Independence is the cornerstone of the auditing profession.  Independence is just another, slightly stronger, word for objectivity. If an auditor is to add any value to the client, investors, lenders, the economy or even the world, he/she must be objective, or “independent” of the information and the entity being audited. This means that the auditor must never be in a situation where their judgement may be impaired by pressures such as financial interests in the outcome, undue pressure, over-familiarity with the client, etc.

Not only does the auditor have to be independent, they must also appear to be independent. It doesn’t help if the auditor is independent but nobody trusts the auditor’s report because the auditor is not perceived to be independent. It’s like the difference between telling the truth and being believed – it doesn’t help if you tell the truth but, for some reason, nobody believes you.

The relationship between an auditor and the client (or more specifically, client management) is fraught with threats to independence. For example, the mere fact that an auditor has to be paid by management creates a threat. To perform an effective audit, there must be a good relationship between the auditor and management, but what happens if the relationship becomes “too cosy”?

Some of these threats are inherent to the audit function and can’t be removed – the only way to deal with them is to build in appropriate safeguards.

One such safeguard is in the Companies Act, 2008, section 92, which prohibits the same individual from serving as auditor for more than five years for certain audits. Legislators and professional bodies have also implemented safeguards, for example the auditors’ code of conduct that prescribes similar rotation requirements for different audits. Another way to deal with it is to warn the user and let them exercise caution if they think necessary. For example, auditors of listed public companies are now required to state in their reports how long the firm has been acting as auditor for the company. Therefore users that believe a long association between auditor and client may impair objectivity can make better informed decisions.

The Independent Regulatory Board for Auditors (IRBA) has recently proposed a further strengthening of the independence requirements: Not only will the individual be required to rotate after a defined period, the audit firm should also be required to be replaced on a regular basis. This is known as Mandatory Audit Firm Rotation (MAFR). This is in line with European Union guidance and is already in place in a number of jurisdictions in the world, for example China, Italy and the Netherlands. Some jurisdictions have considered it and decided against it (e.g. USA, Australia and New Zealand) while others have adopted MAFR and others have implemented and then repealed MAFR, for example Canada, Greece and Singapore.

The arguments in favour of MAFR are obvious, but many valid arguments have been raised against it.

The overwhelming concern is the time (and cost) it takes to familiarise a new auditor with the industry, the company, its processes, etc. A truly effective and efficient audit requires in-depth understanding of these matters and some of that understanding can only come with experience. Frequent change of audit firm adds another layer of compliance costs that can be avoided.

But good governance is never free, therefore the costs may have to be tolerated.  But the question would be if MAFR will improve governance to such an extent that it will justify the costs? A fresh pair of eyes can look better but will they look as deep as an experienced pair of eyes? How long will it take for a new firm to get up to speed? What about other unintended consequences?

Despite these and other objections the IRBA seems determined to push forward with their recommendation to make MAFR compulsory for certain companies. Parliament is currently holding public hearings on this proposal, the second round will be on 17 March. During the first round of hearings in February strong resistance was mounted by organisations such as the South African Institute of Chartered Accountants (SAICA), the CFO Forum and the King Committee.

What do readers think of the proposal?  Please let us know at [email protected] and watch this space for further developments.

Henk Heymans

Partner, Johannesburg

Also read: Mandatory audit firm rotation - the debate continues