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EC AUDIT REFORM: Firms dismiss third-party appointments

There is broad consensus that audit firms should be appointed and remunerated by clients although the tendering process and role of the audit committee could be strengthened and made more transparent. 

In response to the European Commissions (EC) Green Paper on audit reform, the majority of respondents, including professional bodies, the Big Four, the mid-tier and investors, agree the decision of an auditor's appointment should remain with the client and not a third party, such as a regulator.

Some respondents argued that there is an inherent conflict of interest between auditor and client but sufficient safeguards are already in place to ensure independence.

The Big Four and the mid-tier said the role of the audit committee is the most important part of the decision making process and could be strengthened. All respondents emphasised that the audit committee, made up of independent members, should be responsible for choosing auditors and setting their remuneration.

Stamp out 'low-balling'

Academics believe audit firm choice is usually influenced by management:

"This can lead to 'low-balling' (a low price for audit in order to have profitable consulting assignments) but low-balling can be addressed by more transparency on fees paid, limited non-audit services, fixed period appointment of auditors and approval of non-audit services by shareholders or non-executive directors or supervisory boards. If non-audit services were limited, this would no longer be the case." 

Public authorities suggested that third party appointments could take place in exceptional circumstances with public interest entities. A Big Four firm narrows this down to "specific circumstances where a prudential supervisor or stock market regulator may need to appoint an audit firm to perform specific procedures in relation to the audited entity".

The Big Four have also requested the EC investigate the possibility of establishing an independent body to work with audit committees in reviewing their audit appointment procedures to ensure regular and open tendering, independence from management in setting audit remuneration and reduction in market concentration.

 

Market against mandatory audit firm rotation

The majority of firms, professional bodies, investors, academics and public authorities are against mandatory audit firm rotation.

The Big Four claim that studies have proven that the mandatory rotation of firms harms audit quality and is premature as the statutory audit directive dealing with audit partner rotation is still being implemented.

There is also the argument that it will increase costs, impair audit quality without any certainty on being able to address concentration.

At a recent International Accounting Bulletin round table of audit reform, the point was made that a company's management often changed every 5-10 years regardless of the length of the audit cycle, which means auditors deal with different client managers regularly.

Academics said it is important to ensure there is a period of overlap between old and new audit firms so information and knowledge is not lost in the transition. They also consider fixed audit partner rotation as a way of reinforcing the independence of auditors.

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