By Tom Barkley – Tom.Barkley@EthicalBoardroom.com
There are a range of factors taken under consideration when selecting and retaining external auditors. In particular, one key consideration is the independence of the auditing process as history and research has indicated that the success of the external auditor is predominantly based on the probability that an auditor will both find and report a breach in the financial and accounting systems on an organisation. However, companies will often consider several further characteristics when assessing audit firm service suitability. The importance organisations place on the various criteria varies from firm to firm and is typically dependent on the specific needs of that enterprise.
The major factors that are considered in selecting and retaining an auditor include the size of the audit firm, the status of ongoing auditor engagements, the cost of the auditor firm service and the specialty of service the auditing firm offers. Compatibility between the company and auditor, the references obtained about the auditor’s prior work and a written proposal provided from the auditor firm outlining how they intend to meet the organisations needs are also factors taken under consideration when selecting and retaining external auditors.
With regards to the size of the auditor firm, research has indicated that audit quality increases with audit firm size. This is due to the large amount of accumulated industry experience and knowledge. Large or global companies can often require the expansive resources that larger auditors offer – such as large amounts of personnel, expertise and availability, that typically Big Four audit firms are known to possess. Certain larger companies will require a large audit firm to perform the breadth and range of its substantial audit activities. However, for smaller companies, selecting and employing a Big Four firm may not be necessary nor the right choice all factors considered.
The status of an ongoing auditor engagement is also taken under consideration when selecting and retaining an auditor. An established and long relationship with a particular external auditor can have a positive impact on audit quality. The audit firm may have built up a depth of client-specific knowledge, allowing them to fulfil their audit job more comprehensively. However, caution is often also exercised in this area as this relationship may also pose a risk. It could have a negative impact on the quality of the audit through a decreased probability of reporting a discovered breach within the audit function. Familiarity may lead to negligence and worse still ignorance.
For some firms minimising cost may be a primary consideration. It is important for firms to balance the cost with the quality and extent of service provided. Typically a range of price is set in advance and within which the value and service is maximised when selecting an external auditor. The final decision should not be the cost but instead this factor should be incorporated into a balance of factors that incorporate value of service, skill and knowledge rather than the bottom line price. An external auditor should be selected such that needs and expectations may be met sufficiently.
It is also widely accepted that industry specialty can lead to the provision of better quality audit work. This is due to a number of reasons including lower costs from economies of scale, specialist knowledge and superior audit technologies. Additionally, industry experience will improve the detection of false reporting. The compatibility of the company with the potential audit firm is also an important consideration. The relevant parties, involved in the many layers of the company will be working closely with the external auditor and this can make chemistry between company personnel and the auditor’s personnel crucial. Further to this, the culture of an audit firm can be a key consideration in selecting an external auditor.
For many organisations, selecting an auditor based on the references and advice of other industry participants can mitigate elements of risk involved in auditor selection and retention. Companies can gain insight into the nature and service of the auditor from this action and this can help them select the best audit firm for their needs.
Furthermore, the written proposal that a potential firm prepares in outlining its auditing services may provide an indication of how an audit would be tackled by a given firm and aid selection. To maintain a transparent and fair selection process, best practices have indicated that enterprises should share their selection criteria openly with potential audit firms.
Through this clear and open communication the audit function will become more efficient and effective.