Conversation Taboo: Auditors Advising on Auditor Rotation

Posted by Jonathan D. Moll, CPA

Nonprofit Auditor RotationQ. 1 – True or False: It is a best practice for a nonprofit organization to change auditors every 3 years.

Q. 2 – True or False: A thorough understanding of a nonprofit organization’s accounting practices and activities based on years of experience as its auditor increases the quality of an auditors’ report.

The dilemma is evident in the questions above. I will start by stating that the paragraphs below are NOT answers.  They are opinions.  And while they are based on more than a decade of experience within the profession, they are bound to be challenged.  After all, that is how I came to write this post.  I challenged a simple statement that I have heard dozens of times over the years. I was being interviewed by a potential nonprofit organization client in response to an audit RFP when I asked why they were putting the work out for bid. The audit committee trustee stated, “It is our long running policy, and a best practice, to rotate auditors every 3 years.”  I asked the trustee why the committee believed in this policy and the answer I got:  Silence.

Chances are that if you ask an auditor for his opinion on auditor rotation, the answer would depend on whether or not you are an existing client or a prospective client. And I am not proud to admit it, [face red with embarrassment] that I have argued both sides over the years. However, it wasn’t until I joined the board of a nonprofit organization and was asked the question by a fellow trustee while wearing my “trustee hat” and not my “auditor hat” that I really evaluated it without bias.

The overarching “pro” to the discussion regarding auditor rotation is that it reduces the possibility that an audit firm will lose its impartiality and become too close to management. The accounting profession has argued that this risk is minimized by the natural attrition and reassignment of responsibilities that occur on an audit engagement team throughout time.  The risk can be further mitigated by requesting that an audit firm rotate audit engagement partners within the firm.

The “cons” to auditor rotation are numerous.  The learning curve required by a new audit firm can increase audit failure risk and require extra time from the nonprofit organization’s finance and accounting staff. The administrative responsibility for routinely evaluating new audit firms is time-consuming and costly for management and board members.  And most importantly, there is a loss of institutional knowledge capital when audit firms are changed.

Over the years there has been much written about the concept of mandatory auditor rotation.  However, it is important to realize that substantially all available literature on the topic has been from a public company (PCAOB/SEC) mindset. While many of the issues are still relevant, auditor rotation for nonprofit organizations raises some unique issues.  With a focus on maximizing program services, nonprofit organizations often do not have the resources available to build as deep or sophisticated accounting/business offices as their for-profit counterparts.  Also, turnover rates for nonprofit accounting/business office personnel are often high. As a result, the knowledge capital from audit firm continuity can be an invaluable asset and should be considered accordingly.

It is without doubt that nonprofit organizations should periodically evaluate the quality of services provided by their outside auditors. Situations, such as dissatisfaction with service, should lead a nonprofit to seek new auditors. However, audit firms that provide quality service, offer great responsiveness, possess a niche expertise within your industry, and work well with the nonprofit organization’s staff are valuable service providers and a source of institutional knowledge capital. Audit partner or audit manager rotation within a firm can be a solution to overcome the risk of losing impartiality for long-tenured clients while at the same time maintaining experience on staff. In my opinion, change for the sake of change is not necessarily a best practice.

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