CICA seeking comments – Changes to audit partner rotation provisions

The CICA is seeking comments before June 15, 2010 on proposed changes to the audit partner rotation rules for Canadian public companies (other than SEC registrants) as outlined in a recently issued Exposure Draft.

Because the external auditor reports directly to the audit committee, directors serving on audit committees need to understand and assess the implications of the proposed changes to the audit partner rotation provisions.

Audit committees of companies moving to IFRS in 2011 will likely find the proposed changes and their timing very appealing—the proposed term extensions support continuity of knowledge in the audit engagement partner role through this period of significant change.

Under existing rotation rules, some companies would otherwise need to work with a new audit engagement partner in 2011. Audit committees may find that, by communicating to the CICA their support for the proposed change, they will be able to retain the key partners on their audit through the IFRS changeover period.

Audit committees are strongly encouraged to provide their comments to the CICA before the June 15 deadline.

Purpose of rotation provisions

Audit partner rotation requirements address the threat to independence that may arise from individual partners having long association with an audit client. A rotation schedule should effectively balance auditor objectivity with relevant knowledge and experience. If the rotation period is too long, the risk of a familiarity threat increases. If the period is too short, the turnover of partners can be detrimental to audit quality.

Changes proposed

The proposed changes affect the length of the terms that can be served by the lead engagement partner and the engagement quality control reviewer, and the elapsed time required between terms.

• The existing audit partner rotation provisions require a five/five cycle: the lead engagement partner and engagement quality control reviewer can only serve in that position for a period of five years and cannot resume providing such services until a further “time-out” period of five years has elapsed.
• The proposed provisions call for a seven/two cycle: an individual on an audit engagement of a reporting issuer can serve for a total of seven years as:
  • the lead engagement partner
  • the engagement quality control review
  • an audit partner providing more than ten hours of assurance services in connection with the annual or interim financial statements
  • a subsidiary engagement partner, or
  • any combination of these roles.

The individual cannot resume the role of audit partner of the reporting issuer until a further two years have elapsed. These provisions are intended to take effect in 2011.

Rationale for changes and timing

In developing its recommendations, the Independence Task Force (ITF) of the CICA examined both the five/five and seven/two cycles, considered international practices, and assessed the implications in terms of:

• costs to companies
• audit quality
• stability (particularly for specialised industries if specialist knowledge is limited)
• audit choice.

On balance, the ITF concluded that moving to the seven/two cycle is in the public interest.

The ITF also believes that the change should be made promptly, because most Canadian reporting issuers will be adopting IFRS in 2011. As outlined in the Exposure Draft, “This conversion from Canadian GAAP to IFRS will potentially result in numerous changes in an entity’s financial statements, and IFRS disclosure requirements provide that an entity’s first IFRS interim financial report must set out various reconciliations between the two bases of reporting. The ITF is of the view that, in light of the significant financial reporting challenges ahead, it is appropriate to provide for additional continuity for partners by moving from the five/five cycle to a seven/two cycle at this time.”

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