Inside Look at Auditor Changes
Lynn E. Turner, Jason P. Williams, and Thomas R. Weirich
- Auditor changes have been an object of scrutiny recently
as the profession and regulators seek to understand the reasons
behind such changes and what they might portend about a company’s
health. A study of auditor changes over the last two years
yielded interesting results that should be of both interest
and concern to investors and regulators. Auditors should also
know more about the causes for such changes and take appropriate
change in auditors can be the result of either a dismissal
by the company or the auditor’s resignation. Auditor
resignations often occur in the context of grave financial
circumstances, and they can be accompanied by a significant
drop in stock price. Regardless of the reason, the SEC must
be notified of auditor changes through a Form 8-K filing.
The SEC views an auditor resignation differently than a
dismissal, and investigates accordingly. Various recent
academic studies have found that there are more auditor
resignations when litigation risk increases and a company’s
financial health deteriorates. Research indicates that client-initiated
auditor changes occur more frequently over disagreements
about such issues as internal control weaknesses and the
reliability of financial reporting.
it is difficult to attribute a stock price reaction to just
one event, such as the release of information about a material
internal control weakness, the stock price reactions reported
below should be interpreted cautiously. Further research
is warranted about the impact on stock price of the reported
reasons for an auditor change.
of Auditor Changes
upward trend in auditor changes continued in 2004, with
over 1,600 companies making a switch. Over 2,500 companies
have changed auditors in just the last two years (2003 and
2004). (This information was obtained by examining SEC Form
8-K, Items 4.01 and 4.0, for 2004. For 2003, SEC Form 8-K,
Item 4, filings were searched for “resigned,”
“dismissed,” “terminated,” and “ceased,”
in conjunction with “accountants.” Changes from
Arthur Andersen in 2002 were excluded.) In 2004, 1,609 companies
changed auditors, compared to 905 in 2003. Investors and
auditors should continue to focus on what catalyzed the
changes and whether this trend portends any potential negative
impact on shareholder value. In addition, 59% of the companies
provided no explanation to their shareholders of the reason
for the change, leaving them in the dark.
analysis of these changes reveals major issues for 2004,
summarized as follows:
Companies have not made adequate disclosures. In 2004,
59% of companies (947) did not disclose a reason for changing
auditors, compared to 69% of companies (630) in 2003.
number of companies reporting that their internal controls
were inadequate nearly doubled, from 58 in 2003 to 102
in 2004, despite an earlier requirement that the CEO and
the CFO disclose such weaknesses, beginning in August
2002. Small companies (under $25 million in revenue) accounted
for 48% of those with control problems.
the companies reporting changes in auditors, 35% (558)
reported going-concern problems, compared to 29% in 2003.
A going-concern opinion indicates that the auditor thinks
the company may not avoid bankruptcy during the next 12
months. Nearly all (92%) of the registrants that received
a going-concern report were small companies, which carry
a much greater risk.
Non–Big Four auditors gained market share in terms
of absolute numbers. Big Four firms had a net loss of
400 audits, as they gained 164 while losing 564. Second-tier
firms had a net gain of 117 audits, as they gained 233
and lost 116. All other accounting firms gained 1,146
audits while losing 929, for a net gain of 217.
The Big Four continued to drop smaller companies from
their list of audit clients. The Big Four ceased auditing
a net of 280 companies with less than $100 million in
revenues. Forty-six of the 53 companies with revenues
greater than $1 billion that changed auditors had previously
been audited by a Big Four firm; 32 of them chose another
Big Four firm as the replacement.
Thirty companies reporting auditor changes restated financial
statements in 2004, more than double the 14 in 2003. Over
half of these companies also had internal control weaknesses.
Of these companies, 16 had revenues under $25 million.
disclosing disagreements with their auditors over accounting
or auditing matters decreased from 27 in 2003 to 19 in
2004. Companies with revenues under $25 million accounted
for eight (42%) of these disagreements.
auditors concluded they could no longer rely on management
representations, compared to six in 2003. Small companies
accounted for nine (47%) of these nonreliance disclosures.
companies cited fee reductions as their motive for changing
auditors, more than double the number in 2003. Of these
companies, 22 (40%) had revenues under $25 million.
was an increase in the number of changes due to the inability
(or unwillingness) of accounting firms to meet SEC requirements
for auditing public companies. In 2004, 133 such changes
occurred, compared to 57 in 2003.
There was a rise in the number of changes due to accounting
firm mergers. Eighty-three such changes took place in
2004, compared to 22 in 2003.
reported reasons for changes in auditors sometimes provide
insight into a company’s financial statements, as
well as an indication of the quality of the audit. Under
SEC rules (summarized in the Sidebar),
companies are required to disclose certain information when
they change auditors. These disclosures can provide the
first glimpse into potential problems in a company’s
financial statements. Companies do not necessarily have
to disclose a specific reason for the auditor change; investors
can be left to wonder about the real reason for the change.
Investors should always be cautious when a company announces
an auditor change, as it may be related to underlying but
undisclosed problems in the company’s financial reporting
and accounting practices.
aspects of a company’s required disclosure that can
provide insight into its financial reporting and accounting
practices include the following:
Whether the company or the auditor terminated the relationship;
The type of opinion issued within the past two years;
Any disagreements in accounting principles;
Any internal control weaknesses or deficiencies, or any
reference to the company’s ability (or inability)
to meet Sarbanes-Oxley Act (SOA) section 404 requirements;
The auditor’s inability to rely on management’s
Reference to illegal acts;
Any prior consultation with the new auditor about accounting
principles or the type of audit opinion that might be
Whether the auditor agrees with the company’s statements
about its termination in its SEC response letter.
on these issues is likely to provide better understanding
of an auditor change, as well as insight into a company’s
state of affairs. Companies often attempt to hide the real
reason behind an auditor change, and investors may have
to read the disclosure carefully to “ferret out”
the reason behind the change. The real reason may be disclosed
in another filing before or after the actual 8-K auditor-change
filing. The auditor’s response letter itself may not
provide greater detail, as the auditor may want to avoid
controversy and lawsuits. In some cases the auditor’s
response may create more confusion.
an auditor is informed by a company that it has been terminated,
or informs the company that it will no longer serve as the
independent auditor, the auditor is required to send a form
letter directly to the Office of the Chief Accountant of
the SEC. This letter must be sent within four business days,
and is matched with the Form 8-K filings.
of the 78% increase in auditor changes in 2004 reveals that
companies with revenues greater than $100 million were responsible
for a minority of the changes, 15% of the total (238 changes,
compared to 115 in 2003). As in 2003, companies with revenues
under $100 million dominated the number of changes, with
85% of total changes (1,371 changes), compared to 87% in
2003. The Big Four accounted for 564 auditor changes in
2004, 35% of the total. Second-tier firms accounted for
116, or 7%, while other firms accounted for the remaining
929, or 58%. This is consistent with 2003, when the percentages
were 36%, 9%, and 55%, respectively.
the Big Four and second-tier firms, BDO Seidman gained the
greatest number of new clients, 109, followed by Grant Thornton
(80) and Deloitte & Touche (68). Conversely, Ernst &
Young lost 200 clients, followed by PricewaterhouseCoopers
(138) and KPMG (125).
for Auditor Changes
number of circumstances might cause a company and its auditor
to end their relationship. When a company chooses to provide
a reason, investors and auditors should mainly be concerned
about the following: “internal control weaknesses,”
“restatements,” “disagreements on accounting,”
“inability to rely on management,” “scope
limitation,” “unauthorized opinion,” and
“illegal acts.” These types of reasons may point
to deficiencies in a company’s accounting function,
and may ultimately affect the reported financial results.
“Independence impaired” and “cost reductions”
reasons could have implications for the quality of the audit
both before and after the change. Exhibit
1 provides a summary of reasons given for auditor changes
for 2003 and 2004.
internal controls are necessary to obtain reliable
financial information. Without good internal controls, it
is likely that management will make faulty decisions due
to unreliable data. For the same reason, investors will
not be able to adequately analyze a company’s financial
statements and make the right investment decisions.
the passage of the Foreign Corrupt Practices Act in 1977,
all SEC registrants, including small companies, have been
required to maintain adequate internal accounting controls.
SOA section 404 further mandates that a company’s
management assess the effectiveness of these internal controls
and that the auditors attest to, and report on, this assessment.
2 classifies by revenues the companies that reported
material weaknesses in their internal controls for 2004.
It illustrates that internal control problems are more prevalent
at smaller companies. Of companies with revenues under $25
million, 49 reported internal control problems, representing
48% of all companies reporting internal controls problems,
a significant increase from 25 (43%) in 2003. Companies
with revenues between $25 million and $100 million were
again the second-highest group. Of these companies, 30 (29%)
reported internal control problems, compared to 18 (31%)
the previous year. Only two companies with revenues between
$100 million and $500 million and five companies with revenues
greater than $1 billion reported internal control problems
(compared to one and six such companies, respectively, in
2003). These figures indicate that larger companies are
more likely to have more-effective internal control systems,
an intuitive result not only because larger companies need
such systems in order to function, but also because larger
companies usually have more financial resources to implement
and maintain them and to attract higher-quality financial
3 lists the internal control problems reported by companies
with revenues greater than $100 million.
total number of companies reporting internal control problems
increased from 58 in 2003 to 102 in 2004, a jump of 76%.
This increase may be related to SOA section 404 compliance
by accelerated filers, because auditors may have applied
greater scrutiny before issuing a clean opinion on internal
controls effectiveness. Given that small companies do not
have to comply with SOA until July 2006, it may also be
indicative that yet another wave of such disclosures is
forthcoming. Because auditors were not specifically required
to issue opinions on management’s reports on internal
controls in the past, it is likely there were weaknesses
that were not reported. The new rules require auditors to
give independent opinions on management’s assertions
to the shareholders about internal control.
average, the stock price decreased less than 1% in 2004
for those companies with revenues greater than $100 million
that reported a material weakness in internal controls in
connection with a change in auditor. The stock prices of
companies with revenues less than $100 million decreased
an average of 1.8% in 2004, compared to an increase for
the S&P 500 of 9%.
SOA section 404 takes effect, companies will eventually
correct their deficiencies in internal controls and report
fewer deficiencies. In the next few years, SOA section 404
should lead to improved internal controls and more-reliable
most common reasons for reporting internal control weaknesses
were related to personnel. Reasons cited included lack of
qualified accounting staff, insufficient segregation of
duties, and lack of proper training and supervision. Another
common problem was related to the inadequacies of companies’
accounting information systems. All of these are important
to the proper functioning of a company’s internal
control system; until they are at appropriate levels, companies
are likely to continue to have problems.
Big Four are more likely to identify internal control problems.
These firms are also less likely to continue as auditors
for a company after internal control problems are disclosed.
This may raise questions as to whether smaller accounting
firms are taking on increased risks.
number of companies reported in their filings that their
auditor had rendered a going-concern opinion. Of
the companies reporting changes in auditors, 35% reported
going-concern problems, an increase from 29% in the previous
year. Often auditors may have resigned from these engagements
due to a perception of increased risks. In cases where the
auditors were fired, it may be that the company was displeased
with the going-concern opinion, and was in effect “shopping”
for a more favorable opinion.
those companies changing auditors, 30 restated their
financial statements in 2004, up from 14 in 2003. Restatements
may be a sign of other problems in a company’s accounting
function. Over half of the companies filing restatements
also reported internal control deficiencies. For
these companies, the auditor changes all took place after
the restatements, and appeared to be related. In 11 cases
the auditors resigned, and in five the company dismissed
them. The auditors may have perceived increased risks from
clients with internal control weaknesses, which may have
led to their resignation. In cases where the auditors were
dismissed, the relationship might have been strained by
weaknesses uncovered by the auditors that led to the restatements.
the companies reporting a restatement, seven were audited
by Deloitte & Touche, four by Ernst & Young, seven
by KPMG, and five by PricewaterhouseCoopers. Three were
audited by second-tier firms, and four by smaller firms.
Seven of the restating companies, including Network Associates,
United Pan Am Financial, and Fannie Mae, had revenues greater
than $100 million.
the companies reporting restatements with no material weaknesses,
the auditor changes appear to be unrelated to the restatement.
These companies may have had some form of internal control
deficiency that led to the restatement, but failed to disclose
the problem. If this is the case, full information about
the state of the company’s internal control system
was not disclosed publicly. Companies that reported restatements
saw their stock price decrease by an average of 3% in 2004.
public disagreement between a company and its independent
auditor is likely to have a very negative and direct
impact on its reported financial results. Such a disagreement
may be an indication that the company is attempting to apply
improper, aggressive, or non-GAAP accounting that the auditor
is unwilling to accept. A company will sometimes fire an
auditor that disagrees with it and subsequently hire a more
and their auditors are required to report disagreements
on accounting matters, even if the disagreement is subsequently
resolved to the auditor’s satisfaction. During 2004,
only 1% (19) of companies surveyed reported disagreements,
compared to 3% (27) in 2003. Six of these companies had
revenues greater than $100 million, five had revenues between
$25 million and $100 million, and eight had revenues under
$25 million. Exhibit
4 presents a summary of the disagreements of the six
companies with revenues greater than $100 million.
the financial expertise of audit committees may reduce accounting
disagreements, but it is unlikely to eliminate them completely.
Of the six large companies mentioned above, three had a
CPA on their board.
data indicate that the Big Four were more likely to be involved
in disagreements, and less likely to be the successor firm
after a disagreement. Of the 19 companies reporting disagreements
in 2004, the Big Four were predecessors 13 times, or in
68% of the cases. Conversely, the Big Four were successors
six times, or 32%. The Big Four could be more reluctant
to become the successor auditor after a disagreement, especially
for audits of smaller companies. Four of the 19 reported
disagreements were related to revenue recognition problems.
Apart from this, there was no significant pattern related
to the reasons for disagreements.
six companies with revenues over $100 million in revenues
that reported disagreements saw their stock price increase
an average of 4% in 2004.
companies disclosed that their auditors concluded
they could no longer rely on management representations
for the purposes of conducting their audits, compared to
six in 2003. The Big Four audited 10 such companies, three
were audited by second-tier firms, and smaller accounting
firms audited six.
an auditor is unable to rely on information provided by
management, doubt is cast on the integrity of the financial
statements, as well as on management. It also raises a serious
question about possible lack of oversight by the audit committee.
an auditor is unable to rely on management, it means that
something has occurred to cause suspicion about the integrity
of management or of the board of directors. Auditors may
have learned that they had been provided with false or misleading
information, or found that information had been withheld.
In some cases, auditors might refuse to rely on management
because of actions not taken, such as the proper investigation
six companies with over $100 million in revenues that reported
their auditor was no longer willing to rely on management
saw their stock price increase an average of 14% in 2004.
request to expand the scope of an audit is usually an indication
that the auditor has uncovered a problem in the financial
statements and needs to do additional work to arrive at
a conclusion. If an auditor’s resignation or dismissal
was related to a scope limitation, investors should be wary
of the reported financial results. The auditor may have
been fired to prevent further exposure, or may have resigned
to avoid any possible fallout. Five companies reported scope
limitations associated with an auditor change in 2004, compared
to six in the previous year. The low level of reported scope
limitations may indicate that auditors are being allowed
to do their jobs—a positive outcome.
of the five companies whose auditor indicated they needed
to expand the scope of the audit saw their stock price increase
by an average of 30% in 2004.
10A of the Securities and Exchange Act of 1934
requires auditors to report potential illegal acts to the
board of directors and the audit committee. If the matter
is not resolved in a timely manner, it must then be reported
to the SEC in a “Section 10A letter.” Section
10A letters are rare occurrences. Auditors referred to illegal
acts in their SEC response letters for two companies, Lancer
Corporation and Rosedale Decorative Products. Lancer Corporation
was the subject of an SEC investigation concerning the potentially
can withdraw their opinions for a number of reasons.
Companies may take it upon themselves to file their own
reports with an audit opinion, even if the auditors had
not completed the work and had not given them permission
to do so. In other cases, auditors sometimes uncover additional
information after they have issued an opinion, and subsequently
withdraw it. In most cases, the companies had other accounting
and auditing issues, such as accounting disagreements, scope
limitations, or material weaknesses. Sometimes these accounting
issues delayed the audit, and companies may have issued
unauthorized reports to avoid late filing. Audit committees
are responsible for ensuring that companies are not issuing
companies issued reports with unauthorized audit opinions.
All of them were small companies, and all had other accounting
and auditing issues. In the case of Industries International,
the company stated that it had received correspondence from
the auditors indicating that the financial statements had
been reviewed. In its response letter, the auditor asserted
that the company’s statement was “factually
incorrect and misleading.” In such a situation, questions
arise about the integrity of a company’s financial
statements, its management team, and the oversight of its
board of directors.
the 55 companies that disclosed they changed auditors due
to fee reductions, 60% had been previously audited
by the Big Four, 16% by second-tier firms, and 24% by small
accounting firms. Of these companies, 9% ended up choosing
a Big Four firm, 42% a second-tier firm, and 45% a smaller
firm; two companies had yet to name a successor. When a
company discloses that it changed auditors for cost considerations,
investors should closely monitor the amount of audit fees
disclosed in the subsequent proxy statement, to assess whether
this may have a negative impact on the quality of the audit.
few companies specifically mentioned increased costs due
to compliance with SOA section 404 requirements, this may
be part of the reason for the increased number of changes
due to fee reductions. Only one company stated that it changed
auditors due to increased costs related to auditing its
internal controls, but several others said they changed
auditors to reduce costs related to SEC compliance, which
likely also refers to section 404 requirements. Companies
with poor internal control systems will likely find it more
expensive to comply with SOA section 404, and their auditors
will be required to perform more-extensive testing procedures.
55 companies that reported an auditor change in 2004 to
reduce their audit fees saw their stock price increase an
average of 33%.
shopping” refers to the practice of changing auditors
in order to get a desired opinion on an accounting matter
or on the financial statements as a whole. Opinion shopping
is usually evident when a company changes auditors frequently.
In some cases, companies return to auditors they had recently
companies changed auditors at least twice during 2004, and
four changed auditors three times. Most of the companies
changing auditors more than once were small companies. Fourteen
companies with revenues greater than $25 million changed
auditors more than once.
from SEC Registrants
2004, there were a total of 133 auditor changes related
to SEC registration requirements for audit firms. In 2003,
there were 57 such changes. Under SOA, auditors must register
with the Public Company Accounting Oversight Board (PCAOB)
in order to audit SEC registrants. About 70 small audit
firms, most of which audited fewer than three SEC companies,
decided not to register with the PCAOB or comply with other
is extremely difficult for a small accounting firm, with
limited resources, to stay up to date with the developments
affecting public companies. As a result, SEC enforcement
actions often involve small firms. Accordingly, it should
not be a concern to investors if a company changes auditors
as a result of the auditor’s decision to no longer
audit public companies.
surprisingly, many audit firms with no public company clients
have registered with the PCAOB. From public statements made
by PCAOB staff, approximately 400 of the 1,415 registered
firms do not audit public companies. Firms may choose to
register with the PCAOB because of a perception of increased
credibility in the eyes of potential clients. Nonetheless,
these companies are not subject to PCAOB inspections of
their audits, because they do not audit public companies.
These companies may benefit from the reputation bestowed
by PCAOB registration without being subject to its inspections
of their audits. This could lead to the public’s misunderstanding
the level of oversight implied by PCAOB registration.
also change auditors as a result of changes in
control or mergers. Investors need be concerned only to
the extent that the outgoing auditor discloses any information
that might cast doubt on the company’s financial reporting
system. There were 102 auditor changes related to company
mergers in 2004. Only two companies’ auditors noted
any material weaknesses in the last two fiscal years prior
to their dismissal. Most of the companies had going-concern
problems, which might have prompted the mergers in the first
number of changes related to the merger of audit firms more
than tripled last year, from 22 in 2003 to 83 in 2004. The
mergers of Madsen & Associates with Sellers & Andersen;
of Chisholm & Associates with Bierwolf, Nilson &
Associates; and of Follmer Rudzewicz with Urbach Kahn &
Werlin resulted in most of the changes.
cases, less than 1% of auditor changes, involved
auditor resignation due to resource constraints. Five of
the changes involved the resignation of a small accounting
firm, one a second-tier firm, and four a Big Four firm.
In all but two of the cases, the incoming auditors were
small firms. Only one of the 10 companies had revenues greater
than $100 million. These types of resignations are likely
to increase as auditors’ workloads increase due to
companies somewhat belatedly implementing the section 404
requirements for adequate internal controls.
and Auditors: Predecessors and Successors
2004, auditor changes increased dramatically at
companies of all sizes. Nevertheless, companies with revenues
in excess of $1 billion changed auditors 53 times, more
than double the number in the previous year. The number
of auditor changes among companies with revenues between
$100 million and $1 billion also more than doubled, from
90 in 2003 to 185. Small-company changes increased significantly,
from 790 in 2003 to 1,371 in 2004.
companies accounted for a disproportionately high percentage
of auditor changes. Companies with revenues under $100 million
comprised 53% of the FactSet database of SEC-registered
companies, yet they accounted for 85% of auditor changes.
Companies with revenues over $100 million comprised 47%
of the FactSet database, while accounting for just 15% of
large accounting firms and the AICPA have long argued that
rotation of auditors would reduce the quality of audits.
The principal rationale of proponents of auditor rotation
has been concern over the “coziness” with management
that comes from long-term association. Observing the outcomes
from the large number of recent changes in auditors may
provide insights into the effects of auditor change on audit
the 238 companies with revenues over $100 million that changed
auditors, 207 dropped Big Four firms and 13 dropped second-tier
firms. On the other hand, only 87 (38%) retained another
Big Four firm to replace the outgoing auditor. This compares
to a 64% retention rate for the Big Four firms in 2003.
In contrast, 81 (35%) retained a second-tier firm, and 63
(27%) retained a smaller firm. Seven companies have yet
to name a successor.
companies with revenues under $100 million, the Big Four
lost 357 clients (26%) in 2004, compared to 227 (29%) in
2003. On the other hand, they gained only 77 small clients,
or 6%. Second-tier firms lost 103 small clients (8%) in
2004, compared to 74 (9%) in 2003. Small audit firms accounted
for 911 (66%) of small-company changes in 2004, compared
to 489 (62%) in 2003.
the Big Four experienced a net loss of 400 clients in 2004,
compared to 201 in 2003. Small audit firms were the chief
beneficiaries of this change, as they gained 217 clients
in 2004, compared to 71 in 2003. Second-tier firms gained
117 clients in 2004, compared to 30 in 2003.
the disclosures do not provide enough information to definitively
state the reason for the change to smaller firms, there
are a number of likely interpretations. One might be that
the Big Four are applying stricter guidelines in selecting
their clients, a change they have stated publicly. These
firms might be ridding themselves of “riskier”
clients (usually translated to mean smaller clients). A
number of companies have also changed auditors in order
to reduce their audit costs. In these instances, the data
show that companies are more likely to switch from a larger
to a smaller firm. A third possibility is that a number
of small firms have merged their operations and have, therefore,
become more competitive with some of the larger firms. While
smaller audit firms have increased their number of small
audit clients, the largest companies continue to rely on
the Big Four. Of the 90 companies with revenues over $500
million changing auditors, 58% chose a Big Four firm as
Big Four firms lost 35% of all audits, second-tier firms
lost 7%, and other accounting firms lost 58%. At the same
time, Big Four firms were successors 11% of the time, second-tier
firms won 15% of the audits, and other accounting firms
won 74%. Exhibit
5 details the 2004 changes by auditors.
After a Change
seen in Exhibit
6, 82 companies with revenues greater than $100 million
changed auditors in 2003. More than half of them (56%) outperformed
the S&P 500, by an average of 56 percentage points in
the 12 months leading up to the date of the change. The
rest (44%) underperformed the S&P 500, by an average
of 32 percentage points. The year after the auditor change,
30% of companies with revenues greater than $100 million
underperformed the S&P 500, by an average of 16 percentage
points the year after the change, while 70% outperformed
the S&P 500, by an average of 121 percentage points
the year after the change.
those companies with over $100 million in revenues that
reported a weakness in internal controls in 2004 saw their
stock price decline on average less than 1%, companies may
see an uptick in their stock price after reporting a material
weakness in internal control. Of the 11 companies that reported
a material weakness at the time of a change in auditors
in 2003, seven saw their stock value rise and four saw it
fall; the average result was an increase of 44% after the
change. For example, K-Mart reported internal control weaknesses
in 2003, and its stock price increased by over 200% a year
after the auditor change.
on Audit Fees
fees do not always decline when there is a change in auditors.
The audit fees of the 38 companies with revenues
over $100 million that changed auditors in 2003 increased
by an average of $130,000 per company. Fees declined for
16 of the companies in this group, and rose for 22 of them.
fees also declined by an aggregate of $5 million. The total
payments to auditors therefore remained the same. The increased
audit fees may be due to the incoming auditors increasing
fees for the additional work required for SOA section 404
compliance. The reduction in other fees may have occurred
because the companies are relying less on auditors for other
services that may impair independence.
Auditor Changes in 2004
high-profile auditor changes in 2004 highlight
the need for proper oversight of companies’ financial
Mae’s dismissal of KPMG is probably the most significant
auditor change that occurred in 2004. A report by the Office
of Federal Housing Enterprise Oversight (OFHEO) questioned
the company’s application of SFAS 91, Accounting
for Nonrefundable Fees and Costs Associated with Originating
or Acquiring Loans and Initial Direct Costs of Leases,
and SFAS 133, Accounting for Derivative Instruments
and Hedging Activities. The SEC subsequently confirmed
that the company had applied the standards incorrectly.
The company will restate its financial statements for the
last three years, resulting in losses that may be in excess
of $9 billion. The CEO and the CFO were forced to resign.
Fannie Mae’s stock fell by 7% in one day when it disclosed
these accounting irregularities.
significant auditor change in 2004 was American Express’
dismissal of Ernst & Young, which had audited American
Express since 1975. In 2003, the company paid Ernst &
Young $23 million in audit fees and $3.5 million for other
services. The dismissal may have been related to an SEC
investigation into whether Ernst & Young violated auditor
independence rules by entering into a profit-sharing agreement
with the company’s travel service unit. The company
did not make any reference to this investigation in its
auditor change disclosure. This investigation was part of
a larger one by the SEC into Ernst & Young’s auditor
independence compliance procedures. Based upon the outcome
of the findings, Ernst & Young was barred from accepting
new clients for six months. American Express’ stated
reason for the auditor change is that its audit committee
charter required it to review its external auditor every
10 years. American Express did not publicly disclose such
information until 2004, which raises questions about the
apparent and the real reasons for the change.
number of changes in auditors in 2003 and 2004
has escalated significantly, over 2,500 companies in all.
Disclosures regarding auditor changes may provide investors
with a useful glimpse into a company’s financial reporting
system. The authors believe investors should pay close attention
to these disclosures, as the impact on a particular company’s
stock price is unique and specific. The authors believe
that a major concern is a lack of disclosure of adequate
information in auditor change–related filings. Companies
provided no reasons for 59% of the changes in auditors in
2004, leaving investors in the dark. If the SEC revised
its rules, it could bring greater transparency and a better
understanding of the reasons behind auditor changes.
E. Turner, CPA, is managing director of research
at Glass Lewis & Co., LLC, and senior advisor to Kroll,
Jason P. Williams, MBA, ACCA, is a research
analyst at Glass Lewis & Co., LLC.
Thomas R. Weirich, PhD, CPA, is a professor
of accounting, Central Michigan University, Mount Pleasant,