The Public Company Accounting Oversight Board is finding that the push toward mandatory audit firm retendering and rotation is leading to lower audit fees in Europe, sparking audit quality concerns.
Speaking at Financial Executives International’s Current Financial Reporting Issues Conference in New York last month, PCAOB member Lewis Ferguson, who is chairman of the International Forum of Independent Audit Regulators, noted that he and other audit firm regulators abroad are noticing some disturbing trends in Europe since the European Parliament approved mandatory retendering of audit firms in April. The new directive requires most public companies to put out a bid for new auditors at least every 10 years and rotate their audit firms at least every 20 years.
“One of the things we are looking at is the consequences of the requirements of the European community with its new audit directive that requires rotation by auditors between 10 and 20 years,” said Ferguson. “A number of countries are opting for 10 years. Even though the requirement does not go into effect until 2016, many companies are already beginning to rotate.”
One of the findings that is troubling to regulators is that audit fees seem to drop between 20 and 40 percent in cases of rotation in Europe, except in the United Kingdom.
“It seems to be an exception in the United Kingdom, but in the rest of Europe, they seem to have dropped between 20 and 40 percent,” said Ferguson. “As regulators, we are obviously very concerned about whether you can have a high-quality audit if the fees go down by 20 percent, or is the work going to get squeezed?”
The new rules also seem to be creating serious labor problems for auditors, Ferguson noted. “For example, if you take the oil industry, there are four big oil companies in Europe, but only one in each country,” he said. “When you have to rotate off of an oil company, the question is you have thousands of people whom you probably cannot redeploy because Europe does not have labor mobility. You’re not licensed in other countries, so even if you get a petroleum audit in another country, you can’t move your people. So one of the things that’s happening is there is a lot of labor relations that are arising as a result of this. In any event these are some of the issues we are seeing. It makes me very skeptical about whether auditor rotation is a good thing or if it’s going to lead to what the Europeans thought it would lead to.”
The PCAOB had been considering the idea of requiring mandatory audit firm rotation in the United States and issued a concept release in 2011 suggesting the proposal. But after members of the House of Representatives overwhelmingly voted last year in favor of a bill that would prohibit the PCAOB from requiring public companies to change their auditing firms, the PCAOB shelved the idea. However, several members of the PCAOB’s own board had been skeptical of the proposal, which was supposed to make the audit market for competitive for firms outside the Big Four.
“The other interesting statistic is that this program was put in largely as a pro-competitive requirement,” Ferguson said of IFIAR’s findings. “It was really not put in for audit quality reasons and it turns out that what’s happening with rotation is that it appears to be increasing concentration rather than decreasing it because the business seems to be going to either the firm that already has the number one or number two market share in the different markets. So it seems to be doing exactly the opposite of what it was intended to do as a pro-competitive mechanism. It’s going to be something to watch, but it makes me very skeptical about rotation.”
Multinational Audit Inspections
IFIAR includes audit regulators from 18 jurisdictions, and they are embarking on a new initiative to do a multinational inspection.
“One of the things that we recognize commonly is that in order to really oversee the audit of a global multinational enterprise that may be conducted by 50 or 60 separate audit firms that are part of a network is that you really need coordination between regulators around the world,” said Ferguson. “One of our projects is that we will do this year the first multinational inspection of an audit of a major industrial enterprise. Four regulators will simultaneously look at the audit of a major industrial enterprise at the same time and compare results. Four may sound modest, but given the statutory limitations on the data sharing, there are a lot of things that have to be overcome and a lot of cooperative arrangements that have to be put in place in order to be able to do this.”
Revenue Recognition
The PCAOB is also keeping tabs on the work of the joint group established by the Financial Accounting Standards Board and the International Accounting Standards Board on implementation of the newly converged revenue recognition standard for U.S. GAAP and International Financial Reporting Standards.
“The PCAOB is actively involved in monitoring the activities of the Joint Transition Resource Group,” said PCAOB member Jay Hanson, who spoke at the same conference as Ferguson. “I personally sit at the table during those meetings. I was there at the end of October. We have staff from our standard-setting group, one at the table, one in the audience, and one of our inspection leaders there. They are hearing the same debate about the difficulties and uncertainties around many parts of it, so we are trying to keep up with all the challenges that you’re facing there. The elephant in the room that I hear through back channels is a lot of concern about what will the PCAOB do with respect to auditors and second-guessing what they’ve done relative to revenue recognition. If you look carefully at our findings on revenue, we do have a lot of them and not very often, especially with the major firms, do we say the accounting was wrong. We usually say the auditor didn’t do enough to test whether the controls were in place and the accounting was right, but it’s very rare that we actually say the accounting was wrong.”
