Audit rotation hits KPMG, benefits rivals

Last week Vodacom announced that it was changing auditors, shuffling PwC out the door in favour of Ernst & Young.

PwC lasted less than four years as auditor, and the Vodacom stock exchange announcement leaves us none the wiser as to the reason, other than that a review of suppliers happens ”from time to time”.

Two weeks ago Life Healthcare announced it would replace PwC with Deloitte at the end of the current financial year in anticipation of mandatory audit rotation, which kicks in in 2023.

Also last month, investment holding company Zarclear announced that it would retire Deloitte and replace it with BDO after a disagreement over audit fees, and in an effort to reduce operating costs. In January, Trans Hex also cited the need to reduce operating costs as the reasons for retiring PwC in favour of Mazars.

And so it goes. Afrox last month said goodbye to KPMG and welcomed PwC as auditors. KPMG had been the company’s auditors since 2007 and was being rotated out in the interests of good governance.

In February, Cartrack replaced BDO with Deloitte after putting out a tender for one of the Big Four audit firms, saying this was part of a global strategic move.

Also in February, Consolidated Infrastructure Group announced it would be an early adopter of mandatory auditor rotation and replaced BDO with PwC.

In January, Bid Corporation announced PwC would take over as the company auditor after KPMG resigned. The company went to some trouble to send KPMG off with a decent recommendation, saying it was satisfied with KPMG’s audits and that they were parting ways with no disagreements.

Reputational damage

KPMG has been without doubt the big loser, having lost more than 20 listed clients since 2017, capped by its rotation out of Nedbank in October last year in favour of Ernst & Young (EY).

The involvement of KPMG in the audit of VBS Bank, looted of more than R2 billion, and its work with Gupta-associated companies, shredded its reputation.

Old Mutual continues to use KPMG as auditor, and the fact that it gained one or two new clients (see table) suggests things may be stabilising.

In total, 64 companies have rotated auditors since 2017, equivalent to 17% of all JSE-listed companies. For some, it was an opportunity to bargain hunt for cheaper audit services, but for most it was in anticipation of a change in rules mandating a change in auditors every 10 years. This new rule, known as Mandatory Audit Firm Rotation (MAFR), was introduced by the Independent Regulatory Board for Auditors (Irba) and comes into effect in 2023. Some 38% of firms rotating auditors last year cited MAFR as the reason.

Debate

There has been debate as to whether this new requirement is beneficial or harmful to audit clients. Some audit firms have argued that it takes years to understand the intricacies of a client’s business, only to hand it over to a new auditor every 10 years.

Research by Zvi Singer of HEC Montreal and Jing Zhang of the University of Alabama found that auditors discover misstatements far more quickly within the first three years of an audit appointment but, by the time 10 years are up, the quality of their audit is beginning to wane. The authors argue for a maximum audit engagement period of less than 10 years.

Misstatements of financials made in the early years of an audit assignment are allowed to accumulate and increase the longer the audit tenure progresses.

Auditor misstatements are often picked up only when new auditors are appointed. Singer and Zhang were able to identify misstatements after the collapse of Arthur Andersen, once one of the Big Five audit firms. Andersen’s demise meant clients had no choice but to change auditors, which is when anomalies were picked up.

‘Sufficient evidence’ rotation works

Irba CEO Bernard Agulhas says there is now sufficient evidence that auditor rotation improves the quality of the audit and strengthens auditor independence.

He expects 120 or one-third of JSE companies to have rotated auditors by the end of this year. “We can anticipate that by 2021 most listed companies would have complied. The number of early adopters is encouraging, but we nevertheless appreciate that in some cases companies have other audit firms doing non-audit work for them, which results in a conflict of interest and temporarily prevents the easy rotation of the audit from one to another.”

In 2018, 35 companies changed their auditors in early compliance, up from 18 in 2017. This is a 94% increase year on year. In the first three months of 2019, nine companies have announced a change of audit firm.

From 2020, audit firms will be required to publish Audit Firm Transparency Reports to assist company audit committees in choosing the right audit partner. The current transparency reporting process is voluntary.

One of the likely impacts of MAFR is to give second-tier audit firms a chance to perform joint audits. “This will also contribute towards addressing current concerns around concentration in the audit market,” says Agulhas.

Source: Irba and ShareMagic

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