Mandatory auditor rotation: The wrong answer to ensuring audit quality for Arizona school districts.

by Corey Arvizu, CPA, Managing Partner

Posted on November 15, 2018

A bill recently passed in Arizona requires school districts to rotate auditors every three years. Mandatory auditor rotation seems to be the common response when the topic of ensuring an objective, independent audit arises. While initially it seems to be a fair response, when questioned further why auditor independence is important the answer is often “to ensure the auditor is not too comfortable and missing things during the audit.” Or in other words, the individual wants assurance that a quality audit is provided. Looking into the matter further one will find there are many elements of auditor independence, and what truly impacts audit quality has nothing to do with auditor tenure.

Ultimately what auditor rotation is attempting to address is what’s known as a “familiarity threat”, or more specifically the threat that due to a long-term relationship with a client an auditor will become too accepting of the client’s work or explanations. While this threat to independence could possibly be addressed with auditor rotation, there are a number of other independence threats that auditor rotation is unable address, including self-interest, management participation and undue influence. All of these threats, which are as common in any audit as the familiarity threat, likely would increase under required auditor rotation, therefore reducing audit quality. In addition, the point that is often missed when considering the “familiarity threat” is that a long-term client relationship is just as likely to increase auditor skepticism as opposed to reducing it. An auditor is in a much better position to have candid and difficult discussions with a client they have worked with for a number for years.

The audit profession has always focused on continual improvement for the services it performs and the clients it serves. Both audit quality and audit efficiencies increase over time as the firm continually obtains knowledge of an organization’s operations, identifies opportunities to create efficiencies, and develops new and more effective audit strategies. Mandatory auditor rotation effectively eliminates this distinguishing characteristic of the audit profession, which clearly negatively impacts audit quality. In addition, the effect of losing organizational knowledge and audit efficiencies, and the need to be reestablish these every three years due to the mandatory rotation requirement, is that audit fees will undoubtedly increase, likely significantly.

The most important factor of audit quality is the auditor’s expertise in the particular industries it serves. Although a debit will always be to the left, and a credit will always be on the right, that may be where commonalities in the accounting and auditing world end. It is a common misconception that CPAs can perform any type of accounting or auditing work. To the contrary there a numerous complexities in each industry that require the auditor to obtain a minimal level of expertise and knowledge. For example, school districts in Arizona have extensive and unique compliance requirements which the auditor must review each year. The knowledge and experience to sufficiently perform the applicable audit procedures is not quickly and easily gained. It requires a commitment to the industry, focusing firm resources and training of staff to address these unique and complex audit requirements. Required auditor rotation restricts firms that specialize in an industry from performing such work, and inherently reduces audit quality.

An objective, independent auditor is obviously critical to ensuring a quality audit and protecting the interests of the users of the financial statements; however simply changing auditors will not serve either of these purposes. The following are some items that should be considered when the matter of ensuring an objective, independent audit arises.

• Auditors have a number of standards which require them to evaluate, assess and document independence for every audit performed.
• All auditors are required to perform and document the audit in accordance with auditing standards. Although professional judgment is used during an audit, every auditor must meet the requirements of the profession, regardless if it is the first year performing the audit, or the 20^th year performing the audit.
• A firm’s system of quality control and audit documentation is reviewed every 3 years when the audit firm undergoes its peer review. In Arizona the Auditor General also reviews audit documentation of firms on a regular basis.
• There is no evidence that auditor rotation would improve audit objectivity or enhance audit quality. In addition, there is no evidence that audit failures of the past had any correlation with auditor tenure.
• Currently there is no national standard setter or regulatory body requires audit rotation. This includes Sarbanes-Oxley Act, Single Audit Act, IRS regulations, and Government Auditing Standards.
• The procurement process is an excellent method for organizations to evaluate auditor performance and objectivity. Arizona Procurement Rules require school districts to bid audit services and are very prescriptive as to documentation and selection criteria.
• The auditors can meet directly with the governing board. Providing opportunities for auditors to meet with the governing board not only allows the auditors to communicate audit matters directly but it also provides the opportunity for the governing board to ask the auditors tough questions regarding objectivity, the audit process, and the responsibilities of all parties.
• Lastly, should there be an interest in obtaining a different perspective many firms can provide a different audit team to perform the audit. Changing the audit team would ultimately achieve the same result of getting a “fresh look” while retaining the audit firm’s expertise, industry knowledge, and service level.

In conclusion, HeinfeldMeech has served the school district sector for over 30 years. We take great pride in being a resource for school business officials and serving the public good by fulfilling our auditor responsibilities with great care and diligence. Ultimately, required auditor rotation is a disservice to the stakeholders that it is intended to benefit by restricting Arizona school districts from selecting the most qualified, responsive and responsible audit firm.