The article “I rotate my tires.Should I do the same with our City’s auditors?” was published in the Texas Municipal League’s Texas Town and City magazine in October 2006. The article, which was incidentally written by our managing partner, dispels the myths around the notion that change for the sake of change provides benefit to the audit process. As in the case of a great doctor or attorney, you do not change “for a fresh set of eyes”, but rather you stay with the professional who provides timely, quality, and responsive service, in which you are confident in their expertise and value their insight and does so all for a fair value.


I rotate my tires. Should I do the same with our City’s auditors?

By Robert Belt, CPA, CGMA

Submitted to Texas Municipal League for inclusion in Texas Town and City monthly magazine.

Being an auditor, I increasingly get questions about rotation of auditors. When asked if it is good or bad, my response is simple, “Who is your auditor?” Since our firm audits more than twenty-five cities it may seem like a self-serving response, but all kidding aside, here’s the rest of the story.

First, you cannot have a conversation about rotation of auditors without someone mentioning Enron and their auditors, Arthur Andersen LLP. That was a huge fiasco on many different levels and one of the biggest driving issues around the rotation topic. It is also important to keep in mind that the audit aspects of this debacle were different than the issues faced in a government audit engagement, but for the sake of an argument, would auditor rotation have helped? There are a number of things that could have helped and yes, at the right time, rotation of audit firms could have been one of them. While this could have helped, a number of people simply did not do their jobs and some broke the law. The question is, even with the benefit of hindsight, when would have been the optimal time to bring in new auditors? Even if Enron had changed auditors every five years, it is unlikely the timing of the change would have been optimal to prevent a huge financial crisis. In my opinion, the lessons learned from Enron by the auditing profession and governing bodies, such as City Councils, have more to do with auditor independence than rotation, but that is a topic for another day.

The second comment I hear about rotation is the benefit of “having a new set of eyes” or “getting a fresh look.” I will readily admit I have used both statements when bidding against an incumbent auditor, and there can be truth to the statements. The key to the benefit is who is doing the looking? If you are getting someone with better vision, then you made a good call. Would you change doctors just to get a fresh look? No, but if you continue to be sick you would likely try to find a new doctor who might diagnose or treat the illness differently. I would prefer to have a doctor with firsthand knowledge of my medical history.

But here is the other fallacy with the notion of “getting a fresh look” by rotating firms: while most city governments engage the same firm each year, rarely do they have the same auditors. Don’t tell my staff this, but they actually do the real work. The field auditor is where the rubber meets the road. Because of the natural advancement and progression of staff members in firms of any size, it is challenging to get the same staff back on a job each year, resulting in new personnel on the engagement. Each staff member sees things differently, so you are naturally going to get different opinions. In addition, in a city government, personnel change quite regularly, so often the only constant is the name of the firm doing the audit, negating any great conspiracy theory. For example, in six years of auditing one city, I have reported to three mayors, two city managers, two finance directors, and audit committees and City Councils of six different combinations. Field work for this engagement was performed by three different senior auditors, with three different technical reviewers. Consequently, sometimes there is an argument to be made for consistency and historical resources of the same audit firm for an area as vital as the financial activities of a city.

Does the data support the assertion changing auditors is good? The AICPA’s SEC Practice Section analyzed 406 cases of alleged audit failures and reported audit failures were three times more likely when the auditing firm was conducting its first or second audit of the company. They attributed this increased risk in new audits to the auditors’ lack of knowledge of the client and its business, knowledge that is gained over time. This is also supported by SEC statistics on enforcement actions which are more common in the first year of an audit. The U.S. General Accounting Office (“GAO”) released a report in 2003 noting mandatory firm rotation may not be the most efficient way to strengthen auditor independence and enhance audit quality. In addition, the GAO found nearly all the largest public accounting firms and Fortune 1000 publicly traded companies it surveyed believed the costs associated with audit firm rotation are likely to exceed the benefits. Similarly, the GAO found the views of stakeholders, like institutional investors, regulators, and banks, consistent with the views of the respondents to the survey. In summary, while rotating auditors may initially sound like a prudent move by a government board to fulfill its fiduciary duty, the data available support that it hurts rather than helps the quality of audits.

How much does changing auditors cost? On average it has been my experience that for a city government the time requirement for a first year audit is about 30% more than subsequent years. Auditors learn quickly to propose higher fees or not to propose on clients who change auditors within ten years. If audits were actually priced this way, few cities would actually change firms, so firms will typically amortize this additional first year cost over their expected tenure. In addition, from the city’s staff’s perspective, filling out internal control questionnaires is about as enjoyable as completing their new doctor’s medical history form and cuts into their already limited schedule. The bottom line is it is hard on both the audit firm and the client to change auditors and the audit process costs more.

Regardless of cost, do cities benefit from rotating auditors? Yes, sometimes, but as I initially said, “Who is your auditor?”, because it really is about change, not rotation. If you are driving your car and a tire goes flat, you will benefit from going through the effort of putting on your good spare. If you have a perfectly good tire and you want to change the tire in your driveway just to check out your spare, it is not worth the effort. The mistake I see many governments make is they lock themselves into a policy of rotation, not knowing who will bid on their audit. Let’s face it, city audits are complex and the number of experienced firms is limited.

Let me give you an example of another type of government audit. One of my competitors is very good at auditing school districts – something I would not tell them – but nonetheless it is true. The firm had a local school district client for more than twenty years. An elected official began beating the rotation drum. The school district likely got too far into the process before they realized they had one of the best firms in the state at auditing school districts, particularly for a school of their size. The school board ended up with a substantially less experienced firm from outside the region. In my opinion, rotation even after twenty years, just for the sake of rotation, hurt the quality of their audit.

Here is yet another problem. Once you have moved away from a valued relationship concept to a rotation philosophy, what incentive is there for a service provider to keep up their service level? Sure you will get the same report, but will you get the same quality of staff, and will they go the extra mile? As auditors, we often spend extra time with our clients, assisting them through problems, because in addition to the service aspect it makes our job easier next year. In addition, we do a lot of planning to ensure our clients are prepared for new accounting standards years in advance. Your auditor is not required to help ensure you are prepared for GASB 44, but if they know they are going to be standing in front of you in a couple of years explaining the qualification to their report for the data you were not able to provide them, you can bet they are working on the issue now.

If firm rotation is not the answer, how does your City Council fulfill its fiduciary duty in ensuring the quality of your city’s audit? First, get a statement of your audit firm’s qualifications along with a copy of the firm’s peer review letter and letter of findings, if any. These should be clean, and if not, run to the nearest exit. The AICPA recently established the Government Audit Quality Center, which is an effective tool to ensure firms auditing governments are up to speed on new issues. If your auditor is not a member, consider asking them to join the organization. The quality of a city audit is often directly related to the number of similar audits performed by the auditing firm. I have observed a direct correlation between the number of operational problems within the accounting and finance functions of cities, when previously audited by a firm with minimum number of other city clients. So to the extent possible in your geographic area, try to engage firms with a number of city clients, and monitor their client base from year to year.

In summary, in my seventeen year career, I have not seen a city benefit from rotating from one good firm to another of the same caliber of work. I have seen many cities benefit from changing firms because of rotation, only to find their old auditors were not doing a good job. However, this benefit is more directly related to ensuring they had the best service provider, as they could have easily gone the other way for the simple sake of rotation. Change for the sake of change is not always good whether it is your doctor, attorney, or CPA. If you want to change auditors, rotation is as good an excuse as any, but from an auditor’s perspective the concept does not have much merit, and both the auditors and their clients lose as a result.