Auditor Rotation: To Change or Not to Change

How often should you rotate your auditor? Many board members from publicly-traded companies encourage the nonprofit boards they serve to explore audit firm rotation as a best practice. But is it a best practice?

The pandemic disrupted the way we do business. If you’re considering a new audit firm, be sure to inquire about their ability to conduct the audit virtually if that’s what your nonprofit is most comfortable with, or if regulations become more strict.

Is There Guidance Regarding Auditor Rotation for Nonprofit Organizations?

The rise of audit partner or audit firm rotation policies, in large part, is attributable to the Sarbanes-Oxley Act of 2002. Curiously, with the exception of two very narrow provisions of the act dealing with document destruction and whistleblower policies, the act does not apply to nonprofits unless a nonprofit is also an issuer of publicly traded securities or has filed as a registrant to issue such securities under the Securities Exchange Act of 1934 or the Securities Act of 1933, respectively. So, if the Sarbanes-Oxley Act doesn’t apply to nonprofits, why have so many adopted its audit partner rotation policy, or gone even further and turned the policy into one of audit firm rotation?

The Sarbanes-Oxley Act has had effects—intended or otherwise—on the relationships between nonprofits and their auditors since its passage. Never was the act intended to apply to nonpublic entities such as private businesses, nonprofit organizations, governments or municipalities. Nonetheless, as the provisions of the act became better known and more widely understood after its passage, the merits of adopting some of its provisions began to make sense to managers and directors of nonpublic entities, and some of those provisions have evolved into “best practices” over time.

Perhaps the most ubiquitous of these “best practices” is that which has generally become referred to as “auditor rotation.” This broad term encompasses both audit partner rotation and audit firm rotation.

Contrary to widespread misconception, the Sarbanes-Oxley Act doesn’t require rotation of audit firms.

Review common practices for nonprofits to consider when evaluating policies to implement a smooth audit process.

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What Are the Consequences of Audit Firm Rotation?

With audit firm rotation, disruption with a capital “D” occurs and affects everything, often to the detriment of the nonprofit. A study of auditor tenure conducted by professors at the University of Richmond and Texas A&M International University concluded:

The results do not support the arguments of those who propose mandatory auditor rotation and suggest that, contrary to the concerns expressed by the SEC, there is an inverse relationship between auditor tenure and audit reporting failures.

The AICPA opposes mandatory audit firm rotation, citing the often costly and unintended consequences that may result. Instead, the AICPA recommends the strengthening of audit committees and encourages them to be more proactive in their interactions with and supervision of the auditors.

How Do You Determine What Is Best for Your Organization?

• Ensure independence and objectivity. Ask yourself whether your current firm adheres to and performs in accordance with auditing standards. In addition, all firms are subject to a peer review process every three years to ensure the processes of independence and objectivity are followed. Ask your firm for its most recent report.
• Look for participation. Is your auditing firm anxious to meet with your audit committee to discuss procedures, help them understand objectivity and discuss any matters that have come to the auditor's attention? Passionate auditors are valuable to the success of your organization.
• Consider technology and communication preferences. Be sure to consider the technology tools and methods of communication your team is most comfortable with. Some nonprofits will continue to operate cautiously and conduct business digitally. Make sure your audit firm can perform audits remotely using innovative technology.

The arguments for rotation include:

• Audit objectivity. While there is not a standard for mandatory audit firm rotation, some believe it is necessary for audit independence.
• A "fresh look." Depending on organizational and environmental conditions, your audit may profit from new perspective.
• The antidote for this argument is to ask your audit firm to rotate the engagement team—partner and/or staff. This allows you to retain the expertise, industry knowledge, and service you're receiving from the incumbent firm while adding the "fresh look" component you might be seeking.

The arguments against rotation include:

• Increased costs. More costs may be incurred by the organization and its staff in the procurement process and initiation of a new firm. There may also be an increase in audit costs due to additional time spent in the first years of an audit relationship. Of note: The Government Accountability Office surveyed hundreds of companies and auditors about audit firm rotation and reached the general conclusion that rotation increases costs and has very little, if any, effect on the quality of audits.
• Decreased service levels. Some organizations notice that the level of service they receive from their current audit team declines as the relationships come to a close. This should not be the case, but it does happen occasionally and thus should be considered.
• Loss of existing organizational knowledge and relationships. Your audit firm likely has a good handle on your industry and your organization. Starting from scratch when it comes to building relationships and bringing a new firm up to speed can feel daunting.

Consider Level and Quality of Service

If you are not receiving the level and quality of service you expect, discuss the issues with your auditors. If they are no longer able to meet your standards, a change may be in order. But it’s important to remember that change does not come without cost.

Ensure you’re getting the most out of your nonprofit audit. Our advisors can tailor your audit for what works best for your team – whether it’s remote, in person or a hybrid method.

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