Some years ago the Exempt Organizations Division of the IRS posted on the IRS web site a controversial document setting forth the Service’s view on what constitutes good governance practices for tax-exempt entities. The document suggested that audit firms be rotated on a regular basis, with five years as the suggested term. The American Institute of Certified Public Accountants (AICPA) protested the inclusion of this recommendation. Sadly the IRS dropped the document from its website, explaining that the new Form 990 sets forth the IRS’ current position on good governance practices which do not include the five-year rotation suggestion.
The IRS recommended a five year audit rotation in order to address two problems.The first problem is that there is a tendency for audit firms to get too cozy with the management of the organizations they are assigned to audit. Personal and professional ties can easily impede auditor independence.
Secondly, audit rotation provides the opportunity for the organization to be examined with a fresh pair of eyes. Accountants are creatures of habit and checklists. Things are done the same way as they were last year and often in a very mechanical and non critical manner. Sometimes the most glaring internal control weaknesses can be overlooked simply because the auditors were not looking at the big picture but only concentrating on the minutia. A change in auditors guarantees that the organization in its entirety will get a fresh look and glaring internal control problems that may have been overlooked by the prior auditor may get picked up by the new one.
Of course CPA firms with long standing engagements with non profit organizations do not want to give them up for obvious financial reasons. So these firms use their professional association, the AICPA, to advocate against the obvious good governance practice that is clearly in the public interest. Such cynicism is sadly the rule not the exception for most professional organizations.
In any event the IRS had the right idea to begin with. Non profits should rotate their audit firms on a regular basis.
On July 9,2013 the House of Representatives passed a bill that would prohibit the independent audit oversight committee from making auditor rotation for public companies mandatory. The justification for this move is that audit costs would increase. The opposing argument in favor of audit rotation is that you do not want auditors to get too cozy with the management of firms they audit and enforced rotation might prohibit. Also a periodic “fresh pair of eyes” may be helpful in detecting irregularities or improper accounting treatments, I believe that any increase in audit costs is offset by the benefits of rotation.
In addition the public oversight committee should prohibit audit firms from performing any non audit tax or advisory services. Finally it may even be a good idea for an independent board to assign auditors to firms rather than the current practice of having the companies hire their auditors. In this way auditors would have no incentive to subjugate their judgment to company management. Such is the current political and economic power of the big audit firms that these common sense proposals have little chance of being implemented. Only a rash of audit failures on the scale of the Enron debacle is likely to end this state of affairs.