Ethical Auditor: Independence vs Rotation

Rotation

My previous post on ethics was rather popular, which gives me reasons to suggest that people are interested in auditors’ behavior and their place in business culture. Last week The Economist published interesting article about independence of auditors. Here are very appealing facts in the article:

    “… 1896 was also the year that Barclays, a British bank, chose an ancestor of PwC as its auditor, a relationship unbroken to this day. Fidelity is the norm in auditing. GE, Procter & Gamble and Dow Chemical have also clocked up centuries with their auditors. The average tenure for an auditor of a British FTSE 100 company is 48 years. Two-thirds of Germany’s DAX 30 have had their auditors for over 20 years.”

There are several opinions presented in article, one of which suggests that to address the issue it necessary to impose audit firm rotation. After reading I decided to discuss independence, because it is quite disputable area.

Current Situation: Partner Rotation

The literature on audit states that there is familiarity threat, which could arise between staff of audit firm and client. The risk is that auditor would lose professional scepticism because of too close relations with client. To address this issue official documents like SOX (in USA) and accounting codes like ACCA Code of Ethics and Conduct set specific requirements on audit partners rotation in case of dealing with listed (or public interest) clients. The requirements are as follows:

1.  Engagement partner should be rotated after 5 years;

2.    Other key audit partners should be rotated after 7 years;

3.    Partner responsible for quality control should be rotated after 7 years

However, current talks about rotation of firm suggest that above measures are not enough to provide independent audit opinion.

Who to Decide

Now we are coming to the point of appointing auditors on top management level. As known auditors, which expected to be appointed have to be approved by shareholders on annual general meetings. If shareholders did it for 100 years as in above case with Barclays then it all right. They bear all risks of such appointment and they should have understood it. 

However, in current stakeholder theory – shareholders are not the only persons who are affected by activity of listed Company. If it is “public interest entity” then the potential effect on other members of public gives right to public to interfere in the process of auditor appointment. I wrote about it in previous post considering proposals of European Commission on extra audit regulations.

The appointment of auditor becomes especially significant in case of financial institutions in our days as panic on market related with bankruptcies might jeopardize whole economy.

More Regulation – Better Results?

The above article gives example of number of studies which founded that rotations do not necessary results increase of audit quality. On the contrary, because of lack of client knowledge the quality might deteriorate. On the other hand, then it would be necessary to establish special rules for information transfer between auditors to provide better client understanding. The third point is that all these regulation might become too huge for auditors and add much more to existing bureaucracy in our profession.

What are your ideas in this issue, please share your thoughts in comments.