RSS feedsListed companies in the UK are facing up to the implications of audit partner rotation - the fact that their friendly senior auditor suddenly has to move on. The Auditing Practices Board's ethical standard (ES3), specifies that the audit engagement partner must rotate every five years.
Gradually, but with increasing frequency since December 2004 when ES3 became effective, audit partner rotation has been impacting on listed companies, whose audit committees now need to plan ahead for these transitions. For non-listed companies, where the relationship between auditor and company is often much closer, the rotation periods are longer, but the issue can be just as critical.
Try-outs
As the first rotation cycle evolved, it became clear that there were challenges to be addressed on both sides to make it work smoothly and effectively.
Companies have generally found the process to be effective, welcoming a fresh approach, new insight and ideas. But, at the same time, companies want to retain knowledge of their legacy decisions when their audit partner rotates out. In addition they want stability around advice and policies.
Problems have occurred when clients have not felt engaged in the process and therefore feel they have not 'chosen' their new partner, or where issues they felt had been dealt with were either revisited or overturned. In the worst case, badly planned rotations have led to further partner changes and even re-tenders.
To avoid disruption, it is therefore important that a proper handover is achieved and clients are given an opportunity to ensure that the chemistry will work.
There is no one-size-fits-all process and the range of approaches depends on the size of the company and the importance it places on the audit.
In one company, it was just two months before the year-end that the CFO, the audit committee chair and the CEO made their decision after interviewing one of two potential candidates.
In another case, the audit committee chair and the CFO interviewed two candidates and made their decision a full six months before year-end, leaving plenty of time for a proper handover between the outgoing and incoming partners.
Talking tactics
Audit firms seeking to meet the needs of large clients are identifying in advance those partners for rotation with relevant sector, industry, and large client handling experience; all skills which, for a large audit, may already exist within the team.
Leading audit firms recognise the need for a matching exercise so that the new partners earmarked to rotate in to an audit have just as good a relationship with key individuals in the client company.
Partner rotation is being planned years ahead, giving companies the opportunity to interview and get to know the new partners, with a clearly staged and planned handover embedded in the process. As an example of this long-term planning, partners can be removed from an audit team for two years before coming back to lead the engagement.
An APB survey indicates that smaller companies are taking little account of audit partner rotation, but for a small company the issue could arise rapidly if a decision is made to seek a stock market listing. Suddenly the rotation period diminishes from ten to five years, and although there is a two year extension available in these circumstances, it can still be a shock for a company in the midst of listing requirements to be told its trusted adviser is going to have to change.
Companies and their auditors are still in the first cycle of audit partner rotation, and there is a risk that companies under-estimate the impact of a badly managed transition. But leading companies and their auditors are developing best practice which addresses the issues, offering an agreed process to smooth the transition.
Tim Gordon, is managing partner, Ernst & Young London Assurance
