Mandatory Audit Rotation and Audit Independence

This article discusses the current mandatory audit rotation legislation and audit independence, and explores various alternative suggestions to increase independence. It analyzes the motivations for the changes and critiques whether they are likely to be effective. The article also examines the likely impact of firm audit rotation on auditor independence.

Mandatory Audit Rotation and Audit Independence 1
MANDATORY AUDIT ROTATION AND AUDIT INDEPENDENCE
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MANDATORY AUDIT ROTATION AND AUDIT INDEPENDENCE
Question one:
1.0 Key changes to audit firm rotation and alternative suggestions to improve
auditor independence
1.1 Key changes to the rotation
The current mandatory audit rotation legislation and audit independence have
created an intense debate with various alternative suggestion to increase the independence
being brought to light. In relation to the audit independence PCAOB in the year 2011
released concern to the public to give their opinions on the effective and efficient vehicles to
improve audit client independence. PCAOB suggests, mandatory audit rotation among other
alternative ways in which audit firms should observe while dealing with publicly traded
companies (Aschauer and Quick 2018). This is a significant change compared to the previous
days where audit rotation was not a must obligation for audit and accounting firms. The
publicly traded company based on the new laws must change their statutory auditors after a
specified period. This is entirely different from the previous time where a company could
have one audit firm for as long as they could be in good terms.
However, this system has changed as various accounting management boards in
multiple nations believe that long audit client contracts lead to familiarity as well as
relationships between client and the legal audit firm which faults the ability of an audit firm
to remain skeptical. The legislation regarding audit change requires firms to change the audit
firms in ten years, and this is set to take a course in the year 2016 (Cameran, Prencipe, and
Trombetta 2016). The rotation law, on the other hand, allows firms are dealing with joint
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audit firms with a contract tenure which would enable them to have same audit firms for as
long as 24 years. Further, the audit rotation law also restricted contractual obligations related
to banking agreements which may involve the big four audit firms.
1.2 Alternative suggestions
While audit rotation takes the lead as the most appropriate way to increase the audit
independence, there are various alternative solutions which can be used to improve the audit
independence, and effective auditing are being proposed by multiple organization and
financial control groups. Through the analysis of a study done in the US showed that the
American accounting firms suggest that an alternative method of increasing the audit
independence and functionality is trough retooling audit committees of publicly traded
companies in order to strengthen them to make sure that there is client-auditor independence
(Francis 2014). Apart from enhancing the audit oversight to the committee, other solutions to
audit independence include prevention of auditors’ involvement in non-audit tasks as well as
coming up with an independent committee within the client firm with the mandate of hiring
and firing auditor. Most the existing alternatives are believed to work better than mandatory
audit rotation for publicly traded companies.
Question two:
2.0 Motivations for the changes and critique whether these changes are likely to
effective
Audit independence is critical for organizations more so in publicly trading
companies as it will increase perfect auditing which is not influenced by any motive. As
already mentioned above, various stakeholders as well as accounting and audit oversight
bodies believe that long term audit-client contracts leads to reduced audit independecnce.
They support mandtaory audit rotation which they term as the most appropriate way that the
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client –audit familiarity as well as relationships between client and the statutory audit firm
faulting the ability of an audit firm to remain skeptical in their work can be reduced. Further,
the motivation for mandatory audit rotation is the effect of long-term audit relationship on the
firms with significant revenue and material base (Kwon, Lim and Simnett 2014). Moreover,
various stakeholders believe that mandatory audit rotation enhances audit independence,
professional skepticism, and objectivity which arise from new eye potential and potentiality
which is developed with time as well as increase work quality.
However, accounting, as well as the auditors, show limited support to the mandatory
audit rotation regulation which they believe that cannot lead to improving audit quality.
Accounting firms argue that even though audit mandatory leads increases audit
independence, it does not meet the objectivity and skepticism (Lennox, Wu, and Zhang
2014). This because the new auditors always lack experience and proper knowledge of the
client as well as the various financial operation of the client firm and this will reduce the
work quality and waste of time as new audit firm takes time to learn about the firm. Likewise,
mandatory audit rotation will result in the steep learning curve and loss of knowledge of the
client firm. The lack of understanding by an auditor on the firm or the client is also
disadvantageous and is likely to lower quality of audits and the role being performed by the
audit committee as well as their influence and control of the auditors.
Question three:
3.0 The likely impact of the firm audit rotation on auditor independence
The mandatory audit rotation have both negative and positive impact on both audit
firm and the client firm. However, mandatory audit rotation legislature has a positive effect
on the auditor independence. The mandatory audit policy which is currently being adopted
by various helps with enhancement of audit independence by reducing the period of audit-
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client engagement. By reducing the period of the contract, the rate of familiarity and close
relationship between the audit firm and the client reduces allowing the auditors to work in a
more independent way (Reedy and Officer 2011). Periodic rotation also limits the close
relationship between the audit firm management and the company management team thus
limits the possibility of client firms offering non-audit duties to the audit firm.
In addition, the mandatory audit rotation results in new faces performing the audits for
a client. This improves the independence as there is a limited relationship between the audit
team and the client which may course fear or inability to work based on the original
relationships (Tepalagul and Lin 2015). In summary, the mandatory audit rotation has a
positive impact on the auditor independence as it reduces the long-term service relationship
which is always the cause reduced independence between auditors and their client.
Nevertheless, mandatory audits have a negative impact on the client as it results in additional
cost which the client firm must occur to comply with the rotation law.
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References
Aschauer, E. and Quick, R., 2018. Mandatory audit firm rotation and prohibition of audit
firm‐provided tax services: Evidence from investment consultants’ perceptions. International
Journal of Auditing.
Cameran, M., Prencipe, A. and Trombetta, M., 2016. Mandatory audit firm rotation and audit
quality. European accounting review, 25(1), pp.35-58.
Francis, J.R., 2014. What do we know about audit quality?. The British accounting
review, 36(4), pp.345-368.
Kwon, S.Y., Lim, Y. and Simnett, R., 2014. The effect of mandatory audit firm rotation on
audit quality and audit fees: Empirical evidence from the Korean audit market. Auditing: A
Journal of Practice & Theory, 33(4), pp.167-196.
Lennox, C.S., Wu, X. and Zhang, T., 2014. Does mandatory rotation of audit partners
improve audit quality?. The accounting review, 89(5), pp.1775-1803.
Reedy, T.W. and Officer, C.F., 2011. RE: Concept Release on Auditor Independence and
Audit Firm Rotation, PCAOB Rulemaking Docket Matter No. 37.
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Tepalagul, N. and Lin, L., 2015. Auditor independence and audit quality: A literature
review. Journal of Accounting, Auditing & Finance, 30(1), pp.101-121.
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