The major
accounting scandals such as of Enron, WorldCom, and Xerox at the international
level and also in many incorporated companies on a relatively smaller scale
unearthed in Pakistan and throughout the world necessitated stringent rules to
regulate the corporate sector for its sustained growth.
A number
of countries the world over have, therefore, reviewed their prospective
legislation concerned with auditing and accounting practices of their corporate
and audit firms to prevent recurrences of corporate failures, including
accounting scandals. Among these measures, the mandatory rotation of audit
firms after a specific period of time has also been proposed by some countries
as one of the important policy instruments to ensure the accuracy in auditing.
However,
there are a number of key themes and arguments, both for and against, mandatory
rotation. The following points are argued as most important factors that affect
audit quality:
i) Long
involvement of an auditor with any particular client can lead to formation of a
close relationship between them. This is likely to adversely affect the
objectivity and independence of auditors. It has been revealed that major
accounting scandals (some of them referred to above) and also many on small
scale in Pakistani scenario exposed the relationship that existed between
companies and their auditors.
ii) It
could actually help increase the efficiency levels of audit firms, given the
fact that a fellow succeeding auditor is more likely to discover the
inefficiencies and major failings of fellow outgoing auditor.
iii)
Moreover, the so called monopoly of large audit firms existing in many
countries may be broken by healthy competition, inducing firms to improve their
operational skills. It would help the small and medium-sized audit firms to
grow to the benefit of all concerned.
On the
other hand, it is generally recognised that there are (i) additional start-up
costs affecting both the auditors and client, (ii) adverse effects on the
quality of the audit due to a lack of familiarity in the first and early years
of the audit, (iii) lack of incentives if the audit is about to change hands
and (iv) the signals that may be given out currently when there is change in
auditor.
To safeguard
the corporate sector and investors against any such corporate failures and
scandals, some countries such as Australia, Greece, India and Italy have
mandatory rotation of audit firms. However, despite a number of advantages of
mandatory rotation of audit firms pleaded by certain quarters, most of the
countries still have the system of periodic rotation of audit partner. The main
factors for non-implementation of the desired system were a strong opposition
by a strong group of auditors’ community and indifference of the companies
themselves towards its adoption.
The
Security and Exchanges Commission of Pakistan (SECP) decided to adopt the
principle of rotation of audit firm in its Code of Corporate Governance,
notified as far back as in March 2002. However, the Institute of Chartered
Accountants of Pakistan (ICAP) opposed its introduction on some grounds, which
are summed up as under:
i) The
objective of ensuring independence in audit has been addressed by limiting the
auditors of listed companies to undertake only defined services in the list of
companies drawn up by ICAP in consultation with SECP.
ii) The
quality of audit of the listed companies was subject to Quality Control
Regulations by ICAP, which was duly acknowledged by SECP.
iii) The
ICAP has and the members adopted and strictly implemented the International
Audit Standards and had adopted Code of Ethics of International Federation of
Accountants, which specifically addressed the independence and familiarity
issues.
iv)
Section 252 of Companies Ordinance, 1984 clearly gives privilege to the
shareholders to appoint auditors and does not envisage anywhere that these
rights could be impeded in any manner. The rotation of auditors, therefore,
lacks locus standi when viewed in the context of the provisions of law.
The SECP,
however, offered ICAP that application of the requirement may be rationalised
in any of the following manners:
Phased
application to auditors of listed companies according to the size of companies.
Phased
application to auditors of listed companies according to the length of their
audit.
Deferred
its application for one year.
The ICAP
disagreed with the first two propositions. The available record showed that it
was, accordingly, decided that the mandatory rotation of auditor should be
enforced in respect of appointment of auditors after December 31, 2003. The
decision was ratified by the ICAP in its council meeting held on April 26, 2002
but in December 2003, the ICAP again wrote to the Commission that the decision
of rotation of auditors was neither in the interest of accountancy profession
nor in the interest of corporate sector.
On the
request of ICAP, a task force was constituted in consultation with ICAP, said
to represent the members from all stakeholders to study the issue in the local
as well as international scenario.
The
composition of the task force, however, seemed to be highly lopsided as those
having interest against the rotation of the audit firms predominantly
represented it. The representatives of some of the most important stakeholders
such as Ministry of Finance, Federal Bureau of Revenue, State Bank of Pakistan,
Ministry of Investment and SECP were missing on the task force.
Five
rounds of day-long sessions of the task force were held which dealt with the
issue in depth but the ICAP, including those interested in status quo, opposed
it except a member of auditors’ community and a few others kept themselves away
either from the whole proceedings or with the ending sessions.
Keeping in
view all these facts, the Chairman of the Task Force who was so strongly
convinced with the advantages of rotation of audit firms on the basis of
arguments advanced during the proceedings of the meetings, recommended the
following against the views of the majority of the members attending the
session:
Instead of
rotation of lead partners in the firm, mandatory rotation of audit firm, every
five years, for all listed companies should be allowed.
On
rotation, the audit firm, which is replaced, shall not be permitted to compete
for the same audit service for four years.
Appropriate
provisions be incorporated to ensure that in the event of any attempt by the
auditors to circumvent the spirit of law by indulging in malpractices, such as
audit swap, reciprocal arrangement, shifting of audit to a dominant firm or to
a firm of cross ownership or controlling interest or otherwise, shall in
suspension or cancellation of practicing license.
SECP for
adequate reasons and exceptional circumstances shall have power to exempt any
company or class of companies from mandatory rotation of audit firm for which
specific provisions should be clearly specified and added.
Report of
the Task Force — a thorough work of five months was submitted in September 2004
but since then, the issue has been swept under the carpet. There is a need that
the matter of great national interest, having implications for the economy, be
reconsidered by a properly constituted working group having equal
representation of audit community and corporate firms besides concerned
government departments and former members of judiciary, to finalize the
decision which was once a decided one.
Rotation
of audit firms may also facilitate the FBR in scientific evaluation of tax
obligations at least of the corporate sector. The work, which was carried out
by the formerly constituted task force, is available with the SECP, which may
serve as the Working Paper for the proposed group.
The writer
is Senior Economic Advisor, Sustainable Development Policy Institute, Islamabad
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