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February 6, 2011

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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