How 'mandatory' is mandatory auditor rotation?

• Author: Pinnell, Wayne R.
• Position: FINANCIAL REPORTING

In August 2011, the Public Company Accounting Oversight Board issued a concept release soliciting public comment on ways to improve auditor independence, objectivity and professional skepticism. The comment period, which concludes on Dec. 14, will assess limiting the number of consecutive years for which a registered public accounting firm is permitted to serve as the auditor of a public company.

The concept release is rooted in several core concerns surrounding the auditing process:

* There continues to be a fundamental conflict of interest when the audit client pays the auditor, particularly during a long-term relationship. The concern stems from a potential level of comfort between the two firms that may compromise the auditor's objectivity over time.

However, the auditing business is categorized as part of the service industry, which requires establishment and cultivation of client/vendor relationships.

* Setting term limits on audit relationships could enable auditors to provide more transparency in the auditing process. According to PCAOB Chairman James R. Doty, "The reason to consider auditor term limits is that they may reduce the pressure auditors face to develop and protect long-term client relationships to the detriment of investors and our capital markets."

Current Sarbanes-Oxley Act of 2002 standards enable the auditing firm to maintain its relationship with the firm under review indefinitely. However, the audit partner and concurring partner are required to rotate off the project every five years. This allows for the rotation of personnel without the need to engage an entirely new accounting firm with new policies, procedures and expertise.

The thought process described in the concept release could result in new standards that would require the public company to change accounting firms at the end of a designated rotation period. The actual length of time for an auditor's tenure with a client is one of the points for which the PCAOB is seeking feedback.

Many measures are currently in place to address the issue of auditor independence, objectivity and professional skepticism. The PCAOB, American Institute of Certified Public Accountants and the U.S. Securities and Exchange Commission, along with each of the individual state CPA licensing bodies have their own formal requirements. Each of these bodies also has a specified set of potential sanctions and penalties to be administered to CPAs and accounting firms that undertake...