...I. Audit Quality The primary role of accounting is to reduce information asymmetry by providing investors with relevant and reliable information in order to create an efficient allocation of resources. However, there is often a tradeoff between relevance and reliability that needs to be considered when imposing regulations (Scott, 2012). When information asymmetry is present, investor faith decreases, compromising the efficiency of the market. In order to prevent market failures, it is critical to maintain investor confidence; this can be done by achieving high audit quality. Definition The PCAOB defines audit quality as providing “independent and reliable audits” regarding management’s financial statements, internal controls and potential threat for going concerns (PCAOB, 2013). Four key aspects of audit quality include independence, objectivity, skepticism, and competence. Maintaining and improving the four elements is critical to increasing audit quality and the usefulness of the information provided. Independence According to the PCAOB Auditing Standards, auditors should maintain independent mental attitudes. Independence is defined by the AICPA Code of Professional Conduct as independence of both, mind and appearance. Independence of mind requires the auditor to act with integrity, free of outside influence whereas independence of appearance requires the avoidance of situations leading to potential conflict of interests. Unless, the auditor is truly independent, the...
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...Mandatory Audit Rotation Introduction In 2002, Enron became the largest case of fraud in history. It caused it investors to lose sixty billion dollars, two million two hundred thousand in pension plans, and five thousand six hundred jobs (Enron Sentences Will Be Tied to Investor Losses). This all could have been avoided if public companies were forced to changed independent auditors every five years. Throughout this paper, I will be talking about mandatory audit rotation and why I think it is a great idea. First I will talk about the Sarbanes Oxley act and what it requires when it comes to partner rotation. It is important to know what the current rules and requirements are before we discuss how they should be changed. The next item I will discuss is auditor independence and how it is affected by audit rotation. After I talk about the current rules and independence, I will discuss the advantages and disadvantages of mandatory audit rotation. Sarbanes-Oxley Act In 2002, President George W. Bush signed the Sarbanes-Oxley Act of 2002 to protect investors from the possibility of fraudulent activities by corporations. This act was aimed to improve financial statements of corporations and prevent fraud. In section 203 of the Sarbanes-Oxley Act, it gives the requirements of partner rotation. “The new rules provide that an accounting firm will not be independent if either the lead audit partner or the concurring partner performs audit services for more than five consecutive...
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...Mandatory Auditor Rotation Policy Through the course of an audit, auditors are constantly faced with pressure from the client regarding financial reporting and other issues that may arise. Clients can threaten to terminate the auditor, resulting in lost fees and tarnished reputations as the firm tries to pursue future clients. In these cases, partner evaluations can be negatively affected since they are judged based on hours billed and the number of clients they are able to secure. Mandatory auditor rotation is defined as the obligation to limit the number of years during which the accounting firm may be the auditor of record for a client. The Public Company Accounting Oversight Board (PCAOB) is a strong advocate in favor of mandatory auditor rotation, while a majority of accounting firms are opposed to the idea. Problems are more likely to develop in the initial years of the audit relationship (fraud and bankruptcy) when the auditor tries to gain as much knowledge as possible about the client. According to an American Institute of Certified Public Accountants (AICPA) study (Church and Zhang 2006, page 3), audit failures are three times more likely to occur in the first two years of the auditor-client engagement. Auditor rotations have never been mandated in the United States, and I believe this should continue in the future due to the high costs and decreased auditor effectiveness that would result from continual changes in the auditor-client relationships. There...
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...An Examination of Partner Perceptions of Partner Rotation: Direct and Indirect Consequences to Audit Quality Key Points: * In order to improve audit quality by making auditors more independent, regulators mandate partner rotation and cooling-off periods. Specifically, partners would be required to rotate off to another client every five years. As stated in the article, rotation improves independence resulting in a positive impact on audit quality. * However, more often than not, partners would much rather enter a new industry than relocate to preserve their quality of life. Most partners opt to retrain rather than relocate, thus affecting audit quality negatively. Based on the findings described in the article, 93% of audit partners reported needing at least two years to become fully effective in a new engagement. Even partners who stay within the same industry line need some time to get used to differing information technology and other processing systems, client personnel, corporate governance characteristics, and the time it takes to gain client trust at the senior management and board levels. * There are some costs related to rotations, and a cost-benefit analysis should be performed. With that said, it might be hard to quantify the costs and benefits of this situation. How do you weigh the improvement in audit quality due to independence against its decline due to a lag in audit effectiveness (resulting from either a change in client or a change in industry...
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...academicjournals.org/JAT Journal of Accounting and Taxation Full Length Research Paper Auditors’ perceptions on impact of mandatory audit firm rotation on auditor independence –Evidence from Bahrain Kousay Said* and Hussein Khasharmeh Department of Accounting, College of Business Administration, University of Bahrain, P.O. Box: 32038, Kingdom of Bahrain. st th Received 21 November 2013; Accepted 13 February 2014; Published April 2014 The current study examined several issues regarding auditor independence from the perspective of an emerging market such as Bahrain. Factors affecting the ability of auditors to remain independent include long audit tenure, financial dependence on a single audit client, non-audit services provided to audit clients, ex-auditor employment with an audit client and the existence of audit committees. It is therefore timely to examine the importance of auditor independence in the provision of reliable and credible financial information. The current study uses a questionnaire survey to examine auditors’ perceptions of the impact of mandatory audit firm rotation on auditor independence. The results of the study revealed that the majority of auditors agreed that MAR could safeguard auditor independence. The results also reveal that there is a significant relationship between mandatory audit firm rotation and auditor independence. Analyses of variance (ANOVA) were also conducted to test for the possibility of confounding effects arising...
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...Position Paper I agree that audit partner rotation is necessary and sufficient to best serve the accounting/audit profession and investors. Based on the downfalls of companies such as Enron, WorldCom, Tyco International, and a few others, it is essential companies have a rotational auditing system. In the past, companies have had minimal financial regulations, which probably contributed to companies rearranging numbers so nonchalantly. However, that all changed in 2002 with the introduction of the Sarbanes-Oxley Act (SOX). The act was introduced in response to continuous financial scandals that affected numerous investors. Companies were faced with harsher regulations which required each auditing committee to have one financial expert and that auditors rotate from the audit every five years. During the audit, Auditors must interact with management on a daily basis. Some sort of relationship has to form no matter how long the audit takes place. A client must feel comfortable with an auditor and be willing to share information and discuss the problems that exist. While auditors must always maintain a level of professional skepticism, this auditor-client communication is often a function of mutual experience. This is could be beneficial for both parties. If an auditor has familiarity with a company it makes the audit a smooth and understanding process. Having performed the prior-year audit often produces significant benefits that increase audit effectiveness. It is very difficult...
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...corporate setting. The division of accounting most affected by this scandal was the role and function of the external auditors. Auditors by trade serve in the public and stockholders interest. Furthermore, the independence of auditors is essential in performing their duties properly. As a result, which practices are needed to achieve total independence? Moreover, how do we weigh the cost of financial misstatements with the cost of redundancy due to rotation of audit firms? Demanding public companies to rotate their audit firms may appear reasonable on paper, however, this rotation brings more concerns than answers. Currently in the auditing of publicly held companies, lead audit partners are required to rotate of audits every five years. This ruling was enacted from the Sarbanes- Oxley Act of 2002 (SOX). Also, SOX requires a 1-year cooling off period if the Chief Executive Officer (CEO), Chief Financial Officer (CFO), controller, etc. was previously employed by and participated in the audit one year prior to the start of the audit. These laws were passed to promote auditor independence, yet some professionals argue this may not be enough. In 2012, the Public Company Accounting Oversight Board (PCAOB) investigated the concept of requiring United States public companies to change their auditors every few years. This concept was never passed however the PCAOB encountered numerous backlashes from CFOs of publicly traded companies in the U.S.. In October...
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...1666 K Street, NW Washington, D.C. 20006 Telephone: (202) 207-9100 Facsimile: (202) 862-8430 www.pcaobus.org ) CONCEPT RELEASE ON AUDITOR ) INDEPENDENCE AND AUDIT FIRM ) ROTATION; ) ) NOTICE OF ROUNDTABLE ) ) PCAOB Release No. 2011-006 August 16, 2011 PCAOB Rulemaking Docket Matter No. 37 Summary: The Public Company Accounting Oversight Board ("PCAOB" or "Board") is issuing a concept release to solicit public comment on ways that auditor independence, objectivity and professional skepticism could be enhanced. One possible approach on which the Board is seeking comment is mandatory audit firm rotation, which is explored in detail in this release. However, the Board seeks advice and comment on other approaches as well. The Board will also convene a public roundtable meeting in March 2012, at which interested persons will present their views. Additional details about the roundtable will be announced at a later date. Public Comment: Interested persons may submit written comments to the Board. Such comments should be sent to the Office of the Secretary, PCAOB, 1666 K Street, N.W., Washington, D.C. 20006-2803. Comments also may be submitted by e-mail to comments@pcaobus.org or through the Board's Web site at www.pcaobus.org. All comments should refer to PCAOB Rulemaking Docket Matter No. 37 in the subject or reference line. Comments should be received by the Board no later than 5:00 PM EST on December 14, 2011. Board Contacts: Martin F. Baumann, Chief Auditor...
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...Audit – a long-term investor position paper on proposed EU reforms 22 November 2012 Context The signatories to this paper are large institutional investors and investor associations. The institutions manage approximately EUR 1.66 trillion on behalf of their members / investors. We are all long term investors who take our ownership responsibilities seriously, investing significant resources and time in securing, monitoring and voting our assets. Financial reports provide vital information for us to be able to monitor executives’ use of our capital, and the audit of annual statements offers an essential assurance that information in company accounts is ‘true and fair’ (as required by the 4th and 7th Accounting Directives of the EC). The quality of the audit is, therefore, of utmost importance. We believe there are a number of worrying features of the audit market. At a very fundamental level, we are concerned about auditor independence and professional scepticism. Potential conflicts of interest have always been present in the system of auditing, so the challenge is how these are managed. We believe the current system is not delivering, as evidenced by: The failure of auditors to provide adequate warnings prior to the collapse of a number of banks and insurers in the financial crisis. In the EU alone, between September 2008 and the end of 2010, 182 banks received liquidity aid and/or debt guarantees, and 114 banks received either capital injections or asset relief aid1. None of...
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...Mandatory Audit Firm Rotation Mandatory audit firm rotation has been discussed by different accounting boards numerous times since the 1970s. Mandatory audit firm rotation would cause auditing firms to change clients after a certain amount of years with the client. The Public Company Accounting Oversight Board (PCAOB) has recently opened a discussion on audit firm rotation because the Board is concerned about the many problems that have come up on different auditing reports made by top auditing firms. PCAOB is concerned with auditor independence because they feel that it is being compromised as different firms continue to stay with particular clients for extended periods of time. This paper is going to discuss auditor independence and its effect on audit opinion, the history of audit firm rotation, and the advantages and disadvantages of audit firm rotation because it is a solution that is being considered. According to the PCAOB auditor independence is a description of the relationship between auditor and client and the mindset with which the auditor must approach his or her work. A measure for the mindset is the auditor’s ability to exercise professional skepticism, which is an attitude that includes a questioning mind and a critical assessment of audit evidence. For the last eight years the Board conducted annual inspections of the largest audit firms and found that more than 2,800 of the firm’s engagements were audit failures. An audit failure is a failure to obtain reasonable...
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...the supports “Mandatory Auditor Rotation”: Auditor independence is widely considered one of the main causes for the occurrence of accounting fraud and in 2003 congress considered mandatory audit firm rotation as a possible solution. The ruling congress gave was in favor of mandatory audit engagement partner rotation. The reasoning behind the ruling was the surprising lack of evidence found supporting mandatory audit firm rotation as the best solution to improve auditor independence. If mandatory audit firm rotation were passed by congress, auditor independence is likely to improve, however the consequences may not be exactly as anticipated. Audit firms will be further obligated to perform ethical and appropriate work since the next auditor will deeply examine their work. The vast majority of accounting fraud cases in the past have occurred after several years of a company being audited by the same audit firm. The auditor client long-term relationship clearly impairs the auditor independence but is mandatory audit rotation the best solution for auditor independence? We do not agree with mandatory audit firm rotation as the appropriate solution to strengthening auditor independence. Studies have shown that countries requiring mandatory audit firm rotation show little to no evidence that it improves auditor independence. An auditor’s familiarity with the business and the industry in which it operates is essential to the quality of the audit. While accumulating this knowledge...
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...Discussion What are the main duties of each of the positions that comprise Abernethy and Chapman’s engagement team? Abernethy and Chapman’s engagement team comprises of a partner-in-charge, a manager, a senior auditor, and one or more staff auditors. The partner-in-charge leads the engagement team and is responsible for all final decisions made while conducting the audit. The manager, senior auditor, and staff auditors are to perform the actual audit examination. The engagement team’s responsibility is to complete the audit with competency and objectivity. What is the purpose of having both a partner-in-charge and a consulting partner on each audit engagement? Should the partners be rotated periodically? Why or why not? The partner-in-charge is responsible for leading the engagement team through the audit and making decisions during the process. The partner is responsible for reviewing the team’s final work, monitoring quality control standards and maintaining the human-resource policies of the firm. It is required that partners rotate periodically. Auditing & Assurance Services states “as required by the Sarbanes-Oxley Act, the SEC independence rules require the lead and concurring audit partner to rotate off the audit engagement after five years.” (Arens, Elder, and Beasley, 2014, pg. 89) Can an accounting firm hope to accrue any real benefit from a marketing campaign such as the one carried out by Abernethy and Chapman? Should the management of a company select its auditors...
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...problem was through the CEO Monus, who owned at least 60% of the 10 teams of the Worlds Basket Ball Leagues. It is a problem because the CEO was estimated to have embezzled $15 million in the corporation’s assets to support the teams. There are a number of other fraudulent factors involved that have increased the amount of fraud to 500 million! If SOX was enacted in 1992, then it would have helped in the following manner: Section 203, Audit Partner Rotation: “The new rules impose more rigorous standards of independence for the external auditors of SEC reporting companies (including foreign private issuers) than under existing SEC rules that existed” at the time of the Phar-Mor Inc scandal( Lansing, 2011 ). This also required more frequent partner rotation off an audit engagement team. If Coopers and Lybrand were not auditing Phar-Mor Inc on a continuous basis, meaning for a period of less than five years then maybe the new auditing partner could have detected the fictitious inventory that existed in other stores. Using the same auditing partner can lead to complacent and conflict of interest. Another Section that could have helped is Section 206, conflict of interest which states that it is unlawful for a “chief executive officer, controller, chief...
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...accounts that were allocated to inventory at the year end. Those that took part of the fraud consists of Michael Monus, the president; Patrick Finn, the chief financial officer; Jeffrey Walley, vice president of finance; Stanley Cherelstein, the controller; and John Anderson, the accounting manager. Finn, Walley and Cherelstein are all former auditors of the accounting firm, Coopers & Lybrand, which performs audit services for Phar-Mor Inc. There are five specific sections of SOX that could have prevented the Phar-Mor fraud. These five sections are: Title II, section 203, “Audit Partner Rotation.”; Title II, section 206, “Conflicts of Interest.”; Title III, section 302, “Corporate Responsibility for Financial Reports.”; Title IV, section 404, “Management Assessment of Internal Controls.”; and, Title IV, section 406, “Code of Ethics for Senior Financial Officers.” If SOX was in placed, Coopers and Lybrand would have been replaced due to the audit partner rotation regulation. Finn, Walley, and Cherelstein had all worked for Coopers and Lybrand, they were familiar with the routine audit steps, which had helped them in covering up the...
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...Mandatory Firm Rotation Background With the fast advent of globalization, countries, regions and governments have become more interdependent. Companies all over the world including small- and medium-sized entities work together and across geographies to attain sustainable growth. With the world becoming more borderless, it is then imperative that a strong financial planning must be made available for universal adoption. The international business environment relies on unbiased, clear, consistent, relevant and high quality standards. The task to develop and review internationally accepted standards was given to accounting councils and organizations such as IFRS Advisory Council and the Public Company Accounting Oversight Board (PCAOB). With the shared thoughts for a better and universally applicable accounting, accounting-related boards and councils, managers and accountants all over the world constantly review existing standards and examine its implementation. One issue that has been a hot topic of recent debates is the concept of Mandatory Audit Firm Rotation that was released by the PCAOB (TYSIAC, 2012). The Issue The conception of mandatory firm rotation is not fresh and was even considered by the U.S. Congress in the Sarbanes-Oxley Act. The Congress however dismissed the concept in favor of the mandatory engagement partner rotation (Point of View, 2012). However, years after the conception of mandatory firm rotation was revived. Last August 16, a concept release...
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