March 5, 2021

Accounting Board to Seek Comments on Rotating Auditors

The regulatory body, the Public Company Accounting Oversight Board, voted unanimously to seek comment over the next four months on a concept known as mandatory audit firm rotation. The practice would limit the number of consecutive years that an accounting firm could audit the books of a publicly traded company.

The proposal is the third significant measure that the accounting board, created in 2002 as part of the Sarbanes-Oxley Act, has begun to examine in an effort to give investors greater certainty that auditors are in fact doing their job — something that was not always clear after the 2008 financial crisis, the Enron collapse and other recent accounting failures.

“The reason to consider auditor term limits is that they may reduce the pressure auditors face to develop and protect long-term client relationships to the detriment of investors and our capital markets,” said James R. Doty, the chairman of accounting oversight board and an advocate of the idea.

In part, he said, those pressures exist because of “the fundamental conflict of the audit client paying the auditor,” which could create incentives for the auditor to render a favorable, yet misleading, opinion.

Some other members of the five-person board voiced doubts about the concept, however, saying that the cost of getting new auditors up to speed on large companies every few years would burden both the company being audited and the accounting firms.

“I have serious doubts that mandatory rotation is a practical or cost-effective way of strengthening independence,” said Daniel L. Goelzer, who is one of the board’s two certified public accountants. While he recognizes the potential for auditor bias in favor of a client, Mr. Goelzer said, “there are already powerful forces built into public company auditing to foster and maintain independence.”

The board has asked for comments on how to improve auditor independence to be submitted by Dec. 14. It also plans a public meeting to discuss the proposal in March. Any rule approved by the board also has to be approved by the Securities and Exchange Commission to take effect.

Mandatory audit firm rotation has been considered at various times since the 1970s. Most recently, in 2002, Congress considered including it in the Sarbanes-Oxley legislation, but decided instead to require a report on the topic by the General Accounting Office (now called the Government Accountability Office). The act did require auditors to rotate the partner in charge of a company’s audit every five years.

The G.A.O. report, issued in 2003, found that “mandatory audit firm rotation may not be the most efficient way to enhance auditor independence and audit quality.” Firms also estimated that first-year auditing costs would rise by 20 percent as a new auditor got up to speed on a company.

But the report also said that the board would need to consider the results of its reviews of audits and auditing firms to determine whether more needed to be done, particularly in cases where a company had used the same auditor for decades.

Steven B. Harris, a member of the accounting oversight board, said the evidence showed that the Sarbanes-Oxley measures had failed to eliminate “the strong incentives that lead some auditors to serve the interests of the company paying the bills rather than those of investors.”

Eight years of those reviews have revealed “several hundred cases” where “the firm failed to fulfill its fundamental responsibility in the audit — to obtain reasonable assurance about whether the financial statements are free of material misstatement,” according to the board’s release.

In the most recent reporting cycle, ended last year, the board’s inspectors “have also identified more issues than in prior years.”

The board is seeking comments on whether mandatory audit rotation would enhance objectivity among auditors and make them better able to resist management pressure, and if so, what would be an appropriate term length.

Also of interest to the board is whether it might require rotation only for a subset of publicly traded companies, like the largest companies; whether there are enough qualified auditors to permit giant multinational companies to change regularly; and whether the practice would lead to opinion shopping.

Considering mandatory audit rotation is one of three changes in auditing practice that the board is considering. The other proposals also are still in the early stages. One of those, which has already finished its comment period, would require accounting firms to have the partner in charge of an audit sign the firm’s report, much as a company’s executives have to attest to its financial statements.

Another, on which comments are due Sept. 30, would expand the scope of the auditor’s report, which now is little more than a boilerplate statement that the financial information fairly reflects the company’s economic condition.

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