The European Union took another step toward a mandatory audit firm rotation requirement when the member states’ Permanent Representatives Committee approved new audit regulations.
The new regulations and amendments approved include a requirement that public-interest entities rotate engagements with audit firms every 10 years—with provisions for longer periods when engagements are put out for bid or joint audits are performed. Public-interest entities include banks, insurance firms, and listed companies.
To take effect, the new regulations must still be approved by the European Parliament and the council of national governments.
Regulations and amendments approved include:
- A 10-year maximum period during which a member state may allow an audit firm to continue auditing the same public-interest entity. If the engagement is put out for public bid, the member state may allow the engagement to continue for a maximum of 20 years. In cases of joint audits, where multiple audit firms share the engagement, the maximum period is 24 years.
- A prohibition on provision of certain nonaudit services by audit firms to the public-interest entities they audit. Member states will have the right to allow firms to provide some tax and valuation services to their audit clients, provided they are immaterial and have no direct effect on the audited financial statements.
- A requirement that fees from permitted nonaudit services to an audit client cannot exceed 70% of the audit fees.
Center for Audit Quality (CAQ) Executive Director Cindy Fornelli said in a statement that the changes “raise serious concerns for audit quality.” The CAQ is affiliated with the AICPA.
“There is no evidence to show that mandatory firm rotation improves audit quality, and in fact some studies show it has an adverse effect,” Fornelli said. “There is also little evidence that fees from nonaudit services adversely affect the quality of financial reporting. Additionally, these provisions undermine the important role that audit committees have with respect to auditor selection and scope of services.”
The PCAOB has explored the concept of mandatory audit firm rotation in the United States, but a bipartisan House of Representatives vote in July put the brakes on that process.
The Center for Audit Quality (CAQ) urged the PCAOB to streamline a proposed process for auditors to provide investors more information on the audit.
The PCAOB has proposed and requested comments on sweeping changes to the auditor’s reporting model. The proposal would require auditors to identify and report on “critical audit matters” that arise during the audit. In addition, the proposal would require auditors to evaluate other information that is included in an annual report but is outside the audited financial statements.
The CAQ expressed support in a comment letter for the PCAOB’s efforts to update the auditor’s reporting model and supply financial statement users with more information.
But the CAQ highlighted suggestions that it said would improve the proposal. The CAQ suggested:
- Streamlining the auditor’s process for determining critical audit matters. The letter said this can be achieved in part through leveraging the auditor’s communications with the audit committee that already are required. The most important matters in those communications would be the focus of the critical audit matters.
- Revising the auditor’s report to describe the auditor’s responsibility for other information, including the need to report unresolved material inconsistencies or material misstatements of fact. The CAQ is concerned that the proposed standard may create the appearance of a level of assurance that is not supported by the limited audit procedures the proposal describes with respect to other information.
- That the auditor’s report should not include a disclosure of the audit firm’s tenure with the client, and that there are other, more appropriate places this information could be provided. The PCAOB has proposed disclosing audit firm tenure in the auditor’s report.
The CAQ said it also has collaborated with members of the auditing profession to field-test the PCAOB’s proposal. Although testing and analyzing results will take several months, the results are expected to be ready in time for a round-table meeting the PCAOB plans to hold on the issue in the spring.
The comment letter is available at tinyurl.com/n49gnav.
Audit firms’ quality controls will be the subject of PCAOB discussion this year that could lead to a new auditing standard, board Chief Auditor and Director of Professional Standards Martin Baumann said.
The PCAOB plans to issue a concept release seeking comment on ways to address audit firm quality controls. Baumann said at the AICPA Conference on Current SEC and PCAOB Developments that current quality-control standards do not appropriately address several matters that are important to audit quality.
In addition, the PCAOB plans to propose a standard in late 2014 on auditing accounting estimates, including fair value measurements. Baumann said the proposal would be designed to replace a number of interim standards.