Audit Rotation Best Practices

IMGCAP(1)]For publicly traded companies, the audit process is among the more arduous and mundane of all corporate responsibilities.

It claims the precious time and attention of senior executives and is neither strategic nor contributory to company profits or shareholder value. And in the Sarbanes-Oxley era of tightened corporate governance—in the wake of Enron, MCI WorldCom, Tyco and other such scandals—the audit process has only grown in dizzying intensity, prompting an exodus of senior in-house accounting and financial executives to private companies.

But despite the enhanced governance requirements of the last decade, audit quality continues to slip. The Public Company Accounting Oversight Board continues to find deficiencies in audits conducted by the Big Four. In a recent Wall Street Journal article, the chief auditor at the PCAOB stated, “When we look at an audit, the rate of failure has been in a range of around 35 to 40 percent.”

Competition in the audit market has all but disappeared. In the U.K., the Big Four accounting firms hold the auditing business for 99 percent of FTSE 100 companies. In the U.S., those same four companies collected over 94 percent of all auditing fees in 2010. This is certainly not what trust buster Teddy Roosevelt had in mind.

In the interests of improving audit quality, guarding against early 2000s-style corporate scandals and protecting the investor, regulatory authorities around the world are looking at both the audit market and the relationship between company and auditor and are implementing mandatory audit rotation. That is, a legal requirement that companies put up for tender and potentially change their auditor every number of years. The European Union has already enacted such regulation, requiring most companies to put their audit business up for bid every 10 years. And there is a growing clamor for similar regulation in the U.S.

Companies typically retain relationships with their auditors for decades and are loathe to go through the process of putting their auditing business up for tender. It’s easy to understand why. The auditing of a large publicly traded company requires hours of time commitment from both the auditors and the company itself, as well as an understanding of the nuances of the company’s business, operational norms and habits. The process of soliciting and then on-boarding a new auditor is time consuming and could conceivably distract from core business duties.

But it doesn’t have to be. Many companies, particularly those in the E.U., will be engaging in this process for the first time. Finding the right auditor and getting it right the first time is of paramount important. As we have seen somewhat recently, partnering with the wrong auditor could result in mistakes that could have a deleterious impact on business, shareholder value and brand.

With all that in mind, here are some best practices to consider and follow when tendering your audit business:

Understand What You Really Want
With the understanding that quality and costs are not likely to be differentiating factors, it is critical for the management team to identify the basis upon which a decision will be made. Relationships, quality of service, insight, advice and value-added services should all be part of that consideration.

Identifying which of these elements are a priority and then drilling down to arrive at an interpretation and baseline for measurement is key. Once those determinations have been made and priorities set, bidders should be challenged with questions focusing on their experience and understanding of your market, providing examples of how they have approached matters in the past that might relate directly to your business.

Consider the Big Picture
Most large publicly traded organizations are likely to have existing relationships in some form with at least one, and maybe all, of the Big Four. Given that it is unlikely a Big Four auditor will decline to bid, consider what impact entering into an auditing relationship might have on other relationship areas.

The value of advisory, project management or even IT-related relationships may ultimately be more valuable than audit. With this in mind, it might make sense to explore auditors outside the Big Four, companies with whom there is less likely to be conflict and who are hungry to break the oligopoly of the Big Four. Some may surprise you with the level of attention, service and quality they can offer.

Sell Yourself
Everyone wants to have the “A Team” working on your account. For this reason, companies tendering their business need to realize that the providers themselves have a choice about where to invest their best resources and people.

If you want access to those premium resources, you will need to market yourself as the most attractive potential client on the block, focusing on brand credibility, ease of working relationship, flexibility or ability to nicely fill a gap in the provider’s portfolio. Whatever it is, companies need to identify that which will make them a preferred client.

Take Your Time
The actual audit tender process can be managed very quickly. It’s quite normal for the final award to be made shortly after final presentations. Both parties usually agree to terms far more quickly than in a traditional contact. However, the need for speed should not supersede careful planning that is required to get the most out of those final presentations and arrive at the right partner.

Questions should be considered regarding how each candidate fits with the organization’s strategic direction, not just today but for the longer term. Decision makers, who usually are very senior individuals with hectic schedules, should make themselves available to the process to address these questions and also so the bidder can appropriately understand the business. Slowing down the process to ensure the bidders have the needed access to key finance management, C-suite members and the opportunity to review key financial data will ultimately result in more fruitful presentations and an easier path to choosing a new provider.

Get Real
Once appointed, the auditors will get to see everything about the business, warts and all. So there is little point in withholding information during the tender process. Holding back on information during the tender process has the potential to cause problems and undermine the relationship from the very start.

Without doubt, the very idea of initiating an audit review and tendering process can be stress inducing. But it is a reality, especially for companies in the E.U. By following the outlined basic principles and practices, companies may find themselves arriving at a new relationship with a more attentive, motivated and service-oriented provider, ultimately rendering the process highly worthwhile.

Jonathan Cooper-Bagnall is EVP and commercial director leading Proxima’s commercial strategy in the U.S. Proxima is a global procurement services provider offering an alternative approach to conventional in-house procurement and helps companies align their organization’s third-party costs with their corporate aims.

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