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Engaging Auditors PDF
Engaging Auditors PDF
Engaging Auditors
Information and Audit Reforms
Engaging Auditors 3
Client-Auditor Courtship
Engaging Auditors 4
A Case for Case Study
Engaging Auditors 5
Unintended Consequences of
Auditor Rotation
Obtained access to confidential records from
companies
Client requests for proposal for audit services (RFPs),
board and audit committee minutes, and executive
notes
Audit firms (bid documents submitted in response to
RFPs)
18 interviews (client executives and bidding audit
partners)
Both RFP processes arose from auditor rotation
mandate
Case 1: mandatory engagement partner rotation led
the client to invite bids and, ultimately, to un-
mandated change of audit firm.
The audit committee chair and the CFO: availability of
senior audit partners with relevant industry experience
due to rotation in their own firms was a major factor
Opportunity to assess the potential benefits (or lack
thereof) from rotation of the audit partner/firm
Extend prior studies of forced audit partner rotation
(GAO Reports 2004; Kaplan and Mauldin 2008)
Case 2: a government organization implemented
decided to put the audit up for bid every three years
Illuminate potential unintended consequences of
mandatory rotation: perennial courtship of clients
Both cases study prestigious, profitable, growing, and
successful organizations targeted by Big-4 firms
Engaging Auditors 6
Findings
New details of engagement, absent in public records
Useful to examine assumptions; new variables for
models
New questions, thought and conjectures about
engagement
Documenting the process (for auditors, managers,
boards, and regulators)
Understanding how information is produced, exchanged
and used in auditing
Rich materials for nuanced class discussion of
accounting and governance
Involvement of the audit committee in the auditor
selection, although management runs the process
Management the main producer and gatherer of
information and controls what, when, and how it is
distributed to the audit committee and auditors
Auditors struggle to differentiate themselves through
their technical expertise
Relationship building is critical to success in the
courtship process
This effort raises concerns about independence
Significant differences in proposed audit fees
Audit partner rotation can catalyze the RFP process;
rotation influenced client satisfaction with the
incumbent auditor, freed up expert resources at other
audit firms, and fueled auditor courtship practices.
Engaging Auditors 7
Method
Approval from the research ethics board
Each participant (and firm) signed a consent
form, promised confidentiality, a copy of the
written research report, and the opportunity to
suggest corrections of any errors or
misunderstandings
Obtained RFPs (Client 1, >$10 Billion assets,
listed on TSX with NYSE sub, regulated,
financially healthy) sent to the Big-4 audit firms
(Auditors 1-4) in Appendix A
Obtained bid documents directly from all Big-4
audit firms, releases authorized by local
managing partners, Auditor 1 – incumbent,
Auditor 2 – winning bidder, Auditor 3, and Auditor
4.
Interviewed the CFO and the chair of the audit
committee (60-90 minutes each, generally
following a standard script given to them in
advance (Appendix B), recorded on audio tape
and hand notes, within 6-12 months of
completion of the RFP process
After clearance from the CFO, the MDs of the four
audit firms identified the proposed lead
engagement partner; interviewed each proposed
engagement audit partner (sometimes with the
local managing partner) who oversaw the
development of the bid documents; guiding script
in Appendix C; taped and handwritten notes
Engaging Auditors 8
Method
Follow up with Client 1 to clarify our initial
observations from last four steps; obtain additional
records: minutes of board and audit committee
meetings on auditor selection; outline of the client’s
prescribed RFP process; written correspondence
between the audit committee and management;
completed evaluation forms assessing the auditor
bids; and management’s completed scorecard
recording deliberations about each audit firm
As a cross-check on our observations in this case, steps
a-d were repeated for an audit put up for bid in a
government-funded organization (Client 2: a large,
complex, prestigious organization with a budget of
more than $2 Billion in 2008)
RFP to all Big-4 firms plus one national firm, received
3 Big-4 bids. Obtained bid documents from all bidders
and conducted interviews with the three proposed
engagement partners (sometimes local MD
participated) as well as three executives from Client
2. The interview process commenced within weeks of
auditor selection
Supplemented our observations from our primary and
secondary cases by obtaining additional, recent RFPs
for audit services of five other organizations, together
with the written bids submitted by one Big-4 audit
firm on all five potential engagements (Clients 3-7).
These organizations included one publicly traded
company, one private company, and three public
sector enterprises.
The documents and information gathered in the study
are summarized in Table 1
9
Engaging Auditors
RFP and the Bid Process
Client 1’s RFP describes the engagement, lists auditor
selection committee members, and outlines the
communication process, including deadlines for
responses and page limits. Respondents required to
address specific topics, including firm expertise,
transition, rapport, cultural fit.
Client 2’s RFP presents a similar but more detailed
template, requiring a more rigid structure in auditor
proposals
Clients 3-7 RFPs had similar specifications.
In all cases, signing a confidentiality agreement,
auditors were invited to an information acquisition
process. Clients 1 and 2 provided access to private and
public documents in a “data room” and made
executives available for discussion. Clients 3-7
provided less information (much smaller firms)
Client 1’s RFP Process overview: After auditor’s
information acquisition phase, the auditors submitted
their written proposals. Written proposals were read,
summarized, compared with pros and cons, and
evaluated by management. Management (i.e., the
CFO) then provided the proposals and the summary to
all selection committee members. Auditors invited to
give oral presentations to the selection committee.
The selection committees deliberated on the
proposals. The selection committee made its
recommendation to the audit committee, and the
audit committee then approved and submitted the
recommendation to the board. The selected auditor
was notified of appointment; losing firms debriefed
Table 2 details the timeline and records of the RFP
process for Client 1
Engaging Auditors 10
Table 1:Documents and Information Gathered
Engaging Auditors 15
…Auditor Selection
Engaging Auditors 16
Audit committee oversight of
the courtship
Audit committees’ “ownership” of the auditor-client
relationship limited to comfort with the process, not as
decision makers
Participate in meetings with prospective audit partners,
assess their suitability, and offer their assessment. This level
of involvement is consistent with the substantive practices
reported by Beasley et al. (2009)
Confirm Gendron and Bédard (2006): an auditor conjectures
that management drives the selection process by giving the
audit committee a recommendation and supporting
arguments; an audit committee member does not think that
the committee would not have the power to reverse
management’s choice of auditor
U.S. field study, Cohen, Krishnamoorthy and Wright (2009):
management is perceived as the dominant force in auditor
hiring/firing decisions; audit committee and auditor identify
the committee’s responsibility on paper, but recognize
management’s influence in practice.
One of the audit partners in our study lamented that the
audit committee had asked management for a
recommendation; felt more appropriate to ask management
for its assessment, with the final decision by the audit
committee.
Our field study suggests that management controls the
courtship process, with the audit committee in the passenger
seat. Management sets the destination, they read the
auditors’ signs and signals, and the audit committee signs off
at the end of the journey safely executed. The Audit
Committee Chair summarized the process as follows:
“Our AC saw its primary role as one to ensure that a robust
selection process was followed by the company, where the AC
had substantive oversight, and, had the final decision. We
didn't see this role as requiring, or necessarily being
compatible with, the AC actually conducting all work.”
Engaging Auditors 17
Information Acquisition
The RFP document outlines the information the client
wants about the auditor and uses in its decision
These specifications closely reflected the available
guidelines
Included: experience and expertise relevant to client
industry; transition and continuity plans; audit and
quality control approach; dispute resolution process;
fees; and references.
Absent although recommended by the AICPA and Audit
Firm guidelines: relationships and infractions with
regulators; identification of large clients lost, with
reasons; and peer review reports.
Both Client 1 and Client 2 used of decision aids, such
as evaluation forms and scorecards, to assess and rank
the bidding firms on predetermined criteria.
Extensive documents available to prospective
auditors: annual and quarterly reports to
shareholders, confidential documents (such as
business and strategic plans, Board and committee
minutes, and investment listings).
We had expected that the auditors would be highly
interested in risk related documentation made
available to them by the clients. The academic
literature on the market for audit services reports
that auditors integrate risk information into
engagement pricing and client acceptance decisions
(Adams, Bedard and Johnstone 2005; Johnstone and
Bedard 2003; Johnstone, 2000; Bell Landsman and
Shackelford, 2001; and Simunic 1980).
Yet, the auditor interviews suggested a different
approach to information acquisition.
Engaging Auditors 18
Management Gives a Little,
Gets a Lot
Client exerts much effort in acquiring information to
reduce uncertainty about the auditor
Auditor hesitates to request client for information and
submits proposal in the face of uncertainty.
The client defines audit quality in their own terms,
establishes criteria and collects information about
auditors from multiple sources, develops a clear
picture of auditor
Managers of Client 1 quite assertive in obtaining the
answers they were interested in
For example, they wanted to know the auditors’
reasoning and process for arriving at critical accounting
estimates and judgments. They also wanted to make
sure that there were no accounting policy differences
between the company and the auditor, especially any
that might lead to a restatement
Client 1’s audit committee chair: “We were very
concerned about making sure that they believed they
knew enough of the company’s results, and the
company’s transactions, to ensure that they did not
view the risk of restatement as being even a low
probability. We wanted to clear that outright from the
start.”
The U.S. audit partner: prior to engagement, wants to
understand significant transactions and the accounting
for such transactions to reduce the likelihood of a
potential restatement; felt confident that he could
identify potential accounting issues by reviewing the
public filings by the client, and discussing significant
transactions with management; discuss restatement
concerns during the proposal process, so as not to
surprise the client later in the engagement.
Engaging Auditors 19
Meticulous Client, Hungry Auditor
Engaging Auditors 20
Private and Public Clients
Engaging Auditors 21
Bargaining Power Imbalance
The difference in the information acquisition by client
and auditors may be attributable to the auditors’ lack
of bargaining power vis-à-vis management
Probing a client too deeply on sensitive issues during
courtship may generate enough antagonism to lose the
hoped-for engagement
Some aspects of auditors’ apparent lack of interest in
what we had thought was critical information might be
attributable to their prior due diligence, overall
assessment of the client as being low risk, and the
desirability of this client. But, they could not have
known the unadjusted errors through their own
independent investigations.
Auditor efforts were centered on personal meetings
and conversations to understand the clients, to build a
relationship, and to sell themselves.
Less attention on papers, and more on cues from
interpersonal encounters with the management
It appears that to assess and manage risk, the auditors
focused on assessing senior management’s candor,
forthrightness, competence and integrity.
The results from interview with the U.S. audit partner
was very similar to those conducted with Canadian
partners.
The proposals indicated a good understanding of how
to serve the client prospectively; relying on their
personal judgment from interacting with key
management personnel
Engaging Auditors 22
Client to Auditor Feedback
on RFP Process
Client 1’s RFP listed post-selection debriefing
Interviews with the auditors: extensive knowledge
about their competitors; well-informed about their
competitors’ proposals and the client’s assessment of
each competitor
Some auditors even offered their opinions on the
viability of competitor proposals.
A similar detailed and informative feedback process at
Client 2
In both Canada and the U.S., the bidding audit partners
sought and received feedback from the client (why’s
for both winners and losers)
Uncertain about the reasons for providing such
debriefing by the client, and its consequences; not
common in most areas of the economy
Linked to (1) the client’s desire to gain advantage by
promoting intense competition among auditors; (2)
clients retaining losing firms for other professional
services and gleaned additional feedback from
interaction with the client outside of the formal RFP
debriefing
This level of debriefing also suggests that it is difficult
for an audit firm to develop proprietary strategies or
response formats. Bids from audit firms appear very
similar (making it harder for audit firms to
differentiate themselves) partly because of structure
imposed by the client, but also as a result of common
knowledge amongst firms from receiving client
feedback about what features were effective and
ineffective in the bid process.
Engaging Auditors 23
Expertise
All clients demanded auditor expertise in their RFPs
(AICPA and Audit Firm guidelines)
In all seven cases, auditors responded by assembling an
audit team of relationship partners, engagement
partners, managers, and senior/junior audit staff.
All senior personnel, had industry specific experience
spelled out in detail
Client 1: introduced industry specialists from head office,
tax partners, and the lead IT partner; dedicated 5-12
pages to staff profiles, lengthy descriptions of their
industry-specific experience, firm’s industry-specific
market share regionally and globally; industry-specific
clients as references; all bids listed thought leadership
resources in the firm (forums, websites, roundtables, e-
mail alerts and industry specific publications)
Client 2: similar approach to demonstrating auditor
expertise, although emphasis on local office resources
and IT qualifications, in line with the client’s needs
These strategies consistent with common practices
suggested by the U.S. audit partner: importance of
demonstrating expertise through industry leadership and
knowledge resources.
RFPs demanded, and audit bids conveyed expertise
Prior research: audit team composition (expertise and
seniority) important elements of client satisfaction (Behn
et al. 1997); satisfaction a determinant of audit fees
(Behn et al. 1999)
Firms use experts to impress a desirable client, and not
only to respond to a client’s risk characteristics (Bedard
and Johnstone, 2004; Johnstone, 2000)
Engaging Auditors 24
All Auditors Look Good
All auditors appear to be suitable prospects for the
client
Differentiation by commitment of senior personnel to
Client 1 (national CEO attend the oral presentation and
designated as the relationship partner; location of
expertise and involvement of experts in the industry)
Auditor 3 proposed to move a partner with industry
experience, and Auditor 2 proposed to move a senior
manager with industry experiencefor Client 1.
The U.S. audit partner also suggested moving a partner
to the head office city as a way of showing
commitment.
Client 1 valued membership of audit firm personnel on
advisory committees in the relevant industry
associations or regulatory advisory bodies, and all
auditors responded by including team members with
such credentials in their proposals, and included
industry peers of Client 1 as references.
All Big-4 bidders had the technical expertise to
perform a satisfactory audit of this client and closely
bunched in management and audit committee scores
for industry expertise; Client 1’s CFO:
“We all unanimously felt that every firm could do the
job very well with the team they had presented.”
The same sentiment was expressed by the selection
committee of Client 2.
During interviews, an audit partner frustrated that the
standardized accounting environment made
differentiation difficult, reducing it to price
competition
Engaging Auditors 25
Management Seeks Softer
Dimensions of Expertise
Client 1 RFP explicitly asked auditors to provide a
“Summary of relevant training and/or networking
opportunities (with locations) offered to your clients.”
The RFP guides (AICPA; Audit Firm) list involvement
with other clients in the industry, and other
participants in the value chain (e.g., customers,
suppliers) as desirable considerations
Networks keep auditors at the forefront of technical
knowledge, but also provide a platform for
management views and issues to be given due
consideration by regulators;
Auditor’s potential as a connecting link to opportunities
with industry competitors and regulators dominate
concerns about conflict of interest and leakage of
proprietary information
Auditor seen as client’s leads to new customers as well
as competitors with whom Client 1 wanted to
collaborate
Audit engagement viewed as more than an audit—a
relationship that brings opportunities for business
advantage and future connections.
Management wishes not stated in RFP: respnsiveness to
management; Client 1 wanted to be treated like a first
tier client; Client 2 wanted its own complexity to be
appreciated, and overcome geographical challenges
Expressed through subtle cues in meetings and
interviews (responsiveness, cultural fit, chemistry,
sharing wavelength)
Engaging Auditors 26
Building Relationships
“There are processes and there are structures, but
people do business with people.”---a Big-4 Managing
Partner
The interviews: the issuance of the RFPs by Clients 1
and 2 was not the beginning of the courtship
Client 1: all invited auditors knew of the coming RFP
All non-incumbent audit firms had active business
development processes through which they had
already targeted Client 1, and visited senior managers
(CFO/CEO) of Client 1 in their offices, or invited them
to dinner and presentations (express their interest,
exchange information, and develop personal rapport)
Client 1 and Client 2: auditors established prior
relationships from providing other services or through
involvement in business and social communities.
Early courting targeted at Client 1’s senior managers
(i.e., the CEO, CFO), and not the audit committee, as
the key decision makers in this process
The U.S. audit partner also indicated that the key
people who would be involved in courting would be
the CFO and Controller, and sometimes the CEO, even
though the appointment formally made by the audit
committee
Prior research: weakly linked relationships (i.e., past
client experience) with auditor satisfaction (Behn et
al. 1997).
Our cases: importance of relationships for clients and
auditors; effort in building them; possible impact on
auditor independence.
Engaging Auditors 27
Rapport and Cultural Fit
The neutralization of expertise shifts importance to rapport
and cultural fit in the courtship process, stated in RFP
Interviews indicated that the Client 1 had been dissatisfied
with the “bedside manner” of the newly rotated engagement
partner
Clients 1 and 2 clearly expressed in their RFP documents and
interviews that demonstrating rapport was paramount to
auditors winning the engagement.
Imitating the style, dress, appearance, and manners of those
one wishes to please is a deliberate strategy as old as human
history (Gremler and Gwinner 2008).
Auditors also employ such tactics in courting their clients.
Written proposals mirror the clients: client references whose
positions closely matched those of selection committee;
majority of the references provided were executives of other
clients; over 75% of the references that auditors provided to
Client 1 were from CFOs, and only one audit committee chair.
Interviews with audit partners confirm that the audit firms
identify the key decision makers, and then choose referees to
match the roles of the key decision makers
The U.S. audit partner indicated that the key variable in
choosing references was to identify the key decision maker
and then choose a peer (the CFO, in this case) as the key
reference.
Auditors considered references from clients as being very
credible and having a significant influence on the hiring
decision.
Auditors adopting client mottos and slogans in
proposals and presentations (fit, culture, thinking,
attitudes, chemistry, resonance of values)
Engaging Auditors 28
Past Guides the Present
Auditors’ reputation with the clients wins new
ones
Reputation and past experience with their client
was a major deciding factor with Clients 1 and 2.
The AICPA guide even recommends that clients
include in the RFP a request for the auditors to
list major clients recently lost and explain the
loss.
For Client 1, the CFO and the audit committee
chair interpreted auditor reputation as the
engagement partners’ personal reputation with
other CFOs
Client 1: Do other CFOs classified the auditor as
either rigid (undesirable) or flexible (desirable).
Rigid was sometimes described as issuing edicts
(undesirable) versus discussing rationale
(desirable) for an accounting treatment
The audit committee chair said: “The most
important issue for us is their reputation; that
we can discern by references on how they
operate with other companies in our industry.”
No evidence of reputation with investors or any
third party users of financial statements being a
consideration.
Auditors’ reliance on references from current
clients to get future clients is potentially
troubling for auditor independence; this reliance
may bias auditors to gain favor with clients to
serve as references.
Engaging Auditors 29
Independence of Auditor
What does it mean to be an independent auditor?
Absence of a prior relationship?
Yet, in both Canada and U.S., having a prior
relationship with the prospective client is an
important qualification to be on the audit team
(Client 1 and 2).
Interviews reveal that including people with pre-
existing relationships with the client in the audit
team is a critical factor in engagement
This relationship preference not limited to the
engagement partner but percolates down all the
way to junior auditors
Audit firms sees auditing as a “relationship”
business, and interested in assigning people to
their teams who already knew management and
had a cordial relationship with the prospective
client
U.S. partner revealed that auditors seriously
consider the RFP process as a relationship-
building opportunity to establish a connection
with client even if the there is no immediate
engagement
Another channel for the prospective auditor’s
past to influences success in the present
courtship
Engaging Auditors 30
Demonstrating The Locus of
Decision Making Power
Engaging Auditors 32
Audit Fees
Client 1’s RFP invites bids for two years, constraining
auditor ability of auditors to low-ball the fees
Incumbent fee for the current year as a benchmark
(reflects knowledge of the client, assessment of risks
and the extent of audit work necessary for the
engagement)
Best reflects the literature on determinants of audit
pricing (Bedard and Johnstone 2004; Johnstone and
Bedard, 2001; Choi et al. 2008)
Beck and Barefield (1986), suggest that bidding
auditors’ judgments about the prospective
engagement will vary
Client 1: bids for total engagement fee varied from
materially below to materially above the current fee
The successful bid materially below the current fee,
although the management had stressed repeatedly
that fees were not a major motivation for issuing the
RFP.
Incumbent was expected by others to bid (publicly
disclosed) current fee, and this common knowledge
was accurate.
Client 1: the RFP preference for greater involvement
of senior auditors, the low (winning) bidder proposed
higher staff hours and lower partner/manager hours
relative to incumbent’s current time budget
Interviews: Client 1 audit chair and CFO concerned
that a low bid meant the auditor might not have
understood the amount of work involved. The CFO
said: “For Audit Firm 2, we were not sure on how they
would do because the audit fee was too low…I think
they may have underestimated the work they needed
to do on a couple of our subsidiaries.”
Engaging Auditors 33
Hours and Rates
Auditor 3 bid marginally lower, and Auditor 4 bid
marginally higher than the current fee for substantially
more partner/manager hours and more than double the
staff hours
The AC chairman of Client 1’s did not consider the
Auditor 4 hours credible
RFP solicited hourly rates, but did not factor in the
clients decision
Auditor 4 may have misinterpreted the importance of
this number, and undermined his own credibility
Client 2: auditors believed fees would be a major
determinant; management indicated it wasn’t a key
factor; the incumbent bid 100% of current fee, and the
rest bid just below that
All audit firms developed a table breaking down fees
by rank and financial statement cycle, (e.g., sales,
receivables), and auditors claimed that estimating the
total required hours was important in determining their
fee, though Client 1 appeared not to have paid much
attention to these numbers
RFP indicated that future billings for audit fees had to
identify each person by rank, hours worked, and the
hourly rate quoted in the proposal (bid).
This practice supported by RFP guides
Conjecture: Breakdown of total quoted fee into hourly
rates, hours, and task components may be a client
strategy to reduce auditors’ degrees of freedom,
serving as additional bargaining and monitoring
instrument, facilitating cross-checking the auditor
billings against the accepted bids
Client 2 requested a blended hourly rate, which
facilitated comparison of bids
Engaging Auditors 34
Multiple Bids from a Single Auditor
Engaging Auditors 35
Gradation of Partners
What does the gradation of partners imply for the
value of the audit firm and its brand?
Informal identification of audit managers and staff by
seniority and industry experience (e.g., industry expert
senior manager) is common;, this type of
differentiation in pricing among partners by experience
is uncommon
In professional service markets where services are sold
to retail customers, it is common to see differential
pricing based on the service provider’s experience
(Lasik eye surgery, the price increases with the number
of operations done by an eye surgeon)
Can audit firms do better by such partner-level
differentiation, as opposed to relying on the firm’s
brand name and a single billing rate for all audit
partners
In this case, the multiple billing options created
confusion, and the attempt to very explicitly price the
experience of team members backfired and
undermined the credibility of the audit firm.
When commenting on the multiple prices proposed,
Client 1’s AC chair said: “I think at the end result that
was probably a mistake on their part…I don’t care for
that type of stuff… I didn’t think the idea of having an
audit firm where the service you get depends on how
much you pay is really the impression that they would
want to give.”
In the courtship process, setting fees is a way for
auditors to demonstrate their value and signal their
commitment to the clients. Some of the competing
audit firms were aware of the three price strategy used
by Auditor 4 and disapproved of it.
Engaging Auditors 36
Discussion
Client 1 developed an elaborate RFP, and engaged its
internal stakeholders in meeting and rating exercises
to determine its preferred auditor
In the courtship, Client 1 wanted, expected, and
received numerous gestures and promises from the
audit firms, who were all seeking to show their
commitment to providing good client service and
responsiveness to management’s needs
Management knew its definition of audit quality—a
partner with a reputation for working well with
management, and visible signs that they would be a
preferred client, and how to get the relevant
information needed to make its assessments and rank
the prospective audit firms
Audit quality was not opaque for management.
Audit committee was involved in the selection
process; they relied on management to collect,
evaluate and summarize information. At the end of
the auditor-client courtship, the audit committee
asked for, received, and endorsed the
recommendation of management.
The auditors had also done their homework, and
based their pre-courting behavior on the desirability
of becoming the auditor of Client 1.
Courtship emphasized demonstrations of auditor
commitment to the client, audit reliance on CFOs of
current clients to vouch for them, and the inability of
auditors to access crucial information for assessing
risk (e.g., schedule of unadjusted errors).
Significant power imbalance between the client and
prospective auditors; auditors had surprisingly limited
understanding of the underlying quality of internal
controls, the disagreements (if any) between the
client and incumbent auditor, and the unadjusted
errors they might inherit
37
Engaging Auditors
Discussion
Client’s quality of internal control and future
accounting problems remained opaque and not well
understood
Suggest that new auditors are not only more vulnerable
to fraud (Treadway 1978), but also to errors in early
years (Johnson et al. 2002).
Auditors’ lack of proper risk assessment during
engagement ; Placing high reliance on management
reputation and oral representations is a risky strategy
for audit firms.
Client perception that all four audit firms had the
capacity to do a good job on engagement neutralized
the auditor efforts in assembling teams of experts for
engagement
Auditors ifferentiate themselves through (1) pre- and
post-RFP courting of the client (bringing the national
CEOs); being responsive to client desires for local
expertise, offering to move an industry specialists;
mirroring the client in presentations of self and
selection of referees; promising engagement partner
autonomy; and lowering their fees
Inability of audit firms to create a clear expertise-
based differentiation and reliance on referrals from
CFOs of current clients may undermine the profitability
and independence of audit firms.
Auditor rotation has often proposed as a way of
preserving the independence of auditors from their
clients. Rotation of auditors (partners or firms) will
bring a fresh set of eyes (Tan 1995), fewer blinders,
and uproot entrenched relationships that may override
their objectivity and independence. There are also
well-known arguments against rotation as time and
repetition can help the auditor develop perspective
and expertise (Arel et al. 2005)
38
Engaging Auditors
Discussion
A counterargument from this field investigation:
process of engagement, combined with competition in
the market for audit services, weaken auditor
independence, promotes perennial courtship by audit
firms, and repeat this weakening of independence
more often. Rotation affords clients the opportunity to
shop for opinion and avoid auditors who they don’t like
without having to fire them (regulatory red flags)
Rotation pressures on auditors to demonstrate
commitment and responsiveness to the management of
prospective as well as current clients (to win new
engagements)
Reforms and regulations often based on the mistaken
assumption that the relevant information for making
decisions is readily available, perhaps even as common
knowledge
Regulatory debates about auditor independence ignore
the selection processes, the level of information
asymmetry between contracting agents and the
difficulty in gathering the relevant information for
making good decisions are underestimated
Lack of alignment of private incentives of contracting
agents and their public duties adds an additional layer
of friction in this process (Jamal and Sunder 2009).
Dispersed information and conflicting incentives can
undermine most well-intentioned regulatory reforms
Auditor rotation requirement will drive small- and
medium-sized audit firms out of the market, and
increase the concentration of the audit market
Questions: Does increasing the frequency of courtship
through mandatory audit rotation serves to increase
the welfare of shareholders? The only benefit to
shareholders from the process documented here was a
lower audit fee, which is offset by transition costs
incurred by Client 1
Engaging Auditors 39
Thank You.
totokdewayanto@gmail.com
RFP: Introduction
Introduction
X Company …At close to $XX billion in balance sheet
assets and more than Y years of strong growth including
XX percent over the last 12 months, the necessity to
continually review business strategies and risks is
paramount in ensuring sustained success.
Of late, there have been multiple and significant
changes in accounting standards, regulations and the
XYZ industry that have all combined to add a great
deal of complexity to our business with no slowdown in
sight. To name a few, the recent adoption of XYZ
accounting standards, the upcoming implementation of
the XYZ Industry regulations and the transition to IFRS
over the next 5 years represent major changes to our
business organization.
Against this backdrop, X company has determined it is
timely to review the availability of financial services
audit expertise and resources in Canada and is
undertaking a Request for Proposal (RFP) for
independent audit services. This document outlines
the general principles of the RFP. We highlight that our
preference would include the most senior expertise to
be based in Region of Canada, but it is not essential.
All information will be provided to you in strict
confidence. Please complete the RFP Acceptance and
Confidentiality Agreement (Appendix A) and return it
to Mr G as outlined in the Communications Section.
The supplemental information package will not be
distributed prior to the receipt of the RFP Acceptance
and Confidentiality Agreement. Please note this RFP is
being extended to Deloitte, Ernst & Young, KPMG and
PricewaterhouseCoopers.
Engaging Auditors 41
RFP: Scope of Services
Your audit should be conducted in accordance with Canadian
Generally Accepted Auditing Standards and will commence
with the period ending year end date. The audit will be for
the consolidated financial statements of X company.
The mandate will include a review of the interim financial
statements for each of the interim periods. For greater
clarity, the first interim review would be for the three months
ending Date.
The mandate also includes:
The statutory audit of Subsidiary 1, 2, and 3;
Communication of weaknesses found in internal controls
during the course of the financial statement audit;
Analysis of accounting questions and issues in the context of
the audit;
Review of Management’s Discussion and Analysis, Annual
Information Form, and Annual Report to the extent required
by professional standards;
Review of quarterly report to shareholders (including financial
statements and notes);
Specified audit procedures for Subsidiary 4 as required by the
New York Stock Exchange;
Specified audit procedures and audit report on specified
financial information for X Company as required by Industry
Association;
Review of audit working papers of Subsidiary 5’s external
auditors (Audit firm);
Audit of financial statements of Special entity (non-
consolidated special purpose entity).
Note: The RFP does not include the audit of Subsidiary 5.
Engaging Auditors 42
RFP: Process Description
Engaging Auditors 43
RFP: Communications
The RFP process will be open and equitable for all firms. We will
endeavor to ensure all firms have access to the same information. No
information in one proposal will be disclosed to another firm in the RFP
process.
Management will be available to answer questions throughout the
process. To aid in the information-gathering phase, a schedule of
availability with management will be established.
To help ensure an efficient and equitable proposal process, Company X
is requesting that each proposing firm comply with the following
general guidelines:
All inquiries relating to this proposal process, including arrangements
for site visits and interviews, are to be directed to G, VP Finance. He
will be your single point of contact. Contacting any other member,
officer or director of X Company could lead to disqualification. G’s
contact information follows:
Contact information
To facilitate the review of the Company’s information, a data room will
be established at X Company’s corporate office located at address. A
list of information that will be available in the data room is attached
as Appendix C.
In addition, the following individuals will be available to meet with and
provide each firm with their perspective of the critical business issues
facing Company X. The individual interviews will be restricted to 30
minutes, unless an alternative time frame has been agreed upon in
advance, and no more than three people from your firm should attend
each interview. The VP Finance will coordinate the interviews.
B, Chief Executive Officer,
A, Chair of the Audit Committee,
C, Chief Financial Officer,
G, VP Finance,
F, General Counsel,
H, Treasurer,
D, Head Internal Auditor,
I, Senior Vice President, Operations,
J, Chief Technology Officer.
Engaging Auditors 44
RFP: Proposal Form and
Content
Eight (8) copies of the submissions are to be received
by the undersigned no later than date. Your
submissions should be no longer than 30 pages, plus
curriculum vitae for proposed team members. The
submission should contain the following:
1. Detailed description of audit approach
Approach
Methodology for assessment of risks and establishing
audit approach
Risks identified
Scope and approach of work (including adoption of new
significant accounting policies)
Objectives
Split of work among various locations and corporate
functions
Communication with audit committee, including all
communications required by X Company’s Audit
Committee Terms of Reference
Engagement Letter
Breakdown of audit hours for X Company audit broken
down by major financial section for field staff (i.e.
cash, …, other assets) with partner and manager time
noted in total.
Use of Internal Audit
Quality control
Independence policy
Engaging Auditors 45
RFP: Proposal Form and
Content
Expertise
Experience and location of the audit team members
Partners
Senior Managers / Managers
Industry expertise by location
Brief summary of Industry 2 audit and assurance experience
Availability and location of resources for complex accounting
questions
Functioning and size of professional practice groups
Availability of local resources
Confirmation that the firm is duly registered with the
Canadian Public Accountability Board (CPAB)
3. Transition plan (if applicable)
Description of transition plan to ensure minimum
disruption to X Company management
Description of team experience in transition of audits,
references if applicable
4. Independence
Confirmation of your independence from X. Company.
If confirmation not available, then an explanation of
the process to ensure independence.
5. Fees (including any separate fee for CPAB)
An itemized fee quotation for the year ended Year 1.
An itemized fee estimate for the year ended Year 2
An itemized fee estimate for each entity and
requirement listed.
Engaging Auditors 46
RFP: Proposal Form and
Content
References
The Firm shall provide a list of clients (minimum three (3):
maximum five (5)) that are significant Companies in Industry
X who are currently major accounts of the Firm for services
similar or identical to the Services outlined in this RFP. The
firm will describe how the services provided to these
references are similar to the services proposed to X Company.
The Firm must include the client’s company name, address,
contact name, telephone number and e-mail address, and the
length of the association. The Firm’s references will be
contacted.
7. Tax
We would like you to address your view on the nature and
extent of work that you could provide for tax compliance or
tax planning activities.
8. Other services offered by your firm
We would like your proposal to include an overview of the
other services offered by your firm, remaining independent.
Overview could include:
Listing of relevant publications available
Summary of relevant training and/or networking opportunities
(with locations) offered to your clients
9. Presentation
The objective of the presentation is to allow you to present
your offer for services, respond to the questions from the
Selection Committee and allow us to meet your engagement
team. Presentations to the Selection Committee are expected
to be scheduled for Date with the Board decision to follow on
Date.
We request that your oral presentation not exceed 60
minutes. After your presentation, thirty minutes will be
allotted for questions and discussion.
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Engaging Auditors
RFP: Expectations
Throughout the auditor/client relationship we expect:
An open and professional rapport with direct access to
decision makers for all accounting/auditing matters
An efficient and effective risk-based audit process
Significant and relevant industry experience of the members
of the audit team
As partners or managers assigned to the engagement change
over time, the firm will agree to provide resumes of new
personnel to ensure that each have the requisite technical
knowledge and industry expertise to conduct a thorough and
efficient audit
All billings will be cleared in advance of submission. All
billings should provide a detailed description of the work
performed and a summary of the hours and rates billed by
person.
The annual audit plan will be reviewed with X Company and
its Audit Committee in sufficient detail to allow X Company to
understand your audit approach (including the assessment of
significant risks) and efficiently prepare for the audit process.
Timeline
RFP request letters sent to firms.Day 02.
Return of RFP Acceptance and Confidentiality AgreementDay 7
Distribution of Supplemental Information packageDay 7
Data room availabilityDays 7-35
InterviewsDays 35-36
Receipt of submissionsDay 51
Presentation to Selection CommitteeDay 81
Board approves selectionDay 87
Communication of decisionDay 88
Debrief for firmsDays 98-102.
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Engaging Auditors
RFP: Acceptance and
Confidentiality
Agreement
Engaging Auditors 49
RFP: Supplemental Information
(To be provided on receipt of signed RFP Acceptance and Confidentiality
Agreement)
1. Organization structure
2. 200X Annual Report, Annual Information Return and Management
Information Circular.
3. Q3 200X Report to Shareholders
4. Data room details and arrangements
5. List of statutory audits and most recent financial statements
6. Appendix C
7. Information to Be Available in the Data Room
8. Organizational Charts
9. Corporate structure
10. Executives
11. Finance
12. Internal Audit
13. Corporate Office
14. 200X Strategic Plan; 200X Business Plan
15. Consolidation worksheet (and entries) as at Date, 200X
16. Operating Manual
17. Board and Committee Minute Books
18. Accounting Policy Manual
19. Certification Project flowcharts for key controls
20. Quarterly financial reporting disclosure framework
21. Timeline for Interim and Annual Audit
22. Internal Audit Scope and Plan
23. Overview of IT Systems
24. Risk reports
25. Asset listings
26. Year-end working paper files – X Company, Subsidiary 1 and 2
27. Additional information
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Engaging Auditors
Table 2: Timeline of RFP process for Client 1
Event Timeline Description of records Made
(Days) produced available to
researchers
(indicated
by *)
1. Client sends RFP 0 RFP document *
request letters to
firms
2. Firms return RFP 7 Agreements from 4 firms
acceptance and
confidentiality
agreement
3. Client distributes 7 Organizational
supplemental
information information
package
Financial reports and
shareholder
communications
Data room details and
arrangements
4. Data room 7-35 Organizational
availability
Information
Strategic and business
plans
Policy manuals
Internal control reports –
IT, Internal Audit,
flowcharts
Board meeting minutes
Refer to RFP in Appendix A for
complete list
5. Prospective firm 35, 36 n/a
and client
interviews
6. Receipt of 51 Audit firm proposal (bid) *
submissions documents
7. Read, Table listing Pros and Cons of *
summarize and each proposal
evaluate written
Interview Script for Clients
I. Background
Q1. How long did your previous audit firm audit you before
you put out the request for Proposal (RFP) ? _______Years.
Q2. Why did you decide to put the audit up for bid? Please list
the reasons in the order of importance (highest first):
1.
_____________________________________________________
______
2. _____________________________________-
________________________
3. _____________________________________-
________________________
Q3. When you issued the RFP, what chance did you think the
incumbent firm had of retaining the audit engagement? -
______ %
Q4. How did you decide which audit firms to invite to bid on
the engagement?
Q5. Did you consider any non Big-4 audit firms? Explain why or
why not.
Q6. On a 9 point scale, how would you rate your 2007 audited
financial statements ____
Where 1= extremely conservative, 5 = average, and 9 =
extremely aggressive
Q7. What other professional services do you procure through
external contracts (e.g. actuarial, valuation, legal), and are
these service providers subject to periodic bidding (every n
years)?
Service ProviderAverage Periodicity of Being Put up for Bid (in
years)Not Put Up For Bid1.2.3.4.5.
Engaging Auditors 52
Interview Script for Clients
II. Characteristics of Audit Firm That Can be Observed Externally
Q8. On a 9 point scale, how important is the size of the audit firm? ______
Where 1= not at all important, 5 = average, and 9 = extremely important
Q9. Do you perceive any differences in the size of the bidding firms, or are
they all about equal in size? Explain
Q10. On a 9 point scale, how important is the reputation of the audit firm?
______
Where 1= not at all important, 5 = average, and 9 = extremely important.
Q11. Do you perceive any differences in the reputation of the bidding firms,
or do they all have about the same reputation? Explain
Q12. On a 9 point scale, how important is the independence of the audit
firm? ______.
Where 1= not at all important, 5 = average, and 9 = extremely important.
Q13. Do you perceive any differences in the levels of the independence of
the bidding firms, or are they all about equally independent? Explain
Q14. On a 9 point scale, how important is the industry expertise of the
audit firm? ____
Where 1= not at all important, 5 = average, and 9 = extremely important.
Q15. Do you perceive any differences in the industry expertise of the
bidding firms, or do they all have about the same level of Industry Expertise?
Explain
Q16. On a 9 point scale, how important is the audit fee quoted by the audit
firm? ______
Where 1= not at all important, 5 = average, and 9 = extremely important.
Q17. Do you perceive any differences in the audit fee quoted by the bidding
firms, or are they all approximately equal? Explain
Q18. How important are the following attributes of the audit firm? Please
rank the listed categories from 1 (Very important), 2 (Medium important) or
3 (not important).
Rank (1, 2 or 3)
The size of the audit firm
The reputation of the audit firm
The independence of the audit firm
The industry expertise of the audit firm
The audit fee
Engaging Auditors 53
Interview Script for Clients
III. Characteristics of Audit Firms That Can Be Observed
Internally :Accounting Policy Choice Issues
Q19. Are there a set of key accounting issues that you wish to
know the auditors opinion on? Explain. Do bidding firms differ
on these issues?
Q20. What characteristics do you desire in an engagement
partner? How do bidding firms differ on these characteristics?
Q21. What characteristics do you desire in a relationship
partner? Do bidding firms differ on these characteristics?
Q22. Do you have a preference for who makes the final call on
accounting policy issues, and do bidding firms differ on this
issue?
Q23. Do you care about the location of expertise required to
deal with complex accounting issues (local, regional,
national)? Explain.
Q24. Do you perceive any differences in the other services
(e.g., tax) offered by bidding firms, or are they all have about
the same level of other services? Explain
Q25. How important are the following attributes of
accounting policy issues? Please rank the listed categories
from 1 (Very important), 2 (Medium important) or 3 (not
important).
Rank (1, 2 or 3)
The audit firms position on critical accounting issues
Engaging Auditors 54
Interview Script for Clients
IV. Characteristics of Audit Firms That Can Be Observed Internally:
Audit Methodology
Q26. Audit Committees often ask auditors about their “Audit Approach”
and “Risk Approach.” What do you learn from answers to such
questions, and how do the bidding firms differ from each other in this
respect?
Q27. Audit Committees often ask auditors to specify the total number
of audit hours worked, as well as a breakdown of audit hours by staff
level and by functional area. What do you learn from this breakdown of
audit hours, and how do the bidding firms differ on this audit
production process?
Q28. Audit committees often ask auditors about quality control
processes, and availability of expert advice from the professional
practice group, as well as from the local office. What do you learn
from responses to these questions, and how do bidding firms differ in
terms of how expertise is made available to you?
Q29. Since you have an internal audit department, what do you want
to know regarding the relationship between external and internal
auditors, and how do the bidding firms differ in terms of their
proposed interaction with your internal audit department?
Q30. What type of tax and other services would you be interested in
purchasing from the external auditor? How do bidding firms differ in
the quality or type of such services they can offer?
Q31. How important are the following attributes of audit firms? Please
rank the listed categories from 1 (Very important), 2 (Medium
important) or 3 (not important).
Rank (1, 2 or 3)
The Audit Approach
The Audit Production Plan (Total audit hours and breakdown by staff
level)
Availability of Expert advice locally and from other offices
Engagement with Internal Audit department
Provision of tax and other services
Engaging Auditors 55
Interview Script for Clients
V Relationships with the Audit Firm
Q32. How do you assess your interpersonal “fit” with the
audit firm? How do bidding firms vary in terms of their fit?
Q33. How do you assess responsiveness of the audit firm to
your needs? How do you define “responsiveness” and how do
the bidding firms vary in terms of responsiveness?
Q34. How do you assess intention and /or ability of the audit
firm to maintain staff continuity? How do bidding firms vary
on this attribute?
Q35. How do you assess skepticism of audit partner / team?
How do bidding firms vary on this attribute?
Q36. How do you assess ability of the audit firm to deal with
regulators and other external agents in the firm’s
environment? Do you perceive a difference in bidding firm’s
ability to deal effectively with external regulatory bodies?
Q37. How important are the following relationship attributes?
Please rank the listed categories from 1 (Very important), 2
(Medium important) or 3 (not important).
Rank (1, 2 or 3)
The Interpersonal fit
Responsiveness of the audit firm
Staff continuity
Skepticism of Audit partner / team
Deal effectively with regulators and other external agents
Engaging Auditors 56
Interview Script for Clients
VI. Other Questions
Q38. What additional information / type of questions
do audit firms ask when they meet you? Do bidding
firms vary in the nature or amount of questions asked?
Q39. What do you learn from the presentations that is
incremental to the written responses provided by the
audit firms?
Q40. What (if anything) really stood out about each
bidding firm?
Q41. What was the key factor(s) that led to the choice
of your new auditor?
Q42. Who came second? Explain
Q43. Compared to purchasing other professional
services (e.g., legal, actuarial, valuation) how
comfortable are you with assessing the quality of audit
service you actually receive. Please use the 9 point
scale below. Assessing quality of audit services is
______
Where 1= completely opaque and much more difficult
to assess than other professional services, 5 = average,
and 9 = extremely transparent and much easier to
assess than other professional services.
Q44. Please provide a copy of a RFP for audit,
actuarial, tax or any other service that you were
involved in, and indicate what part(s) of this RFP you
were involved in (or is the RFP mostly a standard
template?).
Engaging Auditors 57
Interview Script for Auditors
I. Background
Q1. What do you like to see in a Request For Proposal
document? Please list in order of importance (highest
first):
1.
_______________________________________________
_____________
2. _____________________________________-
________________________
3. _____________________________________-
________________________
Q2. When a RFP is issued, on average what chance do
you think the incumbent firm has of retaining the audit
engagement? ______ %
Q3. What additional questions would you ask the
prospective client?
Q4. Are you able to glean any additional insight
(beyond what was written in the RFP) into the
motivation behind the RFP? If so how, and what do you
think the motivation was for this company?
Q5. What part of your proposal response is standard,
and what part is tailored specifically to the company?
Engaging Auditors 58
Interview Script for Auditors