MANDATORY AUDIT FIRM ROTATION -LET’S RELOOK AT THE BILL
Audit firms have generally supported measures to increase auditor independence, but are mostly sceptical that this is necessarily achievable through audit firm rotation, rather they argue that there are currently a series of measures already in place that underscores the auditor’s independence including mandatory audit partner rotation. As an example in a recent article in the AB Magazine, titled ‘Compulsory audit rotation sparks discord in South Africa’ 1 July 2017, the Magazine reported that EY Africa CEO Ajen Sita, PwC Southern Africa CEO Dion Shango and KPMG South Africa director Michael Oddy rejected the compulsory rotation plan in South Africa, while supporting measures to strengthen auditor’s independence. Earlier in March 2017, Business Day also reported on 17 March 2017 that EY Africa and Pricewa-terhouseCoopers warned against rushing in to change the system when there have been no crises of independence of SA’s auditing profession. Mr. Ajen Sita the CEO of EY Africa is reported to have said that “safeguards already existed in regulations and in audit firms to ensure the independence of auditors in relation to their clients. For example, no audit partners can serve their clients for longer than five years and their audit opinions are subject to an independent review.” Further, he is reported to have noted that “Audit partners, family members and those in their chain of command are barred from owning shares or having any other form of financial interest or business relationship with their audit clients, thus removing any self-interest threats. Audit partners, family members and those in their chain of command are barred from owning shares or having any other form of financial interest or business relationship with their audit clients, thus removing any selfinterest threats.” Finally, he noted that “Audit committees of public companies had a statutory duty to assess the independence and quality of their choice of an auditor and make a recommendation to their shareholders. Disempowering the audit committee from making its own choice due to a forced rotation opens up a new risk on the topic of directors’ liability - an example of unintended consequence.” These are all good points that are also applicable to Zambia that needs to be carefully measured in terms of their cost-benefit analysis. The EU, for example, introduced mandatory rotation rules, however, these are specific to Public Interest Entities (PIEs) rather than all companies. Notwithstanding that, the EU’s 10 years maximum rule is contrary to the 6 years mandatory rotation maximum time being advanced by this Bill. In case of the South Africans, on 1 June 2017, the Independent Regulatory Board for Auditors (IRBA) issued similar rules prescribing that auditors of PIEs must comply with mandatory audit firm rotation (10-year maxi- mum period) with effect from 1 April 2023. Notice the long transitional period, 10 years in force period and the specification to PIEs. It is therefore new territory that this Bill in Zambia seeks to impose the mandatory rotation on all companies. The consequences are many and notwithstanding the oversight costs nightmare that this will bring. We could end up with a process where a large chunk of companies are potentially penalised on the basis of this rule. Apart from the steep measures in the Bill, the other criticisms of mandatory audit firm rotation noted by the AB Magazine article referred to above are that it undermines quality, bleeds institutional knowledge and experience, limits auditor specialisation, strains resources, intensifies market concentration, and limits the ability of audit committees to determine the best firm for their needs. Siregar, Amarullah, Wibowo, Anggraita (2015), research paper on ‘Audit Tenure, Auditor Rotation, and Audit Quality: The Case of Indonesia’ which was published in the Asian Journal of Business and Accounting concluded that although Indonesia have made it compulsory to rotate the appointments of public accountants every 3 years, and the appointment of public accounting firms every 5 years since 2002, the results do not support that mandatory firm rotation increases audit quality, or that a shorter audit tenure (both partner and firm level) increases audit quality. They, therefore, recommended that “Regulators might need to consider revising the regulation (i.e. related to maximum years allowed for an auditor to audit their client) and/or introduce other regulations to increase audit quality.” Siregar, Amarullah, Wibowo, Anggraita (2015) cites Carcello and Nagy (2004) who found that fraudulent financial reporting is more likely to occur in the first three years of audit firm tenure, but they fail to find evidence that fraudulent financial reporting is more likely, given long audit firm tenure. Siregar, Amarullah, Wibowo, Anggraita (2015) also cite Geiger and Raghunandan (2002) who found that there was significantly more audit reporting failures in the earlier years of the auditor-client relationship than when auditors had served these clients for longer tenures. Mandatory firm rotation is still much a debate topic and has fewer take ups in the world and where it is taken up, it is mainly applied to PIEs. As an example, a look at Asia suggests the following profile, that while all countries have adopted mandatory partner rotation, only Bangladesh, China, India, Pakistan, Singapore and South Korea have introduced mandatory firm rotations for certain specific entities such as listed companies, banks and government entities in the case of China. India introduced mandatory firm rotation for banks, privatised insurance companies while Singapore introduced it to the local banks. All other introduced it specifically to listed companies. Indonesia is the only country to introduce mandatory audit rotation for all companies and is about the only one in the world. Hong Kong, Japan, Malaysia, Philippines, Srilanka, and Taiwan have not adopted mandatory audit rotation while they have adopted mandatory partner rotation of an average of 5 years. My cursory review of the various countries suggests the ideas proposed in the Bill are novel, steep by their application and may lead to unintended consequences and a potential for laws enacted that will have few takeups because of a lack of an effective monitoring mechanism in Zambia for this. Are we to say that Zambia Revenue Authority will be given authority that better reside with the Zambia Institute of Chartered Accountants to police this? If not who would have the role to effectively, monitor this. Further, it is clear elsewhere in the world, that the audit firm rotation rules where enacted are in the majority originated by a regulatory approach rather than directly by a legislative approach. It is suggested that any legislation on rotation be left to the regulators who can better manage the trade-off concerning independence-related issues and client specific knowledge. Although, it is acknowledged that the world over regulators has taken positions that favour of rotation as a mechanism to overcome weakness inherent in long audit tenures, it is important to consider the empirical research in other countries that suggest a lack of evidence linking mandatory rotation with an improvement in audit quality before enacting any changes beyond PIEs.