Mandatory Audit Partner Rotation vs Audit Firm Rotation - Essay Example

Auditing Project: Auditors Rotation Introduction Regulators around the world are trying every means to deal withthe scepticism held by auditors. Some of the areas of improvement include objectivity and independence of auditing profession. Further, they have made it mandatory to carry out rotation of the auditors. The move to make the rotation of audit firms mandatory around the world faced opposition from many large audit firms. The audit firms argued that the mandatory rotation of the audit firms would interfere with the quality of the audit and the independence of auditors. Due to the above reasons, the audit firms came up with suggestions that other methods be used rather than rotation of the audit firms. In addition, audit partners rotation is a requirement both in the UK and US in every five years. However, rotation of audit firms is not a requirement in the two countries. The aim of this essay is to bring out clearly the implications for auditor’s independence and the credibility and reliability of financial reporting. In addition, it will offer various courses of action to help strengthen auditor independence, objectivity and professionalism and impacts caused by the courses of action (Reckers, 2006). Mandatory Audit Partner Rotation vs. Audit Firm Rotation The reason why mandatory audit partner’s rotation has always experienced rejection is because it lacks sufficient and convincing evidence that it will improve on the quality of its audits. In the past, companies have not been rotating the external auditors. Credibility and reliability of financial reporting have always been enhanced and reached by companies without having to rotate the audit firms. In the protection of investors and the public interest, Congress established the Public Company Account Overseeing Board (PCAOB), which promotes informative, accurate, and independent audits (United States Government Accountability Office, 2008). Since the organization is a non-profit, it oversees the actions of the auditing firms, hence ensuring the quality of audit is at the required standards. It also ensures the rules and laws of audit are not violated by the audit firms despite the long-term relationship between the auditing firm and the company. Rotation of the audit firms would not be favourable to the audit firms and rotating the firms in every five years would not improve the quality of audits. Audit failure occurs in the first three years of the audit engagement according to empirical research (United States Government Accountability Office, 2008). The audit failures operate as a learning process to the firms and developing relationships with the company being audited. Such activities increase the accuracy of the audits and improve the quality of audits (United States Government Accountability Office, 2008). In addition, rotation of the audit firms would be costly to the form and cause unnecessary consequences. Rotation of the firms would make it difficult for the overseeing Auditing Partners Board to follow on the audit firms since they operate in different companies. The inability of the Auditing Partners Board to oversee the external auditors due to rotation would lose meaning of the establishment of the committee (ICAEW. (2014). Instead, the committee should be encouraged and strengthened to allow for protection of investors and production of credible and reliable financial reports. There would also be various consequences for lack of oversight of the external auditors. First, it will encourage malpractices by the audit firms as there is no oversight provided for them. The result will be on the quality of audit translating into incredible and unreliable financial statement. In the long run, there will be repetitive mistakes that can scare investors from investing in those companies. The implementation of the audit firm rotation would increase the cost of the firms too and cause disruptions to the audit firms (Winn, 2014). Maintaining of same audit firms, on the other hand, will help the committee follow up on the audit firms hence assist in identifying the best-performing firm. The practice will help increase the quality of audit as it is transparent to both the investor and public. Ignoring of the rotation of audit firms will help in strengthening of the committee as well as the audit firms. In addition to this, it will also help in growing of the industry hence improving on the standards of auditing. The approach will also encourage and promote effective work relationship between the organization and professional auditors. The issue of cost will also be when using the approach as a good relationship between the auditor and management can influence the auditor to be lenient with the client (Winn, 2014). On the contrary, overstaying of the audit firms in the company will develop close relationships that might lead to decrease in quality of audit rather than increase in independence. As the length of the auditor-client relationship increases, the possibility of the auditor giving a qualified audit opinion decreases. The quality of audit also decreases due to excessive tenure in the company by the external auditor. In support of the above argument, previous research suggests that the rotation of the audit firms would improve the perception of the financial statement and the reaction of the market. It would result from an increase in confidence of the investors on the company. The auditors are not excessively related to the audit partners and other employees. Such relationship may compromise the financial reports and qualified opinion of the auditor concerning the company. In addition, rotation of the audit firms would give the opportunity to small audit firms, which have risen due to competition. In the current situation, the small audit firms cannot get opportunities to audit large companies due to lack of rotation, and they are not in the industry. The impact of such neglect causes an increase in competition in the market hence promoting auditor independence (Strohm, 2006). Mandatory audit partner rotation has not faced any opposition from any professionals. Apparently, it is done after every five years in countries that exercises it. The practice has various benefits to the company, public, investor, and the audit committee. Rotating the audit partners helps in eliminating any malpractice by the individuals, and it becomes easy for a company to detect arising problem. It also improves on the quality of the audited reports and ensures credible and reliable financial statements. When the Auditing Partners Board sets the maximum time of audit partners in the firm to five years, it ensures that the auditors pay close attention to details provided and are more sceptical in their audit approach. When countries and organizations decide on using the above approach, auditors are more independent, which increases the efficiency of their work. Rotation of audit partner also prevents excessive familiarity between the auditors and the clients of the company that can compromise the reliability of the reports provided. Independence of the auditor is high when mandatory rotation of the audit partner is (Reckers, 2006). However, the approach has various disadvantages. The credibility and relevance of the financial reports may be in the end years of the contract. Since the auditor is well aware that they are living the company, they misappropriate funds through collaboration with other employees in the company hence giving unreliable financial reports. The practice will result to decrease in the quality of audit and misleading information concerning the performance of the company. Mandatory audit partner rotation might increase the risk of audit failure due to lack of in-depth client specific knowledge, which they can only develop on long tenures. The above is by the fact that numerous failures made by the auditors take place during the first period of an auditor in a new organization. The failures arise since auditors have no sufficient information concerning the organization and clients (O’Brien, 2005). Courses of action The aim of the regulatory body and the Auditing Partners Board is to increase the reliability of the financial reports. To make this a reality, various actions can be. Most of the issues are always discussed on the national level thereby making it difficult to make the industry of audit uniform in its actions. An example of this is the case discussed above of the U.S and U.K. To solve these problems, the issues should be discussed on an international level to come up with long lasting solutions. The implementation of the above suggestion would make the solution decided uniform to all states hence making it easier to practice. To avoid inadequate client specific knowledge, the period for the mandatory rotation should be increased. The increase of the period will not only solve the problem of inadequate client specific knowledge but will also reduce audit failures as well as increasing the credibility and reliability of the financial reports. The move will also help in protecting of the investors and increase of accuracy of the reports given. The issue of increase in cost will be checked due to development of effective client and auditor relationship, which results in leniency of the auditor to the management (Hogue, 2006). To enhance competition in the market, rotation of the audit firms should be implemented. The move will allow new and small audit firms to take part in the process leading to increasing in efficiency. It will also increase competition in the market due to increasing in new competitors. As a result, increase audit accuracy. The approach will also help in cutting down the cost imposed by the audit firms, which is healthy for the market. The financial reports and auditors qualified opinion on the market will also be reliable as the audit firms will be trying to market their services. The market should also retain one regulator body for the audit firms and the audit partner. Maintaining of one regulatory body will make it easier for follow-up and streamlining of the audit firms. In addition, it will encourage the audit firms to perfect on their activities, therefore, improving on the quality of audit. The regulatory body should also charge fines for low audit quality and provision of unreliable financial reports. The approach will discourage low-quality audits by the audit firms. In above connection, it may help to enhance competitiveness and eliminate bogus audit firms (Gary, 2008). Mandatory audit partner rotation has proven to improve on the quality of audit and production of financial reports. However, in the end years, the quality of audit decreases. To help curb the vise, the regulatory body should impose heavy penalties on such individuals. The serving tenure of the audit partner should also be. The approach will help reduce and prevent excessive development of client auditor relationship. The issue should also be an international issue rather than a national issue which will help in the improvement of audit quality (Fernando, 2006). Conclusion Mandatory audit firm rotation is not favourable to both the audit firm and the client. Audit firms rotation would result in an increase of expenses incurred by the customer and the auditor. The auditor will be charged set-up costs for them to understand the client’s business model and the organizational structure. The company, which in this case is the client, will be charged costs to support the new auditors in the learning procedure each time a rotation is. The approach will also increase uncertainty in the market as the public can no longer distinguish between voluntary or mandatory rotation of the audit firm. Due to increase in uncertainty, the result will increase in the cost of information. Determination of the costs caused by the mandatory rotation is also difficult, making the whole process tedious and costly. Severe consequences have occurred with rotation of audit firms, and the effects should not be ignored at any given time. The effect should not be taken seriously because there is no proven evidence on the improvement of independence of auditors and quality of audit resulting from rotation of audit firms. The organizations should take keen considerations prior implementing the approach (Campbell, Houghton, et al., 2005). The mandatory audit partner rotation has in many ways proven to be a way of improving the audit quality. The process increases the reliability of the financial reports as well as changing the perception of investors and the market. Audit partners board (APB) are responsible for crucial decisions pertaining audit of financial statements upon which organizations base their opinion (ICAEW, 2014). The absence of such decisions would lead to compromise of quality of audit. The rotation also increases competition with different audit partners’ therefore increasing efficiency. Due to these benefits, countries are not exercising the practice should make it mandatory. The practice also helps in increase of auditor independence that is important to both organization and profession. However, costs arising from the rotation of audit firms are not accounted for in previous research. For this reason, further research should be done to account for the cost arising from audit firms. The research to be should also put into consideration the effects of rotation of the audit firms (Ewelt-Knauer, Gold, and Pott, 2012). Reference List Campbell, T, Houghton, K. A, Australian National University, (2005). Ethics and Auditing. Canberra. Ewelt-Knauer, C., Gold, A., and Pott C, (2012). What do we know about mandatory audit firm rotation? CA House 21 Haymarket Yards Edinburgh. Fernando, A.C, (2006). Corporate governance: principles, policies, and practices. New Delhi: Pearson Education. Gary, J.P, (2008). Research in accounting regulation. Amsterdam; Oxford. Hogue, Z. (2006). Methodological issues in accounting research: theories, methods, and issues. London ICAEW. (2014). APB amends rotation requirements for audit partners on listed entity audits. Retrieved :< http://www.icaew.com/en/technical/ethics/auditor-independence/apb-amends-rotation-requirements-for-audit-partners-on-listed-entity-audits> O’Brien, J. (2005). Governing the corporation: regulation and corporate governance in an age of scandal and global markets. Chic ester, West Sussex. Reckers, P, (2006). Advances in accounting. Burlington: Elsevier Strohm, C. (2006). United States and European Union auditor independence regulation: implications for regulators and auditing practice. Deutscher Universitata-Verlag. United States Government Accountability Office, (2008). Audits of public companies. New York Nova Science Winn, A. (2014). Partner Rotation and PCAOB Inspections: Effects on End-of-Term Audit Quality Read More