Saturday, September 07, 2013

European Commission Reaffirms Support for Mandatory Audit Firm Rotation

In a letter to the U.K. Competition  Commission on its audit tendering proposal, the European Commission took the opportunity to reaffirm its strong commitment to audit firm rotation as the best way to bring diversity to the highly concentrated outside audit of financial statements market. While noting that the Competition Commission proposed mandatory tendering on a five-year basis, the European Commission said that it was addressing a wider range of issues involving enhancing auditor independence and improving audit quality.

In this regard, the Commission views mandatory audit firm rotation as an essential step for ensuring independence and professional skepticism. Audit firm rotation is needed to ensure a ``fresh pair of eyes’’ and avoid the relationship between management and auditors becoming too close. There is a real risk that incumbent auditors would be unwilling to challenge their own past judgments where such an act would be likely to either inflict reputational damage or where restatements might result in potential legal liabilities. When an audit firm knows that it will be replaced, reasoned the Commission, it will be incentivized to maintain skepticism in its judgments since the incoming auditors will be reviewing those judgments in detail.