Audit rotation policy good for companies

Rotation, a controversial policy when applied to the All Blacks, has much to recommend it when it comes to audit partners checking companies’ books.

While businesses generally show a reluctance to change outright the firms who audit them, rotation of the actual partners of an incumbent audit firm is a desirable practice. Essentially, partner rotation is an appropriate and necessary safeguard against undue familiarity.

Yet there are also dangers in rotation. The actual period between rotations has to be carefully balanced, and there needs to be a compromise.

If the rotation period is too long, then the risk of undue familiarity over time is increased. The converse argument is that if the period is too short there is less time for any audit engagement partner to become truly familiar with the client’s business, and the particular audit and financial reporting issues involved.

There is evidence (from independent surveys) that the greatest risk of “audit failure” occurs in the immediate years after partner rotation has occurred, so getting the balance right is important. The Grant Thornton view is that the regime recommended by the International Federation of Accountants, the global organisation for the accountancy profession, is about right – seven years on, two years off.

Short rotation periods may hinder or defer effective handover to the incoming partner. And, in our experience, frauds are more likely to be revealed when someone at the company whose accounts are under review has enough trust in the audit team to pass them relevant information.

This trust factor is particularly important given that a Grant Thornton International Business Report survey last year showed that less than a third of New Zealand’s privately-owned businesses have measures in place to accommodate potential whistleblowers (the figure is low compared with the global average in the survey, which was 45%).

The audit process, therefore, becomes all the more important in pinpointing irregularities.
The question arises that, if audit partner rotation is a good idea, why not simply change out the audit firm? Some jurisdictions hold the view that audit firm rotations should be mandatory, particularly when applied to the banking and insurance sector.

However, the counter-argument is that mandatory audit firm rotation is inappropriate because, among other things:

Frequent rotation risks increasing costs for companies in the long term;
For the same reasons as expressed against over-rotation of audit partners, mandatory rotation of audit firms heightens the risk of audit failure before the auditor builds knowledge;
It reduces auditor choice in specialist industries where firms from an already restricted list of industry-familiar auditors are more often conflicted.

The debate about mandatory audit firm rotation, of course, takes nothing away from the separate argument that it is healthy for big companies to look outside the Big Four (*Deloitte, Ernst & Young, KPMG and PricewaterhouseCoopers) towards other international audit firms, when it comes to considering the annual appointment of their auditors.

For further information, contact:

Chris Dixon
Grant Thornton
Auckland
T 09 308-2971
E cdixon@gtak.co.nz