Mandatory Auditor Rotation: a Way for Regulator to Prevent Audit Failures?

Exceptions can be approved by the Board and are made in cases where the revenue paid for such services contributes less than 5% of revenues paid to the auditing firm. Also, a public accounting firm may provide these non-audit services along with audit services if it is pre-approved by the audit committee of the public company. The audit committee will disclose to investors in periodic reports its decision to approve the performance of non-audit services and audit services by the same accounting firm. This requirement to disclose to investors is likely to inhibit auditing committees from approving the performance of auditing and non-auditing services by the same accounting firm. Other sections outline audit partner rotations, accounting firm reporting procedures, and executive officer independence. Specifically, subsection 206 states that the CEO, Controller, CFO, Chief Accounting Officer or similarly positioned employees cannot have been employed by the company's audit firm for one year prior to the audit.

We find no difference in audit quality between these two samples. Second, we compare the mandatory rotation sample with itself one year earlier (2003) (the mandatory rotation sample in the prior year). We find that the audit quality of companies in the mandatory rotation sample under new audit partners is lower than the audit quality of these same companies one year earlier under old audit partners. Third, we compare our mandatory rotation sample with companies in years before 2003 whose audit partners were voluntarily rotated within the same audit firm (the voluntary rotation sample). We again find no difference in audit quality between these two samples. In sum, we find no support for the belief that mandatory audit partner rotation enhances audit quality. Our findings are robust to various sensitivity checks. Next, we examine the effect of mandatory audit partner rotation on investor perceptions of audit quality, using the earnings response coefficient (ERC) as a proxy for perceived audit quality (Teoh and Wong 1993; Ghosh and Moon 2005), After controlling for common determinants of the ERC, we find that the ERC of the mandatory rotation sample is not significantly different from that of the nonrotation sample or that of the mandatory rotation sample in the prior year, but is significantly larger than the ERC of the voluntary rotation sample. Overall, we find no consistent support for the belief that mandatory

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

The rules regarding auditing can be viewed as a double-edged sword. Firms have to cannot be audited by the same auditors after 5 years of being audited by any particular firm. (SARBANES-OXLEY , 2006)This is intended to have the auditing firms be more independent of the firm it is auditing. In addition, provisions have been put in place regarding when and how an individual who worked at an auditing firm could work at a firm at which they participated in an external audit. This can lead to a significant cost increase at some

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

In light of a number of high-profile corporate failures during the first half of 2001, a number of studies have been performed to address the impact of mandatory rotation of audit firms to ensure the appropriate level of ‘independence ' of auditors. Majority of studies conclude that the detrimental effects of firm rotation on the quality of the audit work by far outweigh its positive effects as a safeguard against various independence and quality threats.

The importance of audit committees increased through the years and especially from pre-Sarbanes – Oxley to post-Sarbanes – Oxley. Although, what are the responsibilities of the audit committee members? How does a Chief Audit Executive (CAE) more effectively serve their audit committee members? How do auditors communicate with audit committees? What are the requirements for audit committees? Most of these questions are inherited from what the audit committee’s best practices are.

The Public Company Accounting Oversight Board (PCAOB) was established as a result of corporate scandals that led to the passing of the Sarbanes-Oxley Act of 2002. This paper will explore the circumstances that led to the creation of the PCAOB. I will then go on to discuss the roles and responsibilities of the PCAOB, and suggestions for improvement of the PCAOB auditing process.

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

The services provided by auditors can have a far-reaching influence. For many years, investors have relied on audited financial statements to make sound investment decisions. Thus, auditors are obliged to protect the interests of investors, taking on the role of gatekeepers (Kane, 2004). In recent years, countries around the world have witnessed examples of corporate fraud. The Sarbanes-Oxley Act, passed by the US Congress in the wake of such scandals, is considered the most influential act with the greatest impact on auditing professionals. This is an example of a government’s attempt to halt corporate fraud by improving corporate governance and strengthening the function of auditing, as a means to restore trust. However, quality and integrity

Independence is considered to be one of the most discussed in accounting literature and is considered to be comprised of two parts (Humphrey, 2008). The first is organizational independence which refers to the auditors willingness to comply with professional standards (Guenin-Parcini, Malsh, Tremblay, 2015). The second aspect

If these standards are not followed there are strict consequences that could cause the loss of designation and even criminal charges. Also, small accounting firms with few clients that make up a large percentage of their income may face an even greater power imbalance between client and auditor. Recommendations such as rotating audits periodically or rotating partners within a firm every 5 years have suggested as ways of keeping independence and ensuring that the auditors are focused on job quality versus keeping the audit and getting paid. However, the best method would be if a special board were set up to investigate why auditors have been fired. If during the investigation it is revealed that disagreement occurred between management and auditors over financial statements and presentation then a third party should be involved. Although there are new accounting policies and bodies in place to restrict this power imbalance; it will never be fully eliminated.

If management can influence auditors during an audit by allowing them to use certain perks this topic is becoming more relevant. To stay competitive and attract talent more companies are shifting towards providing extracurricular benefits. This trend is exposing auditors to more on-the-job perks that can effect operational independence. Allowing auditors to use the on-site amenities provided does not hinder management and the expense would be a nominal one. The subtle use of pressure by management may force the auditor to rely on the clients situational perspective more and accept their interpretation of the

In fact, regarding the issue of firm rotation there are existing independent studies that conclude that audit firm rotation reduces audit quality and that the costs far outweigh the benefits. Research conducted separately by the Public Oversight Board, the Commission on Auditors’ Responsibilities, and the National Commission on Fraudulent Financial Reporting found that audit failures are three times more likely in the first two years of a client/auditor relationship, and that there is a positive relationship between audit firm tenure and auditor competence. There is a substantial body of academic literature that indicates the direct relationship between the length of auditor tenure and the increased discovery of material financial statement errors.

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.