Accounting Today - May 2012

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EDI TOR-IN-CHIEF Daniel Hood ( daniel.hood@sourcemedia.com)

Imperfectly reasonable

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In late March, the Public Company Accounting Oversight Board held a two-day public meeting to discuss the concept release it sent out last August on the subject of auditor rotation. As you might imagine, there were strong opinions on all sides (and more sides than you might have imagined, not all of them strictly relevant).

;e idea of requiring public companies to change independent auditors at set intervals has been around for years. ;e arguments against it remain much the same: It would diminish audit quality and raise costs, since audit ;rms would often be working with companies with which they are unfamiliar. It might even worsen the problem of auditor independence, since ;rms would more frequently be in “sales mode,” trying to convince potential clients to hire them.

;ese are perfectly reasonable arguments. Few doubt, for instance, that mandatory rotation would raise the cost of an audit. And there can be no doubt that it’s easier to audit a company you know well. It’s perfectly reasonable for public companies and auditing ;rms to make these perfectly reasonable arguments, since they have a legitimate interest in the process, and in protecting their businesses.

It’s all perfectly reasonable — but not very smart.

Whether spoken or unspoken, behind every argument about auditor independence is a question about the con;ict of interest that lies at the heart of public accounting: Auditors are paid by the companies they audit. By its very nature, this creates a con;ict of interest, and a pretty grotesque one, at that. It’s like students paying the salaries of those who grade their tests, or ;nancial institutions paying the agencies that rate their instruments. (Oh. Right.)

As with the rating agencies, the only reason this state of a;airs is tolerated is because it just barely passes the Churchill ;reshold of being bad, but not as bad as all the other options. But as long as it remains a bad solution that’s only kept because no better one presents itself, people will always be tempted to tinker with it, seeking “improvements,” and auditors will ;nd themselves endlessly defending the current model, which is basically indefensible.

Once upon a time, when asked who would guarantee the quality of audits, the accounting profession could reply (in the person of Deloitte, Haskins & Sells senior partner Col. Arthur Carter, at a Senate hearing in 1933): “Our conscience.” Since the last free-range conscience went extinct at some point in the late 1970s, that won’t ;y anymore. ;e profession needs a new approach. Instead of arguing the details of each proposal, auditors should get out ahead of them by ;nding creative ways to mitigate the con;ict of interest at the heart of the auditing relationship — and showing that they are as concerned about the independence issue as anyone else.

;ere was evidence of this at the meetings. For instance, Stephen Howe, Americas managing partner at Ernst & Young, suggested empowering the PCAOB to recommend auditor rotation to a company’s audit committee, if it has reason to believe an audit ;rm is no longer independent. And EisnerAmper chief executive o;cer Charles Weinstein suggested mandatory tenure as an alternative to mandatory rotation, freeing ;rms from worrying about holding onto an engagement for a set period of years.

;is kind of creative thinking about ways to bolster independence — as well as frankly acknowledging, as many of the audit ;rm chiefs did, the nature of the con;ict of interest — will go a lot further toward preserving public accounting from would-be tinkerers than all the perfectly reasonable arguments in the world.

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