EU member states approve mandatory audit firm rotation

The European Union took another step toward a mandatory audit firm rotation requirement Wednesday when member states approved new audit regulations.

The new regulations and amendments approved include a requirement that audit firms rotate engagements with public-interest entities 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.

The approval by the Permanent Representatives Committee follows a preliminary agreement on the proposed reforms this week by the European Parliament and the Lithuanian presidency, which is currently presiding over the creation of EU legislation.

To go into effect, the new regulations must still be approved by the European Parliament and the council of national governments.

Regulations and amendments approved Wednesday 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.

“[The rules] are aimed … at strengthening the independence of auditors of public-interest entities as well as at assuring greater diversity into the current highly concentrated audit market,” Lithuanian Finance Minister Rimantas Šadžius said in a statement.

As a result of the rules, supervision of auditors in the EU will be more coordinated under the leadership of the Committee of European Audit Oversight Bodies (CEAOB), Šadžius said. The European Securities and Markets Authority also will play a role in the cooperation on audit oversight.

The requirements are scaled back from those in a 2011 European Commission proposal that would have mandated rotation every six years, and every nine years in cases of joint audits. But the requirements call for more frequent rotation than those in a draft law approved by the European Parliament’s Legal Affairs Committee in April. The draft law called for rotation every 14 years, with the period extending to 25 years if certain safeguards were put into place.

Nick Topazio, CGMA, head of corporate reporting policy at the Chartered Institute of Management Accountants (CIMA), said in a statement this week that CIMA would have preferred that companies and their audit committees were free to determine the appropriate length of time to stay with their audit firm.

“We recognize that there is a need to improve public trust in the audit/client relationship and therefore accept change is necessary,” Topazio said. “Nevertheless, we continue to believe that regulation in this area should be limited to mandatory audit tendering rather than rotation.”

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. Mandatory rotation no longer is part of the PCAOB’s active agenda, board member Jay Hanson said last week.

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