Audit market changes that were preliminarily agreed upon by European Union policymakers this week “raise serious concerns for audit quality,” Center for Audit Quality (CAQ) Executive Director Cindy Fornelli said in a statement.
Mandatory audit firm rotation and prohibition of most nonaudit services by audit firms to their audit clients were among the provisions in an agreement between the European Parliament, the European Commission, and the Lithuanian EU Council presidency, which currently presides over the creation of EU legislation.
“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 in a statement. “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 CAQ is affiliated with the AICPA.
The European Parliament and the council of national governments still must approve the new regulations in a formal vote. Provisions agreed upon include:
- A requirement for audit firms to rotate after 10 years of auditing a public-interest entity. Public-interest entities include banks, insurance firms, and listed companies. The audit engagement can continue for a maximum of 20 years if the audit is put out for public bid, or for a maximum of 24 years in joint audits where multiple firms share the engagement.
- A prohibition on the provision of certain nonaudit services by audit firms to the public-interest entities they audit.
- A requirement that fees from permitted nonaudit services to an audit client cannot exceed 70% of the audit fees.
Fornelli also expressed concerns about the impact the provisions could have for U.S. companies or EU companies with U.S. subsidiaries. An EU subsidiary of a U.S. company would be subject to the provisions if the subsidiary is a bank or an insurance company, or listed on a European exchange, Fornelli said.
“Likewise, U.S. subsidiaries of European companies also could be affected depending on the decisions made on rotation and nonaudit services at the European parent company level,” Fornelli said. “In addition, we are concerned by the provisions because they allow EU member states to go beyond those proposed, for instance, by sweeping in an even broader array of entities than those currently contemplated.”
Fornelli urged U.S. officials, EU officials, and policymakers in EU member states to carefully weigh the consequences of the audit market changes.
In the United States, the PCAOB’s consideration of mandatory audit firm rotation seems to have subsided after the board received legislative pushback in July from the House of Representatives. But the PCAOB plans to hold public discussions in 2014 on the issue of audit firms providing nonaudit services to their audit clients.
— Ken Tysiac ( firstname.lastname@example.org ) is a JofA senior editor.