Auditor rotation rules could lead to dissatisfied clients

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As more companies come under pressure to rotate their auditing firms, particularly in Europe, a new report finds companies that have changed auditors may be feeling some buyer’s remorse.

The European Union passed legislation in 2014 requiring public companies to rotate auditing firms every 10 years. That period can be extended if they at least put the auditing services out for bid as part of a retendering process, or if they have joint audits done by more than one firm. The law took effect last June.

In the U.S., the Public Company Accounting Oversight also issued a 2013 concept release on a mandatory firm rotation requirement, but the concept was scrapped after the House voted in 2013 to prohibit the PCAOB from imposing such a requirement. However, there is still a requirement for audit engagement partners to be rotated every five years in the U.S., although companies can keep their auditing firms indefinitely.

A new study by U.K.-based Source Global Research indicates the U.S. may be wise not to follow Europe’s lead on mandatory audit firm rotation. The researchers surveyed 200 senior executives at U.S. corporations involved in the audit process and found a third of those who retendered audit services around two years ago were not satisfied with their auditor. They are now suffering from what the researchers call the “mid-term blues.”

The first quarter of this year saw an increase in the number of SEC registrants who changed auditors compared with the same period a year ago, the report noted. The researchers predict that as auditor rotation rises, the proportion of clients who experience a “mid-term blues” period will also increase, leading to a “vicious circle” in which clients retender their audit work more frequently, but become increasingly dissatisfied.

“The irony here is that changing auditors is designed to increase client satisfaction, but our research shows that more frequent tendering of the audit will actually reduce it,” said Source Global Research director Edward Haigh in a statement. “It will also lead to more skepticism about value because it makes it harder for firms to move into a long-term, stable relationship in which clients’ views are positive because their needs are being met.”

According to the report, 48 percent of the senior executives polled said their outside auditor adds value, but 50 percent indicated the value added is in line with fees, indicating they view audit as a transaction instead of a value-added activity. Satisfied clients currently rank reputation as the most important factor governing their choice of an auditing firm. However, the report found that three-quarters of dissatisfied clients said they would put value for money at the top of their agenda when choosing their next audit firm.

The report predicts audit clients will be more concerned in the future about a firm’s track record on innovation than its corporate reputation. “There are a lot of pressures in the audit market—from regulators, clients and audit firms—that create inertia here, but investment in innovation is going to become critical as organizations change auditors more often,” said Haigh.

Despite the findings, most of the companies surveyed for the report indicated they were satisfied with their auditing firms. The report found 81 percent of them were “broadly satisfied” with what they get, and only 2 percent were “actively unhappy.” Those numbers held true for both large and midsize organizations. The length of time an organization has employed the same auditor did have an impact, however. Nine out of ten organizations that haven’t gone through a formal process to retender their audit work within the past five years said they are satisfied, while that proportion rose to 100 percent among the small number of organizations that haven’t done this for longer than five years.

Organizations that have retendered their audit work within the past 12 months also appeared to be overwhelmingly positive so far, with 84 percent saying they were satisfied. But only 68 percent of those organizations who retendered their audit services two years ago pronounced themselves satisfied.

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