity, confidentiality, professional behaviour, professional confidence and due care. MAFR is expected to create an environment in the company that would encourage and support the internal auditors to follow these basic principles of auditing (Velte and Stiglbauer, 2012). In case of external auditor MAFR is also expected to bring about fresh perspectives and new objectives in the external auditing process. The main goal of MAFR is to ensure that the quality of the audits is not compromised (Barton, 2002). Also, the factors of independence of appearance and independence of information are likely to be propagated by the MAFR. A change in the auditors will bring about new dimensions and approaches in the audit processes. Also, there would be very less scope of informal relationships being established between the management of the client company and the auditing company. This would ensure that the audits are not influenced by the personal objectives of the management of the client company and as such, the external auditors will be able to conduct the audits in an independent manner and ensure that a correct representation of the financial position and processes of a company is presented in front of the stakeholders of the company (Carcello and Nagy, 2004). A MAFR is also expected to reduce any disparities in the auditing and accounting processes of a client company and reduce the chances of corporate fraudulent practices because the audit reports would be prepared by a new external auditor in every five years. This would enable the regulators to have better control over the auditing activities because the work of one auditor can be cross checked by another auditor after a period of five years (Knechel and Vanstraelen, 2007). This would ensure the consistency and validity of audit information. Arguments supporting MAFR MAFR has been a debatable topic in the audit industry. While the proponents of MAFR have focused on the positive benefits of MAFR, the opponents of the process have highlighted the negative effects that MAFR may have on the audit practices (Vanstraelen, 2000). It is identified that the main objective of MAFR is to ensure that the audits are conducted in an ethically compliant and transparent manner and corporate frauds and scams are minimized to make the modern business environment an ethical and well regulated domain. Several countries like Brazil, Italy and India have taken up MAFR in the past. In contrast, other countries like Canada, Italy and Spain have abolished this practice because they have found little or no benefit from the introduction of the system of MAFR (Brody and Moscove, 2008). However, many countries view MAFR as a way to boost auditor independence, professional scepticism and audit quality. The supporters of MAFR suggest that this process can accomplish the objectives of achieving audit quality and auditor independence by ensuring that close and informal relationships are not established between the management of the client company and the auditors and by reducing the economic dependence of the auditing companies on the client companies. MAFR can reduce the concentration level in the audit industry because it would create opportunities for audit firms of all scales (Kimball, 2009). MAFR would contribute significantly to the main aims of audit which are to underpin the confidence of the industry to make the company more effectively functional, to validate the annual and financial reports to make the company more credible in the view of the stakeholders and to maintain substantial check and control on the integrity and transparency of the disclosures made by the client company. MAFR is largely focused on improving audit quality and achieving auditor independence. Audit quality is largely dependent on professional scepticism, degree of independence of the auditors, and the objectivity of the audit process. MAFR can improve audit quality by enhancing these influencers of audit quality. MAFR can also be beneficial for the investors because an effective audit process can support the investment decisions of the investors. On the other hand, inefficient audits or audit failures may have far reaching implications on the interests of the potential and existing investors of a company. MAFR is also identified to be a useful vehicle for fraud detection. The rotation of the audit companies will ensure that corporate frauds cannot be continued for long. This would help to minimize fraudulent practices in the global business environment. Arguments against mandatory firm rotation The opponents of MAFR are of the view that MAFR is not likely to be as effective in practical implementation as proposed by the European Commission. MAFR has not been proved to be effective in enhancing audit quality (Walker, Lewis and Casterella, 2001). Instead, it can be argued that this system may act as a hindrance in the way of achieving high qualities in audit. The knowledge and experience gained by a particular external auditing company regarding a client company over years becomes redundant when the tenure of the audit is over. This can be considered to be a big loss of relevant audit information (Stanley and DeZoort, 2007). The new auditors have to start the auditing process from the beginning which gives rise to additional costs in the audits and also requires the investment of more time in the audit process. When an auditing company conducts the audit of a company for a long period of time, it not only gains knowledge and information about the financial activities of the company but it also forms a fair idea of the risks involved in the business. An awareness of the risks and other factors affecting the business is important for improving the audit quality. However, in case of MAFR, this knowledge is often lacking which may ultimately reduce the audit quality. MAFR can act as a constraint in the process of developing cooperative relationships between the external auditors and the internal entities of the client company. While the maintenance of an overly informal relation between the two is considered to be derogatory for the audit practices, the absence of a cooperative relation between the two parties may lead to major hindrances in the way of communication and disclosure of information which can affect audit quality as well (Ruiz-Barbadillo, Gomez-Aguilar and Carrera, 2009). Effects of mandatory firm rotation on profession There may be several impacts of the introduction of MAFR on the auditing profession as well. The practice may create the scope of work for the small auditing firms as the big audit companies would not be entitled to hold the auditing responsibility of a client company for a period longer than five years (Ruddock, Taylor and Taylor, 2006). Also, there would be periodic evaluation of the work of an auditor which would make the audit processes more regulated and monitored. The identification of discrepancies in the work of an audit company may be more easily done when the system of MAFR is implemented in the audit industry. On the other hand, MAFR can lead to inconsistent practices in the audit industry because work will be distributed among auditing companies of varying levels of proficiency and expertise (Nashwa, 2004). Many auditing companies are anticipating that MAFR may lead to uncertainty in the audit capacity and disparity in locating the employees with specific skill sets. There may be a loss of incentive among the audit firms to attract and retain specific talents because the audit companies will not be able to cater to clients belonging to a specific business segment. MAFR may also restrict the choice of audit companies and may compel client companies to select auditors who do not have the necessary skills and expertise as present in the current auditors (Myers, 2008). Additional aspects influencing independence of auditors There may be certain additional factors that can impact the independence of the auditors. These factors are not limited to degree of competition in the audit industry, the size and efficiency of the audit company, the fees of the audit company, the tenure of the auditing process, presence of adequate management advisory service companies, economic incentives of the audit companies, the knowledge and experience of the audit companies, the regulatory systems guiding the auditing activities, the interests and ethical views of the auditors and the segment of business of the client company (Neal and Carcello, 2000). The presentation of a true and fair view of the annual reports and financial statements is another main factor affecting auditor independence (Blouin, Grein and Rountree, 2007). If the internal audit process of a company ensures that the financial statements are maintained and presented accurately with a proper representation, then the external auditors will be able to make better evaluations and conduct their work in an efficient and independent manner. A fair amount of auditor independence in an audit process would ensure that the audit opinion presented by the external audit company is accurate and valid (Nagy, 2005). An audit opinion is a summarizing view presented by the auditors after conducting the audit of a company. The audit opinion is extremely necessary for making future corporate and audit decisions. Thus, allowing the auditors to form a clear, ethical and unbiased audit opinion would be representative of the degree of auditor independence gained by the auditors. The MAFR would ensure that there is a level of independence achieved by the auditor which would subsequently improve the quality and consistency of the audit practices (Carey and Simnett, 2006). Conclusion Audit should ideally be an independent process of evaluation. It is highly critical to maintain objectivity and ethics in an auditing process. Though it has not directly been established that MAFR can be a solution to all the issues in international audit practices, yet it can be indicated that MAFR may act as a beneficial factor in improving the level of auditor independence, audit quality, audit consistency and ethical approaches in an audit process. Both the internal and the external auditors should be allowed to take an unbiased view of the audit process. Only then can the audit process be efficient and effective. MAFR is expected to improve the communication and the level of transparency between the internal and external auditors and foster the development of stringent audit practices in a company. While the international regulatory authorities are of the view that MAFR would improve audit quality and auditor independence, the audit companies are of the view that MAFR is not sufficient to ensure audit quality and independence of auditors. 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