Mandatory Audit Firm Rotation – A Literature Review
Since the passing of the Sarbanes-Oxley Act of 2002, much debate has occurred concerning mandatory auditor rotation for publicly held companies. Most corporate scandal involves dishonest or questionable accounting. This realization has brought about the priority to take more measures are taken to assure companies disclose the most reliable financial information. It is believed that a lack of auditor independence may be to blame for fraud as we have seen in recent years. The Sarbanes-Oxley Act of 2002 ordered an investigation of whether or not implementation of a mandatory auditor rotation policy could be beneficial. If this were to take effect it would require that …show more content…
Changing auditors can be very costly for companies. Research has shown that when companies change auditors, they also often end up filing a restatement shortly after. Possibly this is because it has a new set of eyes looking at the information. At any rate, these restatements are shortening the money supply of companies (Daniels, 2009).
Conversely, there are many research based arguments that support mandatory auditor rotation. Some claim that this is simply because extensive auditor tenure allows room for both auditor and clients to become lenient with policies. There has also been an ongoing concern that true auditor independence cannot be achieved because auditors are chosen and paid by the client company’s management (Raiborn, 2006).
Additionally, many times the auditors are dealing directly with those in management while conducting their audit. This relationship is thought to create a conflict of interest which makes this type of reform much more complex than a requirement to change audit firms at regular intervals. Some also believe that increase turnover of auditors could affect the quality of companies’ audits.
As stated earlier, there are increased restatements with an increase in auditor turnover. However, it is believed that if auditor rotation were adopted, over time the number of restatements should decrease as auditors will become more
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Legitimacy in accounting practices is ensured by the check and balance of having independent auditors from registered public accountant firms reviewing financial practices. The report features eleven sections and these sections pertain to accounting overview, independence of auditors to reduce interest conflicts, corporate responsibility, financial disclosures, tax returns, criminal fraud and various elements of white collar criminal activity (107th Congress
After the Enron debacle the responsibility of auditors shifted more towards fraud detection as the scandal highlighted the lack in auditing process with regards to fraud prevention since auditors were partaking in the fabrication and falsification of accounting statement. Thus auditors legitimized the falsified financial statement whether through inaptitude to properly conduct their work or conflict of interest between management and auditors. To sum this view it is important to keep in mind that researching misrepresentation within financial statement only became recently part of the auditor’s legal obligation.
In October 2001, Enron Corporation which was one of the world major energy, commodities and service companies with claimed revenues of nearly 111 billion dollars during 2000 collapsed under the weight of massive fraud in that it has become largest bankruptcy recognition in the US economy. Enron’s earning report was extremely skewed that losses were not represented in their entirety, prompting more and more wishing to participate in what seemed like a profitable company. After collapse of Enron, Auditor independence has become a social issue that weather auditor has to be independent or not. In addition, while auditing must consider matters objectively with dispassion, there were still doubts whether it implemented well. Further, there has been much speculation about the need for the mandatory rotation of auditors or audit firm rotation to warn false accounting between audit firm and client. By examining Enron case, this essay will discuss about advantages and drawbacks of the mandatory rotation of
Sec. 207. Study of mandatory rotation of registered public accounting firms, requires the Comptroller General of the United States to conduct a study on the potential effects of the mandatory rotation of auditors and submit a report within one year to the Committee on Banking, Housing, and Urban Affairs of the Senate and the Committee on Financial Services of the House of Representatives on the results of the study and review required by this
The arguments for and against mandatory rotation of audit firms fundamentally revolves around the issues of auditor independence, audit quality and increased audit costs. Compromising either auditor independence or audit quality will adversely effect the accuracy of audits performed and hence effect the shareholders ' future.
Under the Security Act of 1933 and 1944, any individual that willfully filed untrue statements should be penalized. Auditors acting behalf of the public’s interest should make sure the company’s financial statements are not misleading. All the testing and auditing procedures are to verify that the number on the financial statements, and audit testing should be supported by substantial evidence. When auditors took their responsibility for and but did not show their competence for work, they should be heavily fined because their carelessness resulted the investors making a bad decision. Furthermore, if the auditors did not take their responsibility and showed no work to support their opinions should be charged as gross negligence with a heavy fine and license taken away. If it comes down to fraud, auditors should definitely face criminal charges along with their auditing company, and their license should be taken away
As a result of the Sarbanes-Oxley Act, a variety of methods used by auditors in the past to enhance audit efficiency and effectiveness will no longer be acceptable for integrated audits of public companies. Auditors sometimes used cycle rotation to test controls, this involved testing of controls in several areas of a firm's transaction cycles while doing a transaction walk-through to confirm the absence of control changes in the remaining cycles. This practice will no longer be acceptable in public company audits, since auditors must now report comprehensively on the effectiveness of management's internal control over financial reporting on an annual basis. Due to inherent limitations of internal controls, and the risk of management override, auditors will have to perform tests of details and analytical procedures for each material account balance or class of
It is important to realize that the work as an auditor has been created in this world in order to give a fair and view on audited financial statements. A layman who wanted to make an investment will invest based on what auditor said in his report. Thus, if something bad happen in the company later, the reliability of the auditor is the first to be questioned.
This frequently puts the auditor in the position, in effect, of deciding whether a company is able to obtain the funds it needs to continue operating. Thus, the auditor’s qualification tends to be a self-fulfilling prophecy. The auditor’s expression of uncertainty about the company’s ability to continue may contribute to making it a certainty.
Auditor rotation has long been a subject of debate as a measure to prevent audit failures, especially after the financial crisis. Two types of rotation suggested are firm rotation and audit partner rotation. Mandatory auditor rotation limits the number of consecutive years that a registered public accounting firm or audit partner can serve as the auditor of a company, and is claimed to be able to enhance audit quality and reduce market concentration. The purpose of this paper is to identify, consider and evaluate the impacts of mandatory auditor rotation on audit quality and market competition and, accordingly, conclude whether mandatory
The mandatory audit partner rotation was also one of the aspect targeted by SOX and requires that every lead partner or reviewing partner must be rotated every five years in order to bring a fresh look to each engagement. A particular aspect of all this rotations is the possibility to impose mandatory rotation of registered public accounting firms. The SOX requested to the Comptroller General of the United States to conduct a study addressing this issue and the implications of this requirements. Although the PCAOB has expressed the importance of having some type of rotation in the registered CPA firms and in 2011 issued a concept release proposing mandatory audit firm rotation, some congressman like Republican Robert Hurt have taken steps in order to avoid this type of regulations and the Audit Integrity and Job Protection Act was passed by the House of Representatives in 2013. These act prohibit the mandatory rotation of registered CPA firms arguing this decision correspond to the audit committee and the shareholders of the corporation and no to regulators. In my opinion, the mandatory registered CPA firm rotation is an unnecessary burden to impose to companies, especially small corporations, that would be force to be changing constantly and without any justification of CPA firm. The current audit partner rotation in CPA firms grant that each partner is liable for the work performed by him and his team which ensures the transparency and reliability of the audit they do.
An important function of the accounting field is to provide external users of financial statements with assurance that the financial information being presented is both reliable and accurate. This basic function of accounting is so important that there is an entire field of experts, called auditors, dedicated to assuring its proper performance. Throughout history there have been many instances in which the basic equilibrium between an institution and current/potential investor has been threatened due to a lack of accountability and trust between the two parties. This issue has been the catalyst for many discussions regarding the proper procedures a firm should follow in order to provide
Since reliable financial information is essential for investors and other stakeholders to take adequate decisions, this reliability must be backed by independent review performed by independent and certified auditing firms, which are supposed to verify and certify financial statements issued by a company’s management. If the auditor is not competent and independent from management, the audit of the financial statements loses its credibility (Schelker, 2013, p.295). According to Impastato (2003), because of audit failures, accountants are to blame for investors losing billions of dollars in earnings in addition to market capitalization (as cited in Grubbs & Ethridge 2007).
The lack of independence for external auditors will lead to the neglect of auditing risks (William R.K., 2003), which are the main reasons for the failure of certified accountants and professional accounting organizations. The consequence of the external auditors deprived of independence would be very serious. And there are many cases, which aroused by the failure of external auditors and most are related to the lack of independence. One famous example is the bankruptcy of Enron and the role played by its external auditor, Arthur Andersen (Todd, S., 2003). Arthur Andersen was once one of the biggest accounting companies in the world, and was canceled for the involvement in the Enron bankruptcy scandal.