Expert: Don Sadler - 9/19/2006

Question
Hi Don,
I couldn't find my previous question, thus I am resending it.
- Is it uncommon for companies to change their external auditor routinely after a few years? even though they have no problem with their service.
-What i gather from a friend was that it would be difficult for a company to change the auditors so what companies does was to change enagement partners within the same audit firm.
-Furthermore, changing of external auditors were not welcome by shareholders as it would indicate to them that there are "problems" with management thus the management desire to change auditors. How true are these statements?
Thanks in advance for your advice.

Cheers,
CH

Answer
This is a good question and reflects a somewhat controversial topic in the industry.  It is a fact that, over time, the independence of an external auditor is likely to be compromised due to being overly familiar with the client’s business, aspirations, plans, and possibly even being a participant or informal advisor to the board during the decision making process.

However, a decision to automatically change external auditors every five years or so be approached with care if the organization has the unique characteristics compared with the typical commercial firms with which most audit firms are familiar.  For example, if the business is unique or uncommon, there would likely be a may be a significant drop-off in the effectiveness during the first year as a new external audit team becomes familiar with the business and its varied activities. There is also likely to be some decline in the effectiveness of the internal audit process, since the burden of "training" the new audit team is likely to fall largely on the shoulders of the Internal Auditor.  Depending on the external audit firm employed, there might even be some degradation in performance during the last year or two of the five-year tour if it was a foregone conclusion that the contract could not be extended beyond the fifth year. The temptation to assign junior staff to an expiring non-renewable contract, for training purposes, might be too strong for some firms to resist.

On the other hand, changing the external auditors will likely preclude too familiar a relationship and foster independence.  For example, the Monetary Authority of Singapore has issued a directive requiring local banks, every five years, to change external auditors.  Note that private audit firms argue against this but the conclusion of independent studies support the benefits of mandatory auditor rotation.  Indeed this position was taken by the Consumers’ Union and the AICPA.

The conclusion is that changing the engagement partner is more common than changing the firm however this is mostly due to costs since changing the firm is a more objective and complete means of achieving independence.

Below are some links you might find interesting.


Here is an independent study of mandatory rotation.
http://www.isarhq.org/papers/Hatfield_jackson.doc

Testimony of Consumers Union before the Texas Sunset Commission
http://www.consumersunion.org/consumeronline/pastissues/finances/sunsetreview.ht...

TOWARD UNDERSTANDING SARBANES-OXLEY: BUSINESS AND FINANCIAL ETHICS IN A POST ENRON WORLD
http://www.salsb.org/slj/vol-xiii/fitzgerald.pdf#search=%22common%20%22change%20...