Attestation Update – A&A for CPAs

Technical stuff for CPAs providing attestation services

2 questions for those advocating mandatory auditor rotation. My research on the issue

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The post “Re-Structuring the Audit Profession: The UK’s Competition Commission Hunts the Woozle” by Jim Peterson discusses weaknesses in research behind the Commission’s conclusion that mandatory auditor rotation is necessary. He says:

Diligent digging through the Commission’s augean piles of paperwork makes clear that its ostensibly supportive “research” ranges from the shallow and irrelevant to a results-driven reflection of its confirmation bias.

Wow. Let’s unpack that:

‘Confirmation bias’ means the researchers saw only evidence that supported their opinion. A danger to CPAs as well as researchers, by the way.

‘Results-driven’ means there was a goal, with research aimed to support that goal.

‘Shallow and irrelevant’ means research is not sufficiently vigorous or pertinent to the point.

As the old saying goes, so tell me professor, what do you really think?

Here are a few of the variables the research addressed:

client size, audit complexity, geographic spread, client evolution from private to listed status, length of tenure at the start of the measured period, etc.

2 questions to ask

Here are two hugely relevant correlations Prof. Peterson says the Commission’s research did not address:

Yet, it does not attempt to examine, much less resolve, these two related but distinct questions:

  • With the considerable number of long-tenured auditor-client relationships where the record of non-controversial financial reporting is unbroken, is there any identifiable relationship between the length of auditor tenure and the incidence of diminished quality or “audit failure”?

  • As to the extremely small population of actual “audit failures” – compared to the huge number of non-problematic audits – is there any identifiable relationship between the length of auditor tenure and such failures themselves?

Let me rephrase:

First, amongst the pool of companies with long-term, stable relationships with their auditor, where are the indications of audit failures and what is the correlation between tenure and audit failure?

Seems to me there should be a rich relationship visible if long-term relationships cause audit quality to drop. Phrased differently, at what point do audit failures typically arise? Is it 10 years? 20? 30? 40? Please quantify and calculate a statistical correlation.

Second, amongst the pool of audit failures, what is the correlation to companies with long-term auditors?

Again, seems to me there ought to be a very visible, easily identifiable relationship. If long tenure leads to a decline in audit quality which leads to audit failure, then there should be a very long tenure visible in all audit failures. Again, please quantify with a correlation calc.

My research on audit failure

Here’s the results of my extensive analysis performed over the last two minutes.

There is an extremely strong correlation between audit failures and companies that have Big 4 auditors. The
statistical correlation is 99.0%, which is an exquisitely strong correlation.

Therefore, audit rotation should be required.

Of course, you might point out that I forgot to include in my research the possibly relevant issue that based on audit fees, 99% of the FTSE are audited by Big 4 firms (relationship mentioned in the article).

You might also point out that more than two minutes of research is needed to address the question.

You might also point out that I’m an auditor who intentionally is a one-person firm which might, perhaps, just maybe, create confirmation bias.

Something is broken, but not auditor tenure

Something is wrong in the audit model, particularly with the large firms. If you need more persuading, check out a report the same morning from Francine McKenna: PCAOB Criticizes Quality at PwC; Nothing Happens.

I don’t think long auditor tenure is behind the long list of problems we’ve seen – a few high visibility disasters, a larger pool of fiascos that everyone would agree is an audit failure, and a nonstop list of embarrassing situations that may or may not belong in the category of audit failure.

I seriously doubt mandatory auditor rotation will solve any of the audit quality issues. In fact, I perceive mandatory rotation will probably have serious unintended consequences.

Full disclosure – I’m intentionally a sole practitioner (with no staff) providing audits and reviews to the non-profit community. As another old saying goes, I have a dog in this fight. Filter my comments as you wish.

Ironically, I’m such a small firm that mandatory auditor rotation in the NPO world would have the impact of giving me far more work than I could ever do. I’d get to raise my rates and make a ton of money.

Written by Jim Ulvog

March 14, 2013, 8:48 am at 8:48 am

Posted in Audits

Tagged with ,

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