Mandatory audit firm rotation – a literature review

Page 1 of 4

Mandatory audit firm rotation – a literature review

By | June 2010
Page 1 of 4
Mandatory Audit Firm Rotation – A Literature Review

Introduction
Since the passing of the Sarbanes-Oxley Act of 2002, much debate has occurred concerning mandatory auditor rotation for publicly held companies. Most corporate scandal involves dishonest or questionable accounting. This realization has brought about the priority to take more measures are taken to assure companies disclose the most reliable financial information. It is believed that a lack of auditor independence may be to blame for fraud as we have seen in recent years. The Sarbanes-Oxley Act of 2002 ordered an investigation of whether or not implementation of a mandatory auditor rotation policy could be beneficial. If this were to take effect it would require that companies obtain a new audit firm after a set number of years; possibly every five to seven years. Lately, some companies have voluntarily put policies in place to reflect this, even though it is not currently required by law (Daniels, 2009). Pros and Cons of Longer Auditor Tenure

There are several arguments against mandatory auditor rotation. Many point out that the longer an auditor has worked with a client firm, the more they know the business and the industry of their clients. This is supported by saying that this helps to assure a better more reliable audit. It is also worth noting that having a good audit-client relationship necessitates better communication, which is crucial in any business relationship. Although, opposition to this may believe that there is less scrutiny with longer tenure, the contrary is true, specifically with larger companies and their auditors (Anandarajan, 2008). Various studies have shown results that suggest short term auditor-client relationships may not be very beneficial. For example, some have shown that shorter auditor tenure is related to a higher amount of errors and thus, low quality audits. Also, one study from 2004 by Carcello and Nagy has shown that fraudulent reports are more likely...