Bridge over ocean
1 February 2014 CFA Institute Journal Review

Shining a Light on the Auditors (Digest Summary)

  1. Natalie Schoon

Since the financial crisis, several reforms have been suggested to enhance the independence of auditors. Whether the reforms will be sufficient, however, still remains to be seen.

How Is This Article Useful to Practitioners?

Until 2002, auditors in the United States were generally self-regulating. Since then, audit firms have been limited in the amount of consulting work they can undertake for audit clients, and a new regulator, the Public Company Accounting Oversight Board, has been introduced. As a result, three new regulations have been proposed: the inclusion of a “Critical Audit Matters” section in annual reports; a reduction from 20% to 5% in the amount of work that can be outsourced without disclosure; and disclosure of the lead partner in each audit. The identification of the partner does not increase the partner’s legal liability, but it does put the partner’s reputation on the line and has had a notable effect on earnings manipulation in the United Kingdom. But this disclosure has also resulted in accountants demanding additional compensation. Mandatory audit rotation is not a feature in the US proposals, and although it benefits smaller firms more than the “Big Four” audit firms, it does not remedy the biggest challenge of all, which is that auditors are paid by the firms they audit.

Abstractor’s Viewpoint

The article outlines the potential impact of new regulations introduced by the Public Company Accounting Oversight Board by reviewing the experiences of the United Kingdom when it introduced similar rules. The most critical point, however, is the one mentioned last. In the end, audit firms are appointed by and paid by the firms they audit, not by the shareholders.

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