SAICA recommends that careful considerations should be made regarding mandatory rotation of audit firms

Johannesburg, Monday, 22 July 2013 –The objective of the EU Green Paper is to enhance the regulation of the audit function in order to contribute to increased financial stability. It proposes measures to stabilise the international financial system as a direct aftermath of the international financial crisis.
Auditors have an important role to play and are entrusted by law to conduct statutory audits. This
entrustment responds to the fulfilment of a societal role in offering an opinion on the truth and fairness of the financial statements of audited entities. One of the main aims of the EU Green Paper is to probe the true fulfilment of this societal mandate.
Ashley Vandiar, SAICA’s project director of Assurance explains that the primary benefit of the audit firm rotation proposal is to achieve a very high level of independence. The EU Green paper proposals identify the changes that can be made to the audit profession that attempts to prevent a repeat of the international financial crises and it is believed that increased auditor independence would play a part in achieving this objective. Vandiar argues that this belief is debatable.
According to Vandiar the EU also wants to eradicate the oligopoly created by the big four audit firms and reduce the effect that the downfall of one of these firms will have on the financial market. “There are a number of proposals in the EU Green paper to try and address this, for example, mandatory audit tendering and mandatory joint audits with a Small and Medium Practises. It is believed that mandatory audit firm rotation might also afford the smaller firms an opportunity to break into the markets that are currently only serviced by the larger audit firms. In any event, these are secondary indirect benefits that may or may not even be achieved by audit firm rotation. However, auditor independence will definitely be achieved but at a very high cost, both financially and in terms of audit quality.”
Vandiar maintains that while the intention of this proposal is aimed at improving the economic landscape he warns that it is possibly taking independence one step too far. “If the sole purpose of audit firm rotation is to achieve a greater degree of auditor independence, then one must consider other more feasible options that would also achieve auditor independence”, states Vandiar, explaining that partner rotation and self-interest declarations are also other practical means that enable firms to achieve independence.
He says by making it mandatory for audit firms to rotate, the institutional knowledge and understanding acquired by that particular audit firm would be lost and a whole new process would be started afresh when the new audit firm takes over. “The loss in knowledge when audit firms rotate can be a costly affair that will need to be borne by the client.”
Vandiar advises that while this would address independence in appearance, one can argue that independence in mind was never impaired. “While it is clear that independence is critical, there are arguments that the cost of complying with independence rules should not exceed the benefits,” argues Vandiar quoting research conducted by Elliot and Jacobson in 1998 on audit independence concepts.
He says this argument was subsequently supported by Reiter and Williams in the research study they conducted in 2004, the philosophy and rhetoric of auditor independence concepts. “They maintain that no rule intended to help ensure independence should result in costs to the affected parties exceeding the benefits it can provide in improving the quality of the assurance engagement.”
“The cost at which this high level of independence comes must be assessed and weighed against the proposed benefits”, Vandiar comments, advising that the cost of independence should never outweigh the benefits which he believes would undoubtedly be the result with the introduction of the mandatory audit firm rotation proposal.
The proposals in the EU Green Paper will have a ripple effect that will undoubtedly influence the audit profession in South Africa. While the proposals are not directed at South Africa per se, many of the audit firms, especially the larger ones are international and based in areas that are bound by the proposals flowing from this document. Accordingly, firms based in South Africa will also be required to comply or they may face penalties for failing to do so. There are also sanctions threatened against auditors who do not comply with the proposals.
“Apart from the possible increased costs, mandatory audit firm rotation would also eliminate audit efficiencies that could be passed on from year to year which can be argued to affect audit quality”, Vandiar says. Accordingly, it can be concluded that South African users will also be willing to forego the benefit of high independence in favour of cost efficiency and improved audit quality.
Although SAICA encourages companies to choose audits, increasing this kind of regulatory burden will push companies to elect alternatives to audit. “This will undoubtedly have a negative impact on the growth of the auditing profession.”
There are already safeguard measures in place which address auditor independence in South African such as the SAICA andIndependent Regulatory Board for Auditors (IRBA) codes which require audit partner rotation every seven years.  Also, an auditor is required to be independent and where there are threats to their independence, they are required to implement measures to reduce the threats to an acceptable level. If this is not possible, the auditor is prohibited from accepting the engagement that would compromise their independence. The SAICA and IRBA codes are overarching and are required to be applied by all members of SAICA and IRBA.

• Section 92 of the Companies Act which requires audit partner rotation every five years
• Section 90(2) of the Companies Act which prohibits the auditor from providing certain non-assurance services and
• The SAICA and IRBA Codes of professional conduct, which are both aligned to the International Ethics Standards Board for Accountants Code.”

Vandiar explains that Section 90(2) of the Companies Act is extremely strict on independence and any non-assurance work that is considered to be “related secretarial services” will disqualify the entire audit firm from doing the audit.
Furthermore, the World Economic Forum’s Global Competitiveness Index has once again ranked South Africa number one for the strength of its auditing and financial reporting standards. “This is a clear demonstration of the quality of work performed by South African auditors.”
Vandiar maintains that with all these independence mechanisms in place, further rules to enforce mandatory audit firm rotation would just result in over regulation in South Africa.