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Adequacy Of The Mandatory Rotation Of Audit Firms

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Question:

Discuss about the Adequacy of the Mandatory Rotation of Audit Firms.

 

Answer:

Introduction

According to section 324DA (1) and (2), of the 2001 corporations act, an auditor is not allowed to be an auditor of one firm for a period of five years[1]. This law establishes a mandatory rotation of partners, for purposes of preventing prevent and fairness in financial reporting. However, it is the 2004 Audit Reforms and the Corporation Disclosure Act that was responsible for ensuring that corporate organizations rotate audit firms, after a period of five years[2]. The law has been criticized by a number of stakeholders in the large corporate organizations that it affects the quality of audit reports, because of movement of experienced audit staff who are auditing the financial reports of the company. However, the law has helped in improving corporate governance and financial disclosures in Australia; hence it is working adequately in Australia.

In fact, a research conducted by Hossain and Larrelle indicates that companies which voluntary rotates auditors have seen a significant impact on corporate governance[3]. These companies are now able to develop policies and laws that ensure financial transparency and the satisfaction of the needs of its stakeholders. These stakeholders include customers, shareholders, their suppliers and the government. According to the study by Hossain and Larrelle, the main reason that corporate organizations are complaining about the implementation of the law, is the fact that it is an expensive process for auditors and their firms, to keep on rotating after about five years. However, upon examination of about 1200 companies between 2003 and 2009, Hossain and Larrelle explain that most of these companies allowed for voluntary rotation of audit firms[4].                   

They allowed for voluntary rotation of audit firms because the costs the organization incurred was not that high, and the rotation of these firms led to better efficiency in corporate governance and financial reporting. This is because new auditing firms came up with new ideas on governance based on the changing needs of the society. It also made the company to be flexible in the manner that they engage in financial reporting and corporate governance. Furthermore, during this study, Sarowar and Hossain explain that 15% of the companies that engaged in voluntary rotation of audit firms showed a significant improvement on the efficiency of their corporate governance[5]. Therefore, the result of this study reinforces the notion that the Mandatory Audit Rotation Firm has led to an improvement of the corporate governance of companies in Australia. 

 

Furthermore, Hossain and Larrelle explain that there was an increase in efficiency, in the manner which the audit firms provided financial disclosures. Of the 1200 firms that were analyzed, most of them provided accurate financial reporting, because the auditors feared that a new firm would scrutinize its auditing activities, and in circumstance where there is poor reporting, they will be identified[6]. Hossain and Lorralle explain that before the enactment of the 2004 law that requires companies to rotate the firms engaged in auditing the financial records of a company, Australian companies could have the same auditors for a period of about 20 years. This could compromise the manner which these auditing firms were auditing the records of the organization; hence, promoting fraud and poor financial reporting[7].

However, with the enactment of the Audit Reforms and Corporation Disclosure Act, companies were forced to rotate auditing firms after a period of about five years, resulting to accurate financial reporting and disclosure. Furthermore, auditors of these firms were reluctant to report and disclose the financial records as per the wishes of their clients. Instead, auditors of these firms followed professionalism and ethics while carrying out auditing, because of the need of protecting their brand names and fear of being reported by new auditing firm that will take over, once they leave[8]. Therefore, it is possible to assert that mandatory auditing of firms plays an important role in promoting the independence of an auditor. For the success of an auditing process, the auditors must be independent. The independence of an auditor during the process of financial reporting is recognized under section 324DC of the 2001 Corporations Act[9]. The law is developed on the basis that without an independent auditor, chances of getting accurate report is minimal.   

Despite the adequacy of the mandatory audit rotation of firms, critics argue that it is an insufficient process, and it cannot guarantee the quality of an auditing process[10]. The major reason that these critics argue against the implementation of the audit rotation law is because it takes about two years for a new auditing firm to understand the accounting system and records of a firm[11]. Furthermore, for large companies, it may take longer because they operate complex financial records. However, these allegations are not accurate because of established standards and practices of financial reporting.

Finally, mandatory audit rotation of firms is working adequately in Australia. This is because the law has helped in improving corporate governance through accurate financial reporting and disclosures. Furthermore, the law promotes the independence of auditors, because they will resist to be influenced by their clients, for purposes of providing inaccurate financial disclosures. Despite these advantages, there are concerns that the law is insufficient because it requires more time for new auditors to understand the financial reporting techniques of an organization. However, this is not correct because there are established standards that govern the process of financial reporting.

 

Bibliography

Books, Journals and Articles

Cheuk, Man Chiu, Auditor Rotation Versus Audit Partner Rotation (2006)

Houghton, Keith A et al, The Future Of Audit (ANU E Press, 2010)

Hossain, Sarowar and Larelle Chapple, "Mandatory Auditor Rotation – Australian Evidence" [2015] Australian Journal of Corporate Law

Kim, Hakwoon, Hyoik Lee and Jong Eun Lee, "Mandatory Audit Firm Rotation And Audit Quality" (2015) 31 JABR

Ryken, Kirsty, Renee Radich and Neil L. Fargher, "Audit Partner Rotation: Evidence Of Changes In Audit Partner Tenure As The Result Of Mandatory Regulation In Australia" (2007) 1 Current Issues in Auditing

Cases and Legislations

Corporations Act 2001 Section 324 DC

Audit Reforms and the Corporation Disclosure Act 2004 

OR

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