Accounting Chapter 5 Homework The Pcaob Has Proposed Mandatory Rotation Audit

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Ethical Obligations and Decision Making in Accounting, 4/e 1

Case 5-4 Busy Season Planning

Romello Accounting LLP is a small CPA firm consisting of three partners and seven other

professional staff. The firm offers full attestation and assurance services. Most of the work is for

small and medium-sized nonpublic companies. The firm is registered with the PCAOB and does

audits of about 30 penny stock or pink sheet companies and broker-dealers each year.

Tony Romello, the managing partner of the firm, has been the review partner on all audits for the

last several years. Unfortunately, Tony encountered major health concerns in the last month and

will not be available for the upcoming busy season. Michelle Thompson and Max King, the two

remaining partners, are discussing staffing during the busy season.

Questions

Consider the staffing of audits in responding to the following questions.

1. Identify the stakeholders of audits and their interests. Is there a difference between

stakeholders and interests of public versus nonpublic companies?

The stakeholders include the following.

• Michelle and Max, the two partners debating how to best select a review partner

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• Tony, who is the managing partner of the firm but has major health problems and

can’t serve as a review partner

• The firm – Romello Accounting LLP

• The PCAOB because of its oversight role and inspections

applies to auditors of both public and nonpublic companies.

2. What are a firm’s considerations in having review partners? Does it really matter

from a professional judgment perspective whether review partners rotate off after a

prescribed number of years? Use the KPMG Professional Judgment Framework to

support your response.

Although not addressed directly in this chapter, PCAOB Auditing Standard No. 7, Engagement

Quality Review, provides that an engagement quality review and concurring approval of

issuance of an audit report are required for the following engagements conducted pursuant to the

standards of the PCAOB: (a) an audit engagement; (b) a review of interim financial information;

and (c) an attestation engagement. The objective of the engagement quality reviewer is to

perform an evaluation of the significant judgments made by the engagement team and the related

conclusions reached in forming the overall conclusion on the engagement and in preparing the

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important for audit professionals: the availability tendency, the confirmation tendency, the

overconfidence tendency, and the anchoring tendency.

The availability tendency may lead to judgments based on the accessibility of information rather

than a deliberative analysis of how the facts of the current situation differs from prior ones. Also,

an auditor may rely on past procedures in the current audit even though that approach may not be

relevant to the current situation. This could lead to a major problem that might be alleviated

through rotation.

Extended Discussion

Mandatory auditor (firm) rotation

The danger of audit firms conducting audits of clients over an extended period of time is the

regular audits should not become a sort of long-term annuity for the accounting firm paid for by

the company being audited, rather than being responsive to the investing public. A fresh

perspective supports an independent mindset and strengthens objectivity in conducting the audit.

process in conjunction with the external auditors and should monitor the auditors’ activities.

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Perhaps the onus should be placed on an independent audit committee to ensure that auditors

with a long tenure with the company do not compromise their judgments or cut corners in the

audit.

The PCAOB has proposed mandatory rotation of audit firms by setting limits on the number of

consecutive years that a registered public accounting firm could serve as the auditor of a public

Will rotating accounting firms enhance audit quality?

Perceived advantages

The perceived advantages of mandatory rotation of audit firms largely center on increased audit

quality. Proponents of the PCAOB proposal posit that term limits would help to eliminate some

of the closeness that may exist between audit firms and clients, thereby promoting increased

independence, skepticism and objectivity. There are often situations where auditors may want to

maintain the relationship as opposed to performing the best audit. When an auditor knows that

their relationship is nearing its end in the future, the auditor’s main concern should be to conduct

the audit effectively and efficiently rather than getting hired next year.

Perceived disadvantages

As with any proposal, there are perceived disadvantages to mandatory rotation of audit firms. It

is apparent that term limits could result in the loss of major clients and sources of revenue for

audit firms. Also, the specialized nature of certain industries often necessitates that companies

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firm term limits may preclude companies from selecting audit firms; thus, the company’s audit

committee may have to relinquish its role in the vetting and selection of the audit firm, thereby

diluting the committee’s impact.

In order to perform a quality audit, auditors have to understand their clients’ businesses. This

process requires time and resources on the part of both the audit firm and the client. Further, the

time it takes to understand a new client may in fact increase the risk of audit failure in the first

few years of an audit. There are a lot of costs, and as is the case with any audit, there is a

Recommendations from the Institute of Internal Auditors

Lawrence Harrington, chairman of the North American board of the Institute of Internal

Auditors (IIA), delivered the following recommendations regarding mandatory audit firm

rotation at a PCAOB hearing on March 22, 2012.

I am strongly opposed to mandatory rotation of external auditing firms based on a fixed time

schedule. Much of the potential benefit of auditor rotation has already been achieved through

• Introducing a mandatory change of auditors in limited circumstances such as financial

statement fraud.

• Requiring increased disclosure about the audit committee’s role in overseeing the quality of the

audit, including its periodic evaluation of auditor independence.

• Implementing a system whereby audit committees could request the PCAOB to perform an

enhanced inspection of the audit of their company, with reporting of results to both the company

and its auditors.

I believe the board should continue to focus on ways to enhance auditor independence,

objectivity and professional skepticism. To this end, rather than requiring mandatory firm

rotation, the PCAOB should consider each of the alternatives presented above, with the goal of

increasing the overall efficiency and effectiveness of auditing without incurring the significant

risks inherent in mandatory auditor rotation.

3. Assume Max convinces Michelle to let him serve as the review partner for all audits

and Michelle will serve as the engagement partner on all audits. Do you see any

problems with this approach from an ethical perspective?

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