Auditor selection is crucial. Auditors provide insight into companies’ management systems and reliability of their financial statements, and identify risk areas and room for improvement.
They can have a positive impact on operations and add credibility to audited organisations, which gives potential investors confidence in a given business.
Regulations are in place, and best practices are recognised, to help companies make the right selection with non-executive directors playing a key role. Thorough research is required to ensure the right quality of service, not compromising on aspects such as fees. A company might have to re-tender if an unsuitable candidate is chosen, which would lead to higher overall costs.
Before the 2012 UK Corporate Governance Code provision was adopted—which requires FTSE 350 companies to put their audit out to tender once every ten years—a company changing its auditor was an infrequent occurrence. This was mainly due to specific circumstances including personal clashes between the incumbent auditor and the company; mergers and acquisitions; or poor service from the auditor, to name a few. The aim of the ten-year tender requirement is to address the problem of “cosy relationships” between clients and firms, which affected the quality of service.
Audit tender process—primary responsibility
It is a legal requirement to establish a thorough selection procedure for the auditor, with the audit committee’s supervision. The board should appoint at least three (or, for smaller companies, two) non-executive directors to take on the role, in consultation with the audit committee chairman. One (or more) is required to have recent and relevant financial experience.
The composition of an audit committee reinforces the transparency and independence of the tendering process. Their role is crucial to ensuring the company complies with relevant regulation, and sets specific criteria against which they can compare candidates.
In general, the audited entity is free to invite any audit firm to participate in a tender. There is a cooling-off period of four years for the auditor that is rotating off. Some key points according to EU regulation on auditor procedure for public-interest entities are as follows:
- Selection criteria and documents should be provided to auditors, giving them background information about the company. Negotiations between the audited entity and the tenderers are not prohibited by the regulation.
- The selection procedure should be based on the criteria set out in tender documents.
- The fact that the tender was conducted in a fair manner has to be demonstrated to the competent authority.
- For more complex businesses, the company may want to disclose an intention to tender in advance. This gives audit firms time to prepare.
Audit committee, finance teams and procurement
Despite the fact that procurement and finance teams might be involved in the tender process, audit committees should be responsible for making the final recommendations to the board. The contribution from the other employees is clearly important but their role should only be advisory, with leadership coming from the non-executive directors.
The importance of providing information
Auditors rely on information received from their future clients. Any disparity between the levels of communication could leave some at a disadvantage, which might also affect the diversity of responses. The decision of the audit committee would be influenced as their ability to make an informed judgement could be hindered.
Furthermore, the audit committee is responsible for keeping board members informed on the tender’s progress and any new developments that could have an impact on their choice (e.g. new regulation).
The audit committee can make recommendations on the appointment of an auditor. The final say, however, is down to the board. Its decision and reasons will be recorded in the annual report, and other relevant papers.
The role of the audit committee is not limited to the tender process. If an auditor resigns, they will need to investigate reasons behind it and suggest the best course of action. They should also assess whether there is the risk of an auditor withdrawing from the market, and the potential impact this may have on the business.
What is more, in the annual report they should explain the criteria against which they evaluated the audit process. This enables shareholders to understand why the audit committee made certain recommendations. If there are any other conditions that affected their decision, these should also be recorded.
Non-executive directors need the right expertise and knowledge to fulfil their duties. They are required to conduct extensive research and be great communicators who ensure that all stakeholders are kept up to date with important developments, providing both information and guidance.
Ethics needs to be at the heart of all their actions to ensure that personal relationships or interest do not influence their decision. Meeting those requirements will ensure they are able to fulfil their duties in an effective and efficient manner, contributing to the success of the business.
Henry Irving, FCA, is head of the audit & assurance faculty at the ICAEW.