Preliminary EU agreement includes audit firm rotation

European Union leaders have reached preliminary agreement on audit reforms that would include a requirement for audit firms of public-interest entities to rotate after an engagement of 10 years—with provisions that could extend that period if the engagement is put out for bid or joint audits are performed.

The Lithuanian EU council presidency said in a statement Tuesday that preliminary agreement has been reached over the legislative package of EU audit reforms and is subject to final agreement by member states in a meeting of the Committee of Permanent Representatives of the European Council later this week. Public-interest entities include listed companies, banks, and insurance firms.

In a statement welcoming the preliminary agreement, European Commissioner Michel Barnier described the details of the package. These include:

• A rotation requirement of 10 years. That period could be extended by up to 10 additional years if companies put the engagement out for bid, and by up to 14 additional years when the company being audited appoints more than one audit firm to carry out its audit in what is known as a “joint audit.” According to Barnier, a calibrated transitional period that would consider the duration of current audit engagements is anticipated to prevent a “cliff effect” once the new rules take effect.
• Prohibition of certain nonaudit services by audit firms to their audit clients. These would include limits on tax advice and services linked to the financial and investment strategy of a firm’s audit client.
• A ban on Big Four-only clauses. Third parties will no longer be able to impose requirements on companies demanding that only Big Four firms (Deloitte, EY, KPMG, and PwC) perform audits.
• Requirements for more detailed and informative audit reports. These will focus on information relative to investors.

The requirements are scaled back from changes proposed by the European Commission two years ago, but they call for rotation more frequently than a draft law approved by the European Parliament’s legal affairs committee in April.

The original proposal called for rotation of audit firms every six years—or every nine years for companies that voluntarily opted for joint audits. The April draft law would have required audit firm rotation every 14 years, with an extension to 25 years when certain safeguards were put into place.

“We would have preferred that companies and their audit committees were free to determine the appropriate length of time to stay with their audit firm,” Nick Topazio, CGMA, head of corporate reporting policy at the Chartered Institute of Management Accountants, said in a statement. “However, we recognize that there is a need to improve public trust in the audit/client relationship and therefore accept change is necessary. Nevertheless, we continue to believe that regulation in this area should be limited to mandatory audit tendering rather than rotation.”

Although the PCAOB has explored the concept of mandatory audit firm rotation in the United States, the issue has caused legislative pushback and is not a focus of current board activity, PCAOB member Jay Hanson said last week.

—Ken Tysiac (ktysiac@aicpa.org) is a JofA senior editor.