Industryline

Industry focus: Assurance

Paul Badrick Paul Badrick

Mandatory audit firm rotation requires considered approach to maintain high standards

The Independent Regulatory Board of Auditors (IRBA) recently announced its intention to implement mandatory audit firm rotation (MAFR) for listed companies in an effort to strengthen auditor independence, increase audit quality and to distribute audit work more evenly by decreasing the concentration amongst the Big 4 audit firms.

This means that all listed companies will be required by regulation to change their audit firm after a set period of time. The announcement has drawn criticism from a number of stakeholders who are concerned about the implications this may have on both the audit profession and listed companies.

Grant Thornton shares many of these concerns and is of the view that it is vital for all stakeholders to protect the world-class standards South Africa has worked towards over the years.

South Africa truly has excellent accounting and auditing standards, most notably as affirmed by the World Economic Forum’s Global Competitiveness Report for 2016-17 which ranked the quality of our audit and reporting standards as the best in the world for the seventh consecutive year.

The IRBA acknowledges this in its most recent discussion paper on mandatory audit firm rotation (MAFR).  Therefore, before implementing any major changes to the system, such as those proposed by the IRBA in terms of MAFR, it is of absolute importance to ensure that we guard against potentially destroying the high quality which has been built over many years.

What would mandatory rotation mean for clients?

The IRBA proposes in its latest discussion paper that, for all financial years starting on or after 1 April 2023, an audit firm may not serve a listed company for more than ten years. If this applies to a listed company then, by 1 April 2023, it will have to change its audit firm. The audit firm may only be re-appointed to the same company after a cooling off period of at least five years.

While this implies a monetary cost to effect the audit firm change, the costs associated with the tendering and switching processes are not necessarily the biggest concern. The greater cost to a client could result in the loss in corporate memory when an audit firm is forced to rotate.  Making the transition to a new firm implies a massive interruption in a client’s operating environment. Past experiences have shown that it takes an audit team an average of two to three years to truly understand its client, which has the potential to decrease overall audit quality.

This applies even more so in specialised industries and sectors, where an audit firm either has to get to grips with complex operations or where the company operates in multiple jurisdictions with varying sets of tax and other regulatory requirements.

Risks associated with mandatory rotation

Several notable stakeholders – including the CFO Forum which represents financial heads of various corporates, the JSE, the Banking Association of South Africa, the King Committee and representatives from the ‘Big 4’ audit firms have raised the concern regarding overall audit quality as a major risk to the profession and the companies that operate in South Africa.

They have also pointed to the fact that, by mandating changes in audit firms, it infringes on the rights of shareholders to choose the firm of their preference.

One of our big concerns about MAFR is whether this will result in the distribution of more audit work to firms outside the Big 4. The IRBA has acknowledged that mandatory firm rotation may not achieve a greater spread of audit work among all audit firms.

Mixed international experiences

The concept of MAFR is not new and has been implemented in a number of countries, including Brazil, India, Turkey, the Netherlands and the European Union.

These countries had similar intentions in aiming to reduce the reliance on the four biggest accounting firms and simultaneously to increase independence, but often this has not materialised. In the UK the process resulted in the ‘Big 4’ having the same proportion of listed clients as they did before the mandatory rotation, leading many to refer to the process as a big exercise in ‘musical chairs’. There has been no definitive evidence that it necessarily has led to greater independence and improved audit quality.

How will it impact the industry?

Grant Thornton supports the IRBA in its efforts to create better independence and audit quality, but we should go about achieving this with great care.  We need to be certain that we are not disregarding the measures currently in place to achieve this.

The Companies Act already mandates rotating audit partners every five years, while the IRBA and King Code of Governance Principles sets out mandatory partner rotation after seven years. In addition, the Companies Act also sets out the rules for auditors' independence.

As seen from international examples, merely mandating firm rotation is not enough to ensure greater independence, nor to confirm a more even spread of work. South Africa has worked hard to achieve world-class audit and accounting standards, which has been one of the key factors attracting investment and offshore businesses to our shores. 

We believe a careful and deliberate approach is the only way to ensure we maintain the high standards of our audit profession that do not compromise on the quality of service we deliver to companies.