Mandatory comprehensive audit firm review – a sound alternative to mandatory audit firm rotation?

There are different alternatives being considered to address perceptions that auditors are overly familiar with their clients – mandatory comprehensive audit firm review (MCAR) seems to be gaining some attention.

There are different alternatives being considered to address perceptions that auditors are overly familiar with their clients – mandatory comprehensive audit firm review (MCAR) seems to be gaining some attention.

The appointment of the auditor is nominally made by shareholders of a company, but is usually proposed by the audit committee and, in practice, is highly influenced by the recommendations of management. This creates an inherent conflict in the independent and objective role of the auditor – auditors are expected to critically examine financial statements prepared by the very people who are involved in their appointment (often referred to as a familiarity threat).

To address this conflict, Canada adopted the international model which is a principles-based approach. An auditor must identify and evaluate threats to independence and apply safeguards to reduce threats to an acceptable level, or refuse to accept the audit engagement. In the aftermath of the 2008 economic crisis, several international bodies are challenging this approach and proposing changes to revise auditor independence requirements. For example, see my previous post Musical Chairs Anyone? PCAOB Proposes Mandatory Audit Firm Rotation.

In its response to the Public Company Accounting Oversight Board (PCAOB) Concept Release on auditor independence and audit firm rotation, the Canadian Public Accountability Board (CPAB) suggested the PCAOB explore MCAR as an alternative to mandatory audit firm rotation.

So what is MCAR? MCAR puts an onus on the audit committee to evaluate the effectiveness of the auditor on a periodic basis, and to report the results of this evaluation to the shareholders. In this report, the audit committee would, among other things, justify why the existing auditor has been reappointed or why a new auditor has been appointed. MCAR has potential benefits because it:

  • Promotes the assessment of auditor independence, objectivity and professional skepticism by the audit committee, thereby enhancing audit quality;
  • Provides transparency to shareholders around the auditor appointment process; and
  • Could reduce the familiarity threat either by changing the auditor’s behaviour arising from the evaluation process itself, or by a change in the auditor.

Of course, with any new approach there may be challenges. For example, audit committees would be required to spend more time, effort and resources on the evaluation process. Audit committee members may need additional training and education on how to perform an effective evaluation and write a report on the process. MCAR may also not be appropriate for all sizes and types of entities.

Keep the conversation going…as the debates continue on auditor independence, I would like to hear your views. Is the threats and safeguards model still working in practice or should there be changes? If so, how do you introduce changes that enhance audit quality without burdening the financial reporting process with unnecessary additional costs?  Email me directly.

Eric

Conversations about Audit Quality is designed to create an exchange of ideas on global audit quality developments and issues and their impact in Canada.

About the Author

Eric Turner, CPA, CA

Director, Auditing and Assurance Standards, CPA Canada