Mandatory Audit Firm Rotationfinal

7/24/2019 Mandatory Audit Firm Rotationfinal

1/16

Mandatory udit

Firm Rotation

BY PENG ZHANG

RICHARD CASTRO

ACCT 502

PROF. V IVEK MANDE


2/16

Agenda

Introduction Zombies Pros & Cons

Regulation Theories

Agency Theory

Information Asymmetry Adverse Selection and Moral Hazard

Sarbanes-Oxley Act of 2002

Conclusion

Questions


3/16

Watch Out Auditors!!

BIG 5

Enron Andersen


4/16

Accounting Information Use by Inve

PriorBelief

Rational

Investor

Bill

Cautious


5/16

Mandatory Audit Firm Rotat

PROS Fresh Look at financial reporting

Provides independent, objective,and professional skeptic viewpointfrom shorter engagement times.

Loss of stigma that change inauditor is a bad signal.

CONS Costly ( expense & labor

Less effective audits lowquality after 5 years. Loss independence.

Loss of firm specific expe


6/16

Regulation Theories

Public Interest TheoryThe regulator is assumed to have the best interest of society at hea

- In this case, the aim is to protect the investor by maximizing social wbecause the public demands correction of market failures.

- What is the correct amount of regulation? Some would like lots of re

and others the opposite.

Pg. 532


7/16

Regulation Theories (contd)

Interest Group TheoryAn industry operates with a number of interest groups.

- These groups may lobby for and against regulation. Creation of standard-setting bodies PCAOB

Activities subject to market failure

Due process

Pg. 532


8/16

Agency Theory

What is an agency theory?

Assumption

Self-interest

Informationasymmetries

Concern

Reliability ofinformation

Level of trust

Solutions

Compensate the agent(management)

Monitor the agent(management)

Aud

Mo

Pg. 358


9/16

Agency Relationship

Investors

(Principal)

Auditors

(Agent)

CompanyManagement

(Agent)

Monitor

Hire Hire

Long term relat

Economic de

Psychologica

Decrease the

confidence

Pg. 358

In practice:

the management an

control the appointm


10/16

Problems?

Only support in economics and business administration Relationships are more complex than agency theory

Long-run costs to auditors:

Lawsuits

Reduction in reputation

Reduced public confidence in financial reporting


11/16

Information Asymmetry

Adverse SelectionManagement and auditors have moreinformation than the shareholders. Thelonger the firm and the auditor have workedtogether, the bigger the fear theindependence of the auditor has been lost.

The stockholders are at a great disadvantagesuch as the cases with Enron, Worldcom,Adelphia, etc.

Pg. 22


12/16

Information Asymmetry

Moral HazardIs the company working to the benefit of theshareholder or the managers own?

Only the managers and their auditors knowthe truth. Investors can only work with

publically available information put out bythe company with the assurances of theauditor.


13/16

Sarbanes-Oxley Act of 2002The SOX Act created several laws to increase auditorsindependence such as:

Section 201 Prohibited Auditor Activities

Section 302 Corporate Responsibility for Financial Reports

Section 404 Assessment of Internal Controls

- and -

The Public Company Accounting Oversight Board (PCAOB)

- A private sector, non-profit organization created to overseeauditors.


14/16

Conclusion

Implementing the Mandatory Audit Firm Rotation is not necessary.

Audit partner rotation and audit firm rotation

- Changing the auditors within the same audit firm

Implementing the audit firm rotation partially

- Applying to the large companies and leaders in the industry.

Flexible length of the tenure

- The system of comply or explain


15/16

ConclusionThe SOX Act created enough regulations forauditors to be more independent and companyofficers to be more responsible.

Companies could still voluntarily switchauditors but this may be seen as a bad sign byinvestors.

Even though only the ENRON account was

doing illegal activities, ANDERSEN became anaccomplice and stopped being an auditor, onceconvicted they could not provide audits topublic companies.


16/16

Q&A

How do we prevent

fraud?

How do you keep

auditorsindependent?

How do you prevent

another Enron /

Andersen collapse?

How do you prevent

earnings

manipulation?

Documents

Mandatory Audit Firm Rotationfinal