Rewrite the essay or even reorganize it, if it is necessary. Shorten it to 2 pages and make it decent.
In recent years, there has been a series of financial scandals involving public companies around the world. The auditors provided untruthful auditing reports of the financial statements. These auditing reports resulted in billions of losses to investors, did tremendous harm to society, violated the rights and the interests of the shareholders, creditors, customers, and employees, had a negative influence on the development of the economy, and caused distrust of the accounting profession.
Some people believe that mandatory audit firm rotation should be implemented. Audit firm rotation ensures that the auditing reports are more objective, independent and efficient. It also avoids fraud caused by auditing failure in public companies. However, other people say that forcing public company switching to another audit firm would just be a formality. Switching might not avoid any possible fraud. Rather, the rotation would incur high costs. This paper focuses on the debate on the disadvantages and advantages of mandatory audit firm rotation.
Historically, most companies change audit firms very rarely, and generally, change is due to disagreements regarding fees or the quality of service. In the Sarbanes-Oxley Act, it was suggested that public companies be required to change auditors every five years. In this analytical research paper, we aim at discussing the impact of accounting firm rotation. By analyzing the impact on independence, and the impact on the cost and the quality of the auditing, we debate that public companies should not be forced to change their audit firm.
A mandatory audit firm rotation seemed could provide an independent, objective and professional viewpoint on financial reporting. The public investors could achieve more reliable information from the short term audit tenure. However, when we utilize financial accounting theories to analyze the policy, we found the answer is no. We could not provide support for the mandatory audit firm rotation.
Appling agency theory, audit firms themselves are also considered agents of the principals. Furthermore, it could be assumed that the auditor also is a utility maximizing individual who acts in self-interest. To maximize their profit from auditing, they would choose to overlook irregularities and avoid troublesome fields, so that maintain the contract. However, since audit firm is another organization whose self-interest is more complex than the individual, a one-sided use of agency theory is limited by its outlook on mankind as individuals. Some long-run costs exist to audit firms, such as lawsuits, reduction in reputation, reduced public confidence in financial reporting, which might lead to a loss of business. We could not simply assume a lengthy audit tenure would decrease audit quality by agency theory.
Interest group theory believes that many different interests compete to control government policy, and that their conflicting interests can balance out each other to provide good government. Mandatory rotation would impose a substantial cost on both the companies and audit firms. For specific industries and companies, initiating auditing requires the auditor to develop or retain significant specialized expertise. The loss of institutional knowledge and experience resulting from the rotation would be severe. This loss of knowledge would present a material cost to the company and the capital markets. Thus, the policy could hurt companies’ interest and harm the capital market efficiency, while the policy could not ensure to protect the public’s interest.
Further, audits of public companies provide investors and other users of financial statements with confidence in a company’s reported financial information. In so doing, they serve the public interest by facilitating the efficient and effective operation of the capital markets. Competition in respect of quality helps make sure that the public interest is continuously well-served, and price competition ensures that audit services are provided cost effectively. Mandatory firm rotation as an artificial market intervention may lead to significant adverse consequences – lower quality, less innovation and reduced efficiency resulting in higher prices. Researchers found that audit failures were three times more likely in the first two years of an audit caused by the lack of knowledge of the client’s accounting and internal control systems at the early stage of auditing. It means that audit quality somehow improved as audit tenure.
Considering the capital market efficiency, different groups’ interest, and uncertainty in audit quality. We conclude that implementing a mandatory audit rotation is not necessary.
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