a

GAO

United States General Accounting Office

Report to the Senate Committee on 

Banking, Housing, and Urban Affairs and 

the House Committee on Financial 

Services

November 2003 PUBLIC 

ACCOUNTING FIRMS

Required Study on the 

Potential Effects of 

Mandatory Audit Firm 

Rotation

GAO-04-216
www.gao.gov/cgi-bin/getrpt?GAO-04-216.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact Jeanette M. 

Franzel at (202) 512-9471 or 

franzelj@gao.gov. 

Highlights of GAO-04-216, a report to 

Senate Committee on Banking, Housing, 

and Urban Affairs and House Committee 

on Financial Services 

November 2003 

PUBLIC ACCOUNTING FIRMS 

Required Study on the Potential Effects 

of Mandatory Audit Firm Rotation 

The arguments for and against mandatory audit firm rotation concern 

whether the independence of a public accounting firm auditing a company's 

financial statements is adversely affected by a firm's long-term relationship 

with the client and the desire to retain the client. Concerns about the 

potential effects of mandatory audit firm rotation include whether its 

intended benefits would outweigh the costs and the loss of company-specific 

knowledge gained by an audit firm through years of experience auditing the 

client. In addition, questions exist about whether the Sarbanes-Oxley Act 

requirements for reform will accomplish the intended benefits of mandatory 

audit firm rotation. 

In surveys conducted as part of our study, GAO found that almost all of the 

largest public accounting firms and Fortune 1000 publicly traded companies 

believe that the costs of mandatory audit firm rotation are likely to exceed 

the benefits. Most believe that the current requirements for audit partner 

rotation, auditor independence, and other reforms, when fully implemented, 

will sufficiently achieve the intended benefits of mandatory audit firm 

rotation. Moreover, in interviews with other stakeholders, including 

institutional investors, stock market regulators, bankers, accountants, and 

consumer advocacy groups, GAO found the views of these stakeholders to 

be consistent with the overall views of those who responded to its surveys. 

GAO believes that mandatory audit firm rotation may not be the most 

efficient way to strengthen auditor independence and improve audit quality 

considering the additional financial costs and the loss of institutional 

knowledge of the public company’s previous auditor of record, as well as the 

current reforms being implemented. The potential benefits of mandatory 

audit firm rotation are harder to predict and quantify, though GAO is fairly 

certain that there will be additional costs. 

Several years’ experience with implementation of the Sarbanes-Oxley Act’s 

reforms is needed, GAO believes, before the full effect of the act’s 

requirements can be assessed. GAO therefore believes that the most prudent 

course of action at this time is for the Securities and Exchange Commission 

and the Public Company Accounting Oversight Board to monitor and 

evaluate the effectiveness of existing requirements for enhancing auditor 

independence and audit quality. 

GAO believes audit committees, with their increased responsibilities under 

the act, can also play an important role in ensuring auditor independence. To 

fulfill this role, audit committees must maintain independence and have 

adequate resources. Finally, for any system to function effectively, there 

must be incentives for parties to do the right thing, adequate transparency 

over what is being done, and appropriate accountability if the right things 

are not done. 

Following major failures in 

corporate financial reporting, the 

Sarbanes-Oxley Act of 2002 was 

enacted to protect investors 

through requirements intended to 

improve the accuracy and 

reliability of corporate disclosures 

and to restore investor confidence. 

The act included reforms intended 

to strengthen auditor independence 

and to improve audit quality. 

Mandatory audit firm rotation 

(setting a limit on the period of 

years a public accounting firm may 

audit a particular company’s 

financial statements) was 

considered as a reform to enhance 

auditor independence and audit 

quality during the congressional 

hearings that preceded the act, but 

it was not included in the act. The 

Congress decided that mandatory 

audit firm rotation needed further 

study and required GAO to study 

the potential effects of requiring 

rotation of the public accounting 

firms that audit public companies 

registered with the Securities and 

Exchange Commission. 
Page i GAO-04-216 Public Accounting Firms

Contents

Letter 1

Results in Brief 5

Background 10

Pros and Cons of Requiring Mandatory Audit Firm Rotation 13

Results of Our Surveys 14

Competition-Related Issues 33

Overall Views on Mandatory Audit Firm Rotation 37

Overall Views of Other Knowledgeable Individuals on Mandatory 

Audit Firm Rotation 40

Survey Groups Views on Implementing Mandatory Audit Firm 

Rotation if Required and Other Alternatives for Enhancing Audit 

Quality 44

Auditor Experience in Restatements of annual Financial Statements 

Filed with the SEC for 2001 and 2002 46

Experience of Foreign Countries with Mandatory Audit Firm 

Rotation 48

GAO Observations 49

Agency Comments and Our Evaluation 52

Appendixes

Appendix I: Objectives, Scope, and Methodology 54

Appendix II: Implementation of Mandatory Audit Firm Rotation, if 

Required 72

Appendix III: Potential Value of Practices Other Than Mandatory Audit 

Firm Rotation for Enhancing Auditor Independence and 

Audit Quality 75

Appendix IV: Restatements of Annual Financial Statements for Fortune 

1000 Public Companies Due To Errors or Fraud 78

Appendix V: International Experience with Mandatory Audit Firm 

Rotation 83

Appendix VI: GAO Contacts and Staff Acknowledgments 91

GAO Contacts 91

Staff Acknowledgments 91

Tables Table 1: Audit Committee Chairs’ Reasons for Limiting 

Consideration to Only Big 4 Firms 37

Table 2: Public Accounting Firms’ Population, Sample Sizes, and 

Survey Response Rates 62
Contents

Page ii GAO-04-216 Public Accounting Firms

Table 3: Public Company Chief Financial Officers’ Population, 

Sample Sizes, and Survey Response Rates 66

Table 4: Public Company Audit Committee Chairs’ Population, 

Sample Sizes, and Survey Response Rates 66

Table 5: Views on Potential Value of Other Practices for Enhancing 

Auditor Independence and Audit Quality 77

Table 6: Summary Results of the Fortune 1000 Public Companies 

That Changed Auditors 79

Table 7: Summary Results of the Fortune 1000 Public Companies 

That Did Not Change Auditors 79

Table 8: Summary of Net Dollar Effect of Restatements Due to 

Errors and Fraud 82

Figures Figure 1: Estimated Audit Firm Tenure for Fortune 1000 Public 

Companies 17

Figure 2: Tier 1 Firms: Value of Additional Procedures When Firm 

Has Less Knowledge and Experience with a Client 20

Figure 3: Fortune 1000 Public Companies’ Belief That Additional or 

Enhanced Audit Procedures Would Affect the Risk of Not 

Detecting Material Misstatements 21

Figure 4: Views on How Mandatory Audit Firm Rotation Would 

Affect the Auditor’s Potential to Deal with Material 

Financial Reporting Issues Appropriately 24

Figure 5: Expected Increase in Initial Year Audit Costs over 

Subsequent Year Audit Costs 28

Figure 6: Tier 1 Firms Expecting Additional Expected Marketing 

Costs under Mandatory Audit Firm Rotation Compared to 

Initial Year Audit Fees 30

Figure 7: Fortune 1000 Public Companies’ Expected Selection 

Costs as a Percentage of Initial Year Audit Fees 31

Figure 8: Fortune 1000 Public Companies’ Expected Support Costs 

as a Percentage of Initial Year Audit Fees 32

Figure 9: Support for Mandatory Audit Firm Rotation 40
Contents

Page iii GAO-04-216 Public Accounting Firms

Abbreviations

AICPA American Institute of Certified Public Accountants

CGAA Co-ordinating Group on Audit and Accounting Issues

CNMV Comision Nacional del Mercaso de Valores

CONSOB Commissione Nazionale per le Societa e la Borsa

CVM Comissao de Valores Mobiliarios

EDGAR Electronic Data Gathering, Analysis, and Retrieval 

G-7 Group of Seven Industrialized Nations

GAAP generally accepted accounting principles

GAAS generally accepted auditing standards

IOSCO International Organization of Securities Commissions

NIvRA Royal Nederlands Instituut van Register Accountants

NOvAA Nederlandse Orde van AccountantsAdministratieconsulenten

OSFI Office of the Superintendent of Financial Institutions

PCAOB Public Company Accounting Oversight Board

POB Public Oversight Board

SEC Securities and Exchange Commission

SECPS SEC Practice Section

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Page 1 GAO-04-216 Public Accounting Firms

United States General Accounting Office

Washington, D.C. 20548

A

November 21, 2003 Letr

The Honorable Richard C. Shelby

Chairman

The Honorable Paul S. Sarbanes

Ranking Minority Member

Committee on Banking, Housing, and Urban Affairs

United States Senate

The Honorable Michael G. Oxley

Chairman

The Honorable Barney Frank

Ranking Minority Member

Committee on Financial Services

House of Representatives

Full, fair, and accurate reporting of financial information by public 

companies1

 is critical to the effective functioning of the capital and credit 

markets in the United States. Federal securities laws and regulations 

require publicly owned companies to disclose financial information in a 

manner that accurately depicts the results of company activities and 

require that the companies’ financial statements be audited by an 

independent public accountant. Although public company management is 

responsible for the company’s financial statements, public confidence in 

the integrity of financial statements of publicly traded companies is 

enhanced by the audit process and independence of the auditor from the 

audit client.

Major failures in corporate financial reporting in recent years, including 

accountability breakdowns at Enron and WorldCom and other major 

corporations, that led to restatement of financial statements and 

bankruptcy adversely affected thousands of shareholders and employees. 

As a result, the Sarbanes-Oxley Act of 20022

 was enacted to protect 

investors by improving the accuracy and reliability of corporate 

disclosures. The act’s requirements included reforms to strengthen 

1

 For purposes of this report, public companies refers to issuers, the securities of which are 

registered under 15 U.S.C. § 78l, that are required to file reports under 15 U.S.C. § 780 (d), or 

that file or have filed a registration statements that have not yet become effective under the 

Securities Act of 1933.

2

 Pub. L. No. 107-204, 116 Stat. 745.
Page 2 GAO-04-216 Public Accounting Firms

corporate responsibility for financial reports and auditor independence and 

created the Public Company Accounting Oversight Board (PCAOB). The 

PCAOB has the responsibility to register and inspect public accounting 

firms that audit public companies, and the authority to investigate and 

discipline registered public accounting firms and to set auditing and related 

attestation, quality control, and auditor ethics and independence standards 

in connection with audits of public companies.

Senate report 107-205 that accompanied the Sarbanes-Oxley Act stated that 

in considering reforms to enhance auditor independence, some witnesses 

believed that mandatory audit firm rotation3

 of public accounting firms was 

necessary to maintain the objectivity of audits, while other witnesses 

believed that public accounting firm rotation could be disruptive to the 

public company and the costs of mandatory audit firm rotation might 

outweigh the benefits. The Congress decided that mandatory audit firm 

rotation needed further study and required in Section 207 of the SarbanesOxley Act that GAO study the issues. Specifically, we were asked to study 

the potential effects of requiring mandatory rotation of registered public 

accounting firms.4

 To conduct our study, we did the following:

• Identified and reviewed research studies and other documents that 

addressed issues concerning auditor independence and audit quality 

associated with the length of a public accounting firm’s tenure and the 

costs and benefits of mandatory audit firm rotation.

• Analyzed the issues we identified to (1) develop detailed questionnaires 

to obtain the views of public accounting firms and public company chief 

financial officers and their audit committee chairs of the issues 

associated with mandatory audit firm rotation, (2) hold discussions with 

officials of other interested stakeholders, such as institutional investors, 

federal banking regulators, U.S. stock exchanges, state boards of 

accountancy, the American Institute of Certified Public Accountants 

3

 Mandatory rotation is defined in the Sarbanes-Oxley Act as the imposition of a limit on the 

period of years in which a particular public accounting firm registered with the PCAOB may 

be the auditor of record for a particular public company. For purposes of this report, the 

auditor of record is the public accounting firm issuing an audit opinion of the public 

company’s financial statements.

4

 Section 102 of the Sarbanes-Oxley Act requires public accounting firms that want to audit 

public companies to register with the PCAOB and states that it shall be unlawful for any 

person who is not a registered public accounting firm to prepare, issue, or participate in the 

preparation or issuance of any audit report with respect to any issuer.
Page 3 GAO-04-216 Public Accounting Firms

(AICPA), the Securities and Exchange Commission (SEC), and the 

PCAOB to obtain their views on the issues associated with mandatory 

audit firm rotation, and (3) obtain information from other countries on 

their experiences with mandatory audit firm rotation.

• Identified restatements of annual financial statements for Fortune 1000 

public companies due to errors or fraud that were reported to the SEC 

for years 2001 and 2002 through August 31, 2003, to (1) determine 

whether the restatement occurred after a change in the public 

companies’ auditor of record, and (2) to obtain some insight into the 

value of a “fresh look” by a new auditor of record. 

Our population of public accounting firms consisted of three tiers: Tier 1 

firms included 92 public accounting firms that were members of the 

AICPA’s self-regulatory program for audit quality that reported having 10 or 

more SEC clients in 2001 and 5 public accounting firms that were not 

members of the AICPA’s self-regulatory program but had 10 or more public 

company clients registered with the SEC in 2001.5

 Tier 2 firms included 604 

public accounting firms that were members of the AICPA’s self-regulatory 

program for audit quality that reported having 1 to 9 public company clients 

registered with the SEC in 2001.6 Tier 3 firms included 421 public 

accounting firms that were members of the AICPA’s self-regulatory 

program for audit quality that reported having no public company clients 

registered with the SEC in 2001. We surveyed 100 percent of the 97 Tier 1, 

firms and we administered our surveys to random samples of 282 of the 604 

Tier 2 firms and 237 of the 421 Tier 3 firms. We received responses from 74 

of the 97 Tier 1 firms, or 76.3 percent.7

 Because of the more limited 

participation of Tier 2 firms (85, or 30.1 percent) and Tier 3 firms (52, or 

21.9 percent) in our survey, we are not projecting their responses to the 

population of these firms. The presentation of this report focuses on the 

5

 The 92 Tier 1 firms with 10 or more public company clients represented about 90 percent of 

the total public company clients reported by member firms in their 2001 annual reports to 

the AICPA's former self-regulatory program for audit quality. Hereafter in this report, "Tier 1 

firms" refers to the 97 firms that had 10 or more public company clients.

6

 The 604 Tier 2 firms with 1 to 9 public company clients in 2001 represented about 10 

percent of the total public company clients reported by member firms in their 2001 annual 

reports to the AICPA's former self-regulatory program for audit quality.

7

 Estimates of Tier 1 firms are subject to sampling errors of no more than plus or minus 7 

percentage points (95 percent confidence level) unless otherwise noted, as well as to 

possible nonsampling errors generally found in surveys.
Page 4 GAO-04-216 Public Accounting Firms

responses from the Tier 1 firms, but any substantial differences in their 

overall views and those reported to us by either the Tier 2 or 3 firms that 

responded to our survey is discussed where applicable.

We also drew random samples of 330 of the Fortune 1000 public 

companies8

 after removing 40 private companies from the list, 450 of the 

14,887 other domestic companies and mutual funds, and 391 of 2,141 

foreign companies that make up the universe of the 17,988 public 

companies that are registered with the SEC as of February 2003. For each 

of these three groups of public companies, we asked their chief financial 

officers and audit committee chairs to complete separate questionnaires.

Of the 330 Fortune 1000 public companies sampled, we received responses 

from 201, or 60.9 percent, of their chief financial officers and 191, or 57.9 

percent, of their audit committee chairs.9

 Because of limited participation 

of the other domestic companies and mutual funds (131, or 29.1 percent, of 

their chief financial officers and 96, or 21.3 percent, of their audit 

committee chairs) and the foreign public companies (99, or 25.3 percent, of 

their chief financial officers and 63, or 16.1 percent, of their audit 

committee chairs), we are not projecting their responses to the population 

of such companies. This report focuses on the responses from the Fortune 

1000 public companies’ chief financial officers and their audit committee 

chairs, but any substantial differences between their overall views and 

those reported to us by the other groups of public companies that 

responded to our surveys is discussed where applicable.

For additional information on our scope and methodology including details 

of our samples, response rates, and efforts to follow up with 

nonrespondents to our surveys, see appendix I. We conducted our work in 

Washington, D.C., between November 2002 and November 2003 in 

accordance with U.S. generally accepted government auditing standards.

8

 We removed 40 private companies from the list of Fortune 1000 public companies. 

Therefore, our population of Fortune 1000 public companies was 960. 

9

 The estimates from these surveys are subject to sampling errors of no more than plus or 

minus 6 percentage points (95 percent confidence level) unless otherwise noted, as well as 

to possible nonsampling errors generally found in surveys. 
Page 5 GAO-04-216 Public Accounting Firms

A copy of each of our questionnaires, annotated to show in total the 

respondents’ answers to each question for the Tier 1 firms and the Fortune 

1000 public companies chief financial officers10 and their audit committee 

chairs, will be presented in a separate GAO report (GAO-04-217) to be 

issued at a later date.

Results in Brief Nearly all Tier 1 firms and Fortune 1000 public companies and their audit 

committee chairs believed that the costs of mandatory audit firm rotation 

are likely to exceed the benefits. Also, most Tier 1 firms and Fortune 1000 

public companies and their audit committee chairs believe that either the 

audit firm partner rotation requirements of the Sarbanes-Oxley Act as 

implemented by the SEC, or those partner rotation requirements coupled 

with other requirements of the Sarbanes-Oxley Act that concern auditor 

independence and audit quality, will sufficiently achieve the benefits of 

mandatory audit firm rotation when fully implemented. Our discussions 

with a number of other knowledgeable individuals in a variety of fields, 

such as institutional investment; regulation of the stock markets, the 

banking industry, and the accounting profession; and consumer advocacy, 

showed that most of the individuals we spoke with held views consistent 

with the overall views expressed by those who responded to our surveys.

Considering the arguments for and against mandatory audit firm rotation 

and the requirements of the Sarbanes-Oxley Act concerning auditor 

independence and audit quality, which are also intended to achieve the 

same type of benefits as mandatory audit firm rotation, we believe that 

more experience needs to be gained with the act’s requirements. Therefore, 

the most prudent course at this time is for the SEC and the PCAOB to 

monitor and evaluate the effectiveness of the act’s requirements to 

determine whether further revisions, including mandatory audit firm 

rotation, may be needed to enhance auditor independence and audit quality 

to protect the public interest.

Our research of studies concerning issues related to mandatory audit firm 

rotation showed the primary arguments relate to auditor independence, 

audit quality, audit cost, and competition-related issues for providing audit 

services. Regarding auditor independence and audit quality issues, our 

10 Hereafter, "Fortune 1000 public companies" refers to their chief financial officers.
Page 6 GAO-04-216 Public Accounting Firms

analysis of survey results of Tier 1 firms and Fortune 1000 public 

companies showed the following:

• The average length of the auditor of record’s tenure, which proponents 

of mandatory audit firm rotation believe increases the risk that auditor 

independence and ultimately audit quality may be adversely affected, 

was about 22 years for Fortune 1000 public companies.

• About 79 percent of Tier 1 firms and Fortune 1000 public companies 

believe that changing audit firms increases the risk of an audit failure in 

the early years of the audit as the new auditor acquires the necessary 

knowledge of the company’s operations, systems, and financial 

reporting practices and therefore may fail to detect a material financial 

reporting issue.

• Most Tier 1 firms and Fortune 1000 public companies believe that 

mandatory audit firm rotation would not have much effect on the 

pressures faced by the audit engagement partner in appropriately 

dealing with material financial reporting issues.

• About 59 percent of Tier 1 firms reported they would likely move their 

most knowledgeable and experienced audit staff as the end of the firm’s 

tenure approached under mandatory audit firm rotation to attract or 

retain other clients, which they acknowledged would increase the risk 

of an audit failure.

Regarding audit costs, our survey results show that Tier 1 firms and 

Fortune 1000 public companies expect that mandatory audit firm rotation 

would lead to more costly audits.

• Nearly all Tier 1 firms estimated that initial year audit costs under 

mandatory audit firm rotation would increase by more than 20 percent 

over subsequent year costs to acquire the necessary knowledge of the 

public company and most of the Tier 1 firms estimated their marketing 

costs would also increase by at least more than 1 percent, which would 

be passed on to the public companies.

• Most Fortune 1000 public companies estimated that under mandatory 

audit firm rotation, they would incur auditor selection costs and 

additional auditor support costs totaling at least 17 percent or higher as 

a percentage of initial year audit fees.
Page 7 GAO-04-216 Public Accounting Firms

Our check of audit fees and total company operating expenses reported by 

a selection of large and small public companies in 23 industries for the 

most recent fiscal year available found that for the large public companies 

selected, average audit fees represented approximately 0.04 percent of 

company operating expenses and, for the small public companies selected, 

average audit fees represented approximately 0.08 percent of company 

operating expenses. Based on estimates of possible increased audit-related 

costs from survey responses from Tier 1 firms and Fortune 1000 public 

companies, mandatory audit firm rotation could increase these auditrelated costs from 43 percent to 128 percent of the recurring annual audit 

fees. This illustration is intended only to provide some insight into how, 

based on Tier 1 firms’ and Fortune 1000 public companies’ responses, 

mandatory audit firm rotation may affect the initial year audit-related costs 

public companies may incur and is not intended to be representative. 

Regarding competition-related effects of mandatory audit firm rotation, 54 

percent of Tier 1 firms believe mandatory audit firm rotation would 

decrease the number of firms willing and able to compete for audits of 

public companies and 83 percent of Tier 1 firms believe that the market 

share of public company audits would either become more concentrated in 

a small number of public accounting firms or would remain the same. As 

we have previously reported,11 the number of public accounting firms 

providing audit services to public companies is highly concentrated with 

the 4 largest firms auditing over 78 percent of all U.S. public companies and 

99 percent of public company sales. Many Fortune 1000 public companies 

reported that they will only use a Big 4 firm for a variety of reasons, 

including the capability of the firms to provide them audit services and the 

expectations of the capital markets that they will use Big 4 firms. 

Mandatory audit firm rotation would further decrease their choices for an 

auditor of record, and the Sarbanes-Oxley Act auditor independence 

requirements concerning prohibited nonaudit services may also further 

limit the public companies’ choices for an auditor of record. Tier 1 firms 

expected that public companies in specialized industries, which in some 

industries currently have more limited choices for an auditor of record than 

other public companies, could be more affected by mandatory audit firm 

rotation than other public companies. 

11 U.S. General Accounting Office, Public Accounting Firms: Mandated Study on 

Consolidation and Competition, GAO-03-864 (Washington, D.C.: July 30, 2003).
Page 8 GAO-04-216 Public Accounting Firms

We believe that mandatory audit firm rotation may not be the most efficient 

way to enhance auditor independence and audit quality considering the 

additional financial costs and the loss of institutional knowledge of a public 

company’s previous auditor of record. The potential benefits of mandatory 

audit firm rotation are harder to predict and quantify, though we are fairly 

certain that there will be additional costs. In addition, the current reforms 

being implemented may also provide some of the intended benefits of 

mandatory audit firm rotation. In that respect, mandatory audit firm 

rotation is not a panacea that totally removes the pressures on the auditors 

in appropriately resolving financial reporting issues that may materially 

affect the public companies’ financial statements. These inherent 

pressures are likely to continue even if the term of the auditor is limited 

under any mandatory rotation process. Furthermore, most public 

companies will only use the Big 4 firms for audit services. Given this 

preference, these public companies may only have 1 or 2 real choices for 

auditor of record under any mandatory rotation system given the 

importance of industry expertise and the Sarbanes-Oxley Act’s auditor 

independence requirements. However, over time a mandatory audit firm 

rotation requirement may result in more firms transitioning into additional 

industry sectors if the market for such audits has sufficient profit margins.

The Sarbanes-Oxley Act contains significant reforms aimed at enhancing 

auditor independence (e.g., additional partner rotation requirements and 

restrictions on providing nonaudit or consulting services) and audit quality 

(e.g., establishing the PCAOB and management and auditor reporting on 

internal controls over financial reporting) that are also intended to achieve 

the same type of benefits as mandatory audit firm rotation. The PCAOB’s 

inspection program for registered public accounting firms could also 

provide an opportunity to provide a “fresh look”, which would enhance 

auditor independence and audit quality through the program’s inspection 

activities and also may provide new insights regarding (1) public 

companies’ financial reporting practices that pose a high risk of issuing 

materially misstated financial statements for the audit committees to 

consider and (2) possibly either using the auditor of record or another firm 

to assist in reviewing these areas. However, it will take at least several 

years for the SEC and the PCAOB to gain sufficient experience with the 

effectiveness of the act in order to adequately evaluate whether further 

enhancements or revisions, including mandatory audit firm rotation, may 

be needed to further protect the public interest and to restore investor 

confidence. The current environment has greatly increased the pressures 

on public company management and auditors regarding honest, fair, and 

complete financial reporting, but it is uncertain if the current climate will 
Page 9 GAO-04-216 Public Accounting Firms

be sustained over the long term. Rigorous enforcement of the act’s 

requirements will undoubtedly be critical to its effectiveness. 

We also believe that audit committees with their increased responsibilities 

under the Sarbanes-Oxley Act can play a very important role in enhancing 

auditor independence and audit quality. In that respect, the Conference 

Board Commission on Public Trust and Private Enterprise stated in its 

January 9, 2003, report that auditor rotation is a useful tool for building 

shareholder confidence in the integrity of the audit and of the company’s 

financial statements. The commission advocated that audit committees 

should consider rotating audit firms when there are circumstances that 

could call into question the audit firm’s independence from management. 

These circumstances included when (1) significant nonaudit services are 

provided by the auditor of record to the company (even if approved by the 

audit committee), (2) one or more former partners or managers of the audit 

firm are employed by the company, or (3) lengthy tenure of the auditor of 

record, such as over 10 years—which our survey results show is prevalent 

at many Fortune 1000 public companies. We believe audit committees that 

encounter these circumstances, at a minimum, need to be especially 

vigilant in the oversight of the auditor and in considering whether a “fresh 

look” (e.g., new auditor) is needed. We also believe that if audit 

committees regularly evaluated whether audit firm rotation would be 

beneficial, given the facts and circumstances of their companies’ situation, 

and are actively involved in helping to ensure auditor independence and 

audit quality, many of the benefits of audit firm rotation could be realized at 

the initiative of the audit committees rather than through a mandatory 

rotation requirement.

In order to be effective, however, audit committees need to have access to 

adequate resources, including their own budgets, to be able to operate with 

the independence necessary to effectively perform their responsibilities 

under the Sarbanes-Oxley Act. Further, we believe that the audit 

committee’s ability to operate independently is directly related to the 

independence of the public company’s board of directors. It is not realistic 

to believe that an audit committee will unilaterally resolve financial 

reporting issues that materially affect a public company’s financial 

statements without vetting those issues with the board of directors. Also, 

the ability of the board of directors to operate independently may also be 

affected in corporate governance structures where the public company’s 

chief executive officer also serves as the chair of the board of directors. 

Like audit committees, boards of directors also need to be independent and 

have adequate resources and access to independent attorneys and other 
Page 10 GAO-04-216 Public Accounting Firms

advisors when they believe it is appropriate. Finally, for any system to 

function effectively, there must be incentives for parties to do the right 

thing, adequate transparency to provide reasonable assurance that people 

will do the right thing, and appropriate accountability when people do not 

do the right thing.

This report makes no recommendations. We provided copies of a draft of 

this report to the SEC, AICPA, and PCAOB for their review. 

Representatives of the AICPA and the PCAOB provided technical 

comments, which we have incorporated where applicable. Representatives 

of the SEC had no comments.

Background Under federal securities laws, public companies are responsible for the 

preparation and content of financial statements that are complete, 

accurate, and presented in conformity with generally accepted accounting 

principles (GAAP). Financial statements, which disclose a company’s 

financial position, stockholders’ equity, results of operations, and cash 

flows, are an essential component of the disclosure system on which the 

U.S. capital and credit markets are based. 

The Securities Exchange Act of 1934 requires that a public company’s 

financial statements be audited by an independent public accountant. That 

statutory independent audit requirement in effect granted a franchise to the 

nation’s public accountants, as an audit opinion on a public company’s 

financial statements must be secured before an issuer of securities can go 

to market, have the securities listed on the nation’s stock exchanges, or 

comply with the reporting requirements of the securities laws. As of 

February 2003, there were about 17,988 public companies that were 

registered with the SEC and subject to the federal securities laws (15,847 

domestic and 2,141 foreign public companies). Based on 2001 annual 

reports of public accounting firms submitted to the AICPA, about 700 

public accounting firms that were members of the AICPA's former selfregulatory program for audit quality reported having approximately 15,000 

public company clients registered with the SEC, of which the Big 4 public 

accounting firms12 had about 70 percent of these public company clients 

and another 88 public accounting firms had about 20 percent of these 

12 PricewaterhouseCoopers LLP, Ernst & Young LLP, Deloitte & Touche LLP, and KPMG LLP.
Page 11 GAO-04-216 Public Accounting Firms

public company clients. The other approximately 600 public accounting 

firms had the remaining 10 percent of the reported public company clients.

The independent public accountant’s audit is critical in the financial 

reporting process because the audit subjects financial statements, which 

are management’s responsibility, to scrutiny on behalf of shareholders and 

creditors to whom management is accountable. The auditor is the 

independent link between management and those who rely on the financial 

statements.

Ensuring auditor independence—both in fact and appearance—is a longstanding issue. There has long been an arguably inherent conflict in the 

fact that an auditor is paid by the public company for which the audit was 

being performed. Various study groups over the past 20 years have 

considered the independence and objectivity of auditors as questions have 

arisen from (1) significant litigation involving auditors, (2) the auditor’s 

performance of nonaudit services for audit clients, which prior to the 

Sarbanes-Oxley Act, had risen to 50 percent of total revenues on average 

for the large accounting firms,13 (3) “opinion shopping” by clients, and 

(4) reports of public accountants advocating questionable client positions 

on accounting matters.

The major accountability breakdowns at Enron and WorldCom, and other 

failures in recent years such as Qwest, Tyco, Adelphia, Global Crossing, 

Waste Management, Micro Strategy, Superior Federal Savings Bank, and 

Xerox, led to the reforms contained in the Sarbanes-Oxley Act to enhance 

auditor independence and audit quality and to restore investor confidence 

in the nation’s capital markets. To enhance auditor independence and audit 

quality, the act’s reforms included

• establishing the PCAOB, as an independent nongovernmental entity, to 

oversee the audit of public companies that are subject to the securities 

laws;

• making the PCAOB responsible for (1) establishing auditing and related 

attestation, quality control, ethics, and independence standards 

applicable to audits of public companies, (2) conducting inspections, 

investigations, and disciplinary proceedings of public accounting firms 

registered with the PCAOB, and (3) imposing appropriate sanctions;

13 Senate Report 107-205, at 14 (2002).
Page 12 GAO-04-216 Public Accounting Firms

• making the public company’s audit committee responsible for the 

appointment, compensation, and oversight of the registered public 

accounting firm;

• requiring management and auditors’ reports on internal control over 

financial reporting;

• prohibiting the registered public accounting firm from providing certain 

nonaudit services to a public company if the auditor is also providing 

audit services;

• requiring the audit committee to preapprove all audit and nonaudit 

services not otherwise prohibited;

• requiring mandatory rotation of lead and reviewing audit partners after 

they have provided audit services to a particular public company for 5 

consecutive years; and

• prohibiting the public accounting firm from providing audit services if 

the public company’s chief financial officer, chief accounting officer, or 

any person serving in an equivalent position was employed by the firm 

and participated in the audit of the public company during the 1-year 

period preceding the date of starting the audit.

Mandatory audit firm rotation was also discussed in congressional hearings 

to enhance auditor independence and audit quality, but given the mixed 

views of various stakeholders, the Congress decided the effects of such a 

practice needed further study.
Page 13 GAO-04-216 Public Accounting Firms

Pros and Cons of 

Requiring Mandatory 

Audit Firm Rotation

Our review of research studies, technical articles, and other publications 

and documents showed that generally the arguments for and against 

mandatory audit firm rotation concern auditor independence, audit 

quality,14 and increased audit costs. A breakdown in auditor independence 

or audit quality can result in an audit failure and adversely affect those 

parties who rely on the fair presentation of the financial statements in 

conformity with GAAP.

Those who support mandatory audit firm rotation contend that pressures 

faced by the incumbent auditor to retain the audit client coupled with the 

auditor’s comfort level with management developed over time can 

adversely affect the auditor’s actions to appropriately deal with financial 

reporting issues that materially affect the company’s financial statements. 

Those who oppose audit firm rotation contend that the new auditor’s lack 

of knowledge of the company’s operations, information systems that 

support the financial statements, and financial reporting practices and the 

time needed to acquire that knowledge increase the risk of an auditor not 

detecting financial reporting issues that could materially affect the 

company’s financial statements in the initial years of the new auditor’s 

tenure, resulting in financial statements that do not comply with GAAP.

In addition, those who oppose mandatory audit firm rotation believe that it 

will increase costs incurred by both the public accounting firms and the 

public companies. They believe the increased risk of an audit failure and 

the added costs of audit firm rotation outweigh the value of a periodic 

“fresh look” by a new public accounting firm. Conversely, those who 

support audit firm rotation believe the value of the “fresh look” to protect 

shareholders, creditors, and other parties who rely on the financial 

14 Audit quality as used in this report refers to the auditor conducting the audit in 

accordance with generally accepted auditing standards (GAAS) to provide reasonable 

assurance that the audited financial statements and related disclosures are (1) presented in 

conformity with GAAP and (2) are not materially misstated whether due to errors or fraud. 

This definition assumes that reasonable third parties with knowledge of the relevant facts 

and circumstances would have concluded that the audit was conducted in accordance with 

GAAS and that, within the requirements of GAAS, the auditor appropriately detected and 

then dealt with known material misstatements by (1) ensuring that appropriate adjustments, 

related disclosures, and other changes were made to the financial statements to prevent 

them from being materially misstated, (2) modifying the auditor’s opinion on the financial 

statements if appropriate adjustments and other changes were not made, or (3) if 

warranted, resigning as the public company’s auditor of record and reporting the reason for 

the resignation to the SEC. 
Page 14 GAO-04-216 Public Accounting Firms

statements outweigh the added costs associated with mandatory firm 

rotation.

More recently, the Sarbanes-Oxley Act’s requirements that concern auditor 

independence and audit quality have added to the mixed views about 

whether mandatory audit firm rotation should also be required to enhance 

auditor independence and audit quality.

Results of Our Surveys The results of our surveys show that while auditor tenure at Fortune 1000 

public companies averages 22 years, about 79 percent of Tier 115 firms and 

Fortune 1000 public companies16 are concerned that changing public 

accounting firms increases the risk of an audit failure in the initial years of 

the audit as the new auditor acquires the knowledge of a public company’s 

operations, systems, and financial reporting practices. Further, many 

Fortune 1000 public companies will only use Big 4 public accounting firms 

and believe that the limited choices, that are likely to be further reduced by 

the auditor independence requirements of the Sarbanes-Oxley Act, coupled 

with the likely increased costs of financial statement audits and increased 

risk of an audit failure under mandatory audit firm rotation strongly argue 

against the need for mandatory rotation.

In addition, most Tier 1 firms and Fortune 1000 public companies believe 

that the pressures faced by the incumbent auditor to retain the client are 

not a significant factor adversely affecting the auditor appropriately dealing 

with financial reporting issues that may materially affect a public 

company’s financial statements. Most Tier 1 firms, and nearly all Fortune 

1000 public companies, and their audit committee chairs believe that the 

Sarbanes-Oxley Act’s requirements concerning auditor independence and 

audit quality, when fully implemented, will sufficiently achieve the intended 

benefits of mandatory audit firm rotation, and therefore, they believe it 

would be premature to impose mandatory audit firm rotation at this time.

Finally, about 50 percent of Tier 1 firms and 62 percent of Fortune 1000 

public companies stated that mandatory audit firm rotation would have no 

15 Hereafter, the presentation of our detailed Tier 1 firm survey results represent estimated 

projections to their population.

16 Hereafter, the presentation of our detailed Fortune 1000 public companies’ and their audit 

committee chairs’ survey results represent estimated projections to their populations.
Page 15 GAO-04-216 Public Accounting Firms

effect on the perception of auditor independence held by the capital 

markets and institutional investors. However, 65 percent of Fortune 1000 

public companies reported that individual investors’ perception of auditor 

independence would be increased, while the Tier 1 firms had mixed views 

on the effect on individual investors’ perceptions. At the same time, most 

Tier 1 firms reported that mandatory audit firm rotation may negatively 

affect audit assignment staffing, causing an increased risk of audit failures, 

and may create some confusion as currently a change in a public company’s 

auditor of record sends a “red flag” signal as to why the change may have 

occurred. In contrast, most Fortune 1000 public companies did not believe 

scheduled changes in the auditor of record would result in a “red flag” 

signal.

Auditor of Record Tenure, 

Independence, and Audit 

Quality

Currently, neither the SEC nor the PCAOB has set any regulatory limits on 

the length of time that a public accounting firm may function as the auditor 

of record for a public company. Based on the responses to our surveys, we 

estimate that about 99 percent of Fortune 1000 public companies and their 

audit committees currently do not have a public accounting firm rotation 

policy, although we estimate that about 4 percent are considering such a 

policy. Unlimited tenure and related pressure on the public accounting firm 

and applicable partner responsible for providing audit services to the 

company to retain the client and the related continuing revenues are 

factors cited by those who support mandatory audit firm rotation. They 

believe that periodically having a new auditor will bring a “fresh look” to 

the public company’s financial reporting and help the auditor appropriately 

deal with financial reporting issues since the auditor’s tenure would be 

limited under mandatory audit firm rotation. Those who oppose 

mandatory audit firm rotation believe that changing auditors increases the 

risk of an audit failure during the initial years as the new auditor acquires 

the knowledge of the public company’s operations, systems, and financial 

reporting practices. 
Page 16 GAO-04-216 Public Accounting Firms

The Conference Board’s Commission on Public Trust and Private 

Enterprise17 in its January 9, 2003, report recommended that audit 

committees should consider rotating audit firms when there is a 

combination of circumstances that could call into question the audit firm’s 

independence from management. The Commission believed that the 

existence of some or all of the following circumstances particularly merit 

consideration of rotation: (1) significant nonaudit services are provided by 

the auditor of record to the company—even if they have been approved by 

the audit committee, (2) one or more former partners or managers of the 

audit firm are employed by the company, or (3) the audit firm has been 

employed by the company for a substantial period of time, such as over 10 

years. 

To initially examine the issues surrounding the length of the auditors’ 

tenure, we asked public companies and public accounting firms to provide 

information on the length of auditor tenure. According to our survey, 

Fortune 1000 public companies’ average auditor tenure is 22 years. Two 

contrasting factors greatly influence this 22-year average—the recent 

increased changes in auditors lowered the average and the long audit 

tenure period associated with approximately 10 percent of Fortune 1000 

public companies raised the average. About 20 percent of the Fortune 1000 

public companies had their current auditor of record for less than 3 years, a 

rate of change in auditors over the last 2 years substantially greater than 

the nearly 3 percent annual change rate historically observed.18 This 

increased rate of auditor change was driven largely by the recent 

dissolution of Arthur Andersen LLP. More than 80 percent of Fortune 1000 

public companies that changed auditors over the last 2 years did so to

17 The Conference Board is a not-for-profit organization that conducts conferences, makes 

forecasts and assesses trends, publishes information and analysis, and brings executives 

together to learn from one another. The Conference Board formed the commission to 

address the circumstances that led to the recent corporate scandals and subsequent decline 

of confidence in U.S. capital markets. The commission included former senior federal 

government officials, such as a former Chairman of the Board of Governors of the Federal 

Reserve System, former Chairman of the SEC, and former Comptroller General; a state 

government official responsible for the state’s retirement system; a former U.S. senator; 

various private sector executives holding senior positions of responsibility; and a college 

professor.

18 R. Doogar (University of Illinois, Urbana-Champaign) and R. Easley and D. Ricchiute 

(University of Notre Dame), “Switching Costs, Audit Firm Market Shares and Merger 

Profitability,” (Nov. 20, 2001), which was discussed in GAO-03-864, cited a level of 2.7 

percent annual client switching of auditors based on prior research the authors performed 

using 1981-1997 Compustat data.
Page 17 GAO-04-216 Public Accounting Firms

replace Andersen.19 Increasing the overall average audit tenure period for 

Fortune 1000 public companies were the approximately 10 percent of 

public companies that had the same auditing firm for more than 50 years 

and have an average tenure period of more than 75 years. Excluding those 

Fortune 1000 public companies that have replaced Andersen in the last 2 

years as well as those companies that had the same auditor of record for 

more than 50 years, the average for the remaining Fortune 1000 public 

companies is 19 years. See figure 1 for the Fortune 1000 public companies’ 

estimated audit firm tenure. 

Figure 1: Estimated Audit Firm Tenure for Fortune 1000 Public Companies

An intended effect of mandatory audit firm rotation is to decrease the 

existing lengthy auditor tenure periods, thus lessening concerns about the 

firm’s desire to retain a client adversely affecting auditor independence. 

19 The Fortune 1000 public companies that hired a new audit firm to replace Andersen over 

the last 2 years reported that Andersen had served as their companies’ auditor of record for 

an average of 26 years.

22

19

22

14

9

4

10

0

5

10

15

20

25

100

1-2 3-10 11-20 21-30 31-40 41-50 50 or

more

Years

Percentage

Source: GAO analysis of survey data.
Page 18 GAO-04-216 Public Accounting Firms

About 97 percent of Fortune 1000 public companies expected that 

mandatory audit firm rotation would lower the number of consecutive 

years that a public accounting firm could serve as their auditor of record. 

The Fortune 1000 public companies were not given a possible limit on the 

number of years that a public accounting firm could serve as their auditor 

of record under mandatory audit firm rotation. Therefore, they reported 

their general belief that mandatory rotation would have the effect of 

decreasing auditor tenure based on their past experiences.

Impact of Auditor 

Knowledge and Experience 

on the Auditor’s Detection 

of Misstatements

Since the new auditor’s knowledge and experience with auditing a public 

company after a change in auditors is a concern, we asked public 

accounting firms and public companies a number of questions about 

factors important to detecting material misstatements of financial 

statements. Tier 1 firms noted that a number of factors affect the auditor’s 

ability to detect financial reporting issues that may indicate material 

misstatements in a public company’s financial statements, including 

education, training, and experience; knowledge of GAAP and GAAS; 

experience with the company’s industry; appropriate audit team staffing; 

effective risk assessment process for determining client acceptance; and 

knowledge of the client’s operations, systems, and financial reporting 

practices.20 Although each of the above factors affects the quality of an 

audit, opponents of mandatory audit firm rotation focus on the increased 

risk of audit failure that may result from the new auditor’s lack of specific 

knowledge of the client’s operations, systems, and financial reporting 

practices. Based on the responses to our survey, we estimated that about 

95 percent of Tier 1 firms would rate such specific knowledge as either of 

very great importance or great importance in the auditor’s ability to detect 

financial reporting issues that may indicate material misstatements in a 

public company’s financial statements.

GAAS require the auditor to obtain a sufficient knowledge of the client’s 

operations, systems, and financial reporting practices to assess audit risk21

and to gather sufficient competent evidential matter. About 79 percent of 

20 Although not specifically listed in our applicable survey question, several Tier 1 firms 

commented that public company management’s integrity, honesty, and cooperation is of 

very great or great importance in the auditor’s ability to detect material financial reporting 

issues.

21 GAAS define audit risk as the risk that an auditor may unknowingly fail to appropriately 

modify his or her opinion on financial statements that are materially misstated.
Page 19 GAO-04-216 Public Accounting Firms

Tier 1 firms and Fortune 1000 public companies believed that the risk of an 

audit failure is higher in the early years of audit tenure as the new firm is 

more likely to not have fully developed and applied an in-depth 

understanding of the public company’s operations and processes affecting 

financial reporting. More than 83 percent of Tier 1 firms and Fortune 1000 

public companies that expressed a view stated that it generally takes 2 to 3 

years or more to become sufficiently familiar with the companies’ 

operations and processes before the additional resources often needed to 

become knowledgeable are no longer needed. Tier 1 firms had mixed 

views about whether mandatory audit firm rotation (e.g., the “fresh look”) 

would either increase, decrease or have no effect on the new auditor’s 

likelihood of detecting financial reporting issues that may materially affect 

the financial statements that the previous auditor may not have detected. 

However, 50 percent of Fortune 1000 public companies reported that 

mandatory audit firm rotation would have no effect on the auditor’s 

likelihood of detecting such financial reporting issues, while other Fortune 

1000 public companies were generally split regarding whether mandatory 

audit firm rotation would either increase or decrease the auditor’s 

likelihood of detecting such financial reporting issues.

As shown in figure 2, Tier 1 firms had mixed views of the value of additional 

audit procedures during the initial years of a new auditor’s tenure, although 

72 percent reported that additional audit procedures would be of at least 

some value in helping to reduce audit risk to an acceptable level. 
Page 20 GAO-04-216 Public Accounting Firms

Figure 2: Tier 1 Firms: Value of Additional Procedures When Firm Has Less 

Knowledge and Experience with a Client

Most Fortune 1000 public companies believed such additional audit 

procedures would decrease audit risk, as shown in figure 3. 

0 5 10 15 20 25

Source: GAO analysis of survey data.

Very great value

Great value 22

Moderate value

22

Some value 25

Little or no value

22

Don’t know 6

3

Value of

additional

procedures

Percentage

100
Page 21 GAO-04-216 Public Accounting Firms

Figure 3: Fortune 1000 Public Companies’ Belief That Additional or Enhanced Audit 

Procedures Would Affect the Risk of Not Detecting Material Misstatements

The Tier 1 firms were also asked about the potential value of having 

enhanced access to key members of the previous audit team and its audit 

documentation to help reduce audit risk. The Tier 1 firms generally saw 

more potential value in having enhanced access to the previous audit team 

and its audit documentation than in performing additional audit procedures 

and verification of the public company’s data during the initial years of the 

auditor’s tenure. Nearly all of the Tier 1 firms believed that access to the 

previous audit team and its audit documentation could be accomplished 

under current GAAS.22 

22 Several Tier 1 firms commented that cooperation of the predecessor public accounting 

firm is a barrier to full access of the firm’s audit documentation and indicated that this is an 

area that the PCAOB may need to address.

7% Likely increase risk 

24% Neither increase or decrease risk 

66% Decrease risk

No basis to evaluate 

3%

Source: GAO analysis of survey data.
Page 22 GAO-04-216 Public Accounting Firms

Pressures Faced by Firms in 

Dealing with Financial 

Reporting Issues

Proponents of mandatory audit firm rotation cite that pressures to retain 

the client can adversely affect the auditor’s decision to appropriately deal 

with financial reporting issues when public company management is not 

supportive of the auditor’s position on what is required by GAAP. They 

believe that mandatory audit firm rotation would serve as an incentive for 

the auditor to take the appropriate action since the auditor would know 

that tenure as auditor of record and the related revenues are for a limited 

term.23

We asked public accounting firms and public companies based on their 

experiences whether the auditor’s length of tenure is a factor in whether 

the auditor appropriately deals with material financial reporting issues and 

whether mandatory audit firm rotation would affect the pressures the firms 

face. About 69 percent of Tier 1 firms and 73 percent of Fortune 1000 

public companies do not believe that the risk of an audit failure increases 

due to the auditors’ long-term relationship with the public companies’ 

management under a long audit tenure and the auditors’ desire to retain the 

clients. About 55 percent of the other Tier 1 firms24 and 65 percent of the 

other Fortune 1000 public companies25 were uncertain whether the risk of 

an audit failure would increase or decrease due to the auditors’ long-term 

tenure.

About 71 percent of Tier 1 firms and 67 percent of Fortune 1000 public 

companies believe that pressure on the engagement partner to retain the 

client is currently small or not a factor in whether the auditor appropriately 

deals with financial reporting issues that may materially affect a public 

company’s financial statements. However, 28 percent of Tier 1 firms and 33 

percent of Fortune 1000 public companies believe such pressures are 

moderate or stronger. About 18 percent of Tier 1 firms and Fortune 1000 

public companies believed that under mandatory audit firm rotation, the 

pressures on the engagement partner would still be a moderate or stronger 

23 Although mandatory audit firm rotation would likely set a limit on the number of 

consecutive years the public accounting firm could serve as the company’s auditor of 

record, it may also provide that the business relationship could be terminated by either 

party during that time.

24 The 95 percent confidence interval surrounding this estimate ranges from 41 percent to 

62 percent.

25 The 95 percent confidence interval surrounding this estimate ranges from 51 percent to 

77 percent.
Page 23 GAO-04-216 Public Accounting Firms

factor in retaining the audit client and in appropriately dealing with 

financial reporting issues. Therefore, based on these views, mandatory 

audit firm rotation would likely somewhat reduce the pressures on the 

engagement partner to retain the client. However, most Tier 1 firms and 

Fortune 1000 public companies generally considered these pressures to be 

small or not a factor in the auditor appropriately dealing with material 

financial reporting issues. 

Tier 1 firms and Fortune 1000 public companies expressed similar views, 

that mandatory audit firm rotation would not significantly change the 

pressures on the engagement partner to retain the client as a factor in 

whether the engagement partner appropriately challenges overly 

aggressive/optimistic financial reporting26 by management. 

As shown in figure 4, overall about 54 percent of Tier 1 firms and 71 percent 

of Fortune 1000 public companies believe mandatory audit firm rotation 

overall would have no effect on the new auditor’s potential for 

appropriately dealing with material financial reporting issues. 

26 GAAP are subject to interpretation by public company management and underlying 

concepts of GAAP may be applied to transactions of a public company that are not 

specifically addressed by GAAP. The auditor may encounter situations in which public 

company management aggressively or optimistically applies the concepts of GAAP to 

achieve a certain result that arguably may not reflect the economic substance of the 

transactions while public company management believes such financial reporting complies 

with GAAP.
Page 24 GAO-04-216 Public Accounting Firms

Figure 4: Views on How Mandatory Audit Firm Rotation Would Affect the Auditor’s 

Potential to Deal with Material Financial Reporting Issues Appropriately

The remaining Tier 1 firms are split between whether mandatory audit firm 

rotation would increase or decrease their potential to appropriately deal 

with material financial reporting issues. However, about 67 percent of the 

remaining Fortune 1000 public companies believe that mandatory audit 

firm rotation would increase the potential for the new auditor to deal 

appropriately with such financial reporting issues.27 In contrast, either with 

or without mandatory audit firm rotation, about 62 percent of Tier 1 firms 

and 63 percent of Fortune 1000 public companies believe the potential of a 

subsequent lawsuit, regulatory action, or both against the public 

accounting firm and its engagement partner is a moderate or stronger 

pressure for them to deal appropriately with financial reporting issues that 

may materially affect a public company’s financial statements. 

27 The 95 percent confidence interval surrounding this estimate ranges from 54 percent to 79 

percent.

26

54

20

N/A

19

71

7

3

Increase

potential

Neither increase

or decrease

potential

Decrease

potential

No basis to

evaluate

Percentage

Tier 1 firms

Fortune 1000 public companies

0 10 20 30 40 50 60 70 80 100

Source: GAO analysis of survey data.

Auditor’s potential
Page 25 GAO-04-216 Public Accounting Firms

How Mandatory Audit Firm 

Rotation May Affect 

Perception of Auditors’ 

Independence

Researchers have also raised questions about how the capital markets’ and 

investors’ current perceptions of auditor independence and audit quality 

would be affected by mandatory audit firm rotation. Under mandatory 

audit firm rotation, about 52 percent of Tier 1 firms and about 62 percent of 

Fortune 1000 public companies believed that the current perception of 

auditor independence held by capital markets and institutional investors 

would not be affected by requiring mandatory audit firm rotation while 34 

percent of Tier 1 firms and about 38 percent of Fortune 1000 public 

companies believed the perception of auditor independence would 

increase. However, about 65 percent of Fortune 1000 public companies 

believed that perception of auditors’ independence held by individual 

investors would more likely increase under mandatory audit firm rotation 

while the Tier 1 firms had mixed views on the effect on individual investors. 

See the Overall Views of Other Knowledgeable Individuals on Mandatory 

Audit Firm Rotation section of the report for the results of our discussions 

with other knowledgeable individuals, including institutional investors, for 

their views on how mandatory audit firm rotation may affect their 

perception of auditor independence.

How Mandatory Audit Firm 

Rotation May Affect Audit 

Assignment Staffing

Our research into the effects of mandatory audit firm rotation identified 

concerns about whether public accounting firms would move their most 

knowledgeable and experienced audit personnel from the current audit to 

other audits as the end of their tenure as auditor of record approached in 

order to attract or retain other clients. In response to our survey questions 

about whether mandatory audit firm rotation would affect assignment of 

audit staff, about 59 percent of Tier 1 firms indicated that they would likely 

move their most knowledgeable and experienced audit staff to other work 

to enhance the firm’s ability to attract or retain other clients and another 28 

percent were undecided. Only about 13 percent of Tier 1 firms stated it was 

unlikely that an accounting firm would move staff to other work. Of the 

Tier 1 firms that stated they would likely move their most knowledgeable 

and experienced staff, 86 percent28 believe that moving these staff would 

increase the risk of an audit failure. About 92 percent of Fortune 1000 

public companies also believed that by moving these audit staff, the risk of 

an audit failure would be increased.

28 The 95 percent confidence interval surrounding this estimate ranges from 77 percent to 90 

percent.
Page 26 GAO-04-216 Public Accounting Firms

How Mandatory Audit Firm 

Rotation May Affect Public 

Accounting Firms’ 

Investment in Audit Tools

Opponents of mandatory audit firm rotation expressed concern that limited 

audit tenure under mandatory rotation could cause public accounting firms 

to not invest in audit tools related to the effectiveness of auditing a specific 

client or industry. About 76 percent of Tier 1 firms stated that their average 

audit tenure would likely decrease under mandatory audit firm rotation, 

and about 97 percent of Fortune 1000 public companies expected the 

length of their auditors’ tenure would decrease compared to their previous 

experience with changing auditors. In response to our survey questions 

about this possibility, about 64 percent of these Tier 1 firms said mandatory 

audit firm rotation would not likely decrease incentives to invest the 

resources needed to understand the client’s operations and financial 

reporting practices in order to devise effective audit procedures and tools, 

while 36 percent said it would. Conversely, about 67 percent of Fortune 

1000 public companies were concerned that mandatory audit firm rotation 

could negatively affect incentives for public accounting firms to invest in 

effective audit procedures and tools. 

How Mandatory Audit Firm 

Rotation May Affect the 

Current “Red Flag” Signal to 

Investors When a Change in 

a Public Company’s Auditor 

of Record Occurs

Currently, when a change in the auditor of record occurs it acts as a “red 

flag” signal to investors to question why the change occurred and if the 

change may have occurred because of reasons related to the presentation 

of the public company’s financial statements, such as differences in views 

of public company management and the auditor of record regarding 

financial reporting issues. Researchers have raised concerns that the “red 

flag” signal may be eliminated by mandatory audit firm rotation, as 

investors may not be able to distinguish a scheduled change from a 

nonscheduled change in a public company’s auditor of record.

Regarding the “red flag” signal, most Tier 1 firms believed that mandatory 

audit firm rotation would not change the current reaction by investors to a 

change in the auditor of record, and therefore a “red flag” signal is likely to 

be perceived by investors for both scheduled and unscheduled changes in 

the public company’s auditor of record. Several Tier 1 firms commented 

that users of financial statements would not be able to readily track 

scheduled rotations and therefore would be confused whether the change 

in auditors was scheduled or unscheduled. In contrast, most Fortune 1000 

public companies believed that scheduled auditor changes under 

mandatory audit firm rotation would likely not produce a “red flag” signal 

and that the “red flag” signal for unscheduled changes in the auditor of 

record would be retained. Fortune 1000 public companies did not provide 

any comments to further explain their beliefs. However, currently, public 
Page 27 GAO-04-216 Public Accounting Firms

companies are required by SEC regulations to report changes in their 

auditor of record to the SEC. Therefore, public companies could use this 

reporting requirement to disclose whether the change in auditor of record 

under mandatory audit firm rotation was scheduled or unscheduled. 

Potential Impact on AuditRelated Costs and Fees

Opponents of mandatory audit firm rotation believe that the more frequent 

change in auditors likely to occur under mandatory audit firm rotation will 

result in the public accounting firms and ultimately public companies 

incurring increased costs for audits of financial statements. These costs 

include

• marketing costs (the costs incurred by public accounting firms related 

to their efforts to acquire or retain financial statement audit clients),

• audit costs (the costs incurred by a public accounting firm to perform an 

audit of a public company’s financial statements),

• audit fee (the amount a public accounting firm charges the public 

company to perform the financial statement audit),

• selection costs (the internal costs incurred by a public company in 

selecting a new public accounting firm as the public company’s auditor 

of record), and

• support costs (the internal costs incurred by a public company in 

supporting the public accounting firm’s efforts to understand the public 

company’s operations, systems, and financial reporting practices). 

About 96 percent of Tier 1 firms stated that their initial year audit costs are 

likely to be more than in subsequent years in order to acquire the necessary 

knowledge during a first year audit of a public company’s operations, 

systems, and financial reporting practices. Nearly all of these Tier 1 firms 

estimated initial year audit costs would be more than 20 percent higher 

than subsequent years’ costs.29 Similar responses were received from 

Fortune 1000 public companies. (See fig. 5.)

29 Several Tier 1 firms commented that mandatory audit firm rotation could also result in 

costs to relocate staff given the unpredictability of where new audit clients would be located 

and increased costs for education and training of staff.
Page 28 GAO-04-216 Public Accounting Firms

Figure 5: Expected Increase in Initial Year Audit Costs over Subsequent Year Audit 

Costs

About 85 percent of Tier 1 firms stated that currently they are more likely 

to absorb their higher initial year audit costs than to pass them on to the 

public companies in the form of higher audit fees because of the firms’ 

interest in retaining the audit client. However, about 87 percent said such 

costs would likely be passed on to the public companies during the more 

limited audit firm tenure period under mandatory rotation. Similarly, about 

77 percent of Fortune 1000 public companies stated that currently when a 

change in the companies’ auditor of record occurs, the additional initial 

year audit costs are likely to be absorbed by the public accounting firms. 

However, about 97 percent of the Fortune 1000 public companies expected 

the higher initial year audit costs would be passed on to them under 

mandatory audit firm rotation. 

20

11

23

24

7

1

14

10

10

19

49

10

2

N/A

Fortune 1000 public companies

Tier 1 firms

0 10 20 30 40 50 100

More than 40 percent

but less than 50 percent

More than 30 percent

but less than 40 percent

More than 20 percent

but less than 30 percent

More than 10 percent

but less than 20 percent

10 percent or less

No basis or experience

More than 50 percent

Percentage

Source: GAO analysis of survey data.

Increase in initial 

year audit costs
Page 29 GAO-04-216 Public Accounting Firms

Comments received from a number of the Tier 1 firms indicated that 

currently initial years’ audit costs are recovered from the public companies 

over the firms’ tenure as auditor of record. However, the firms under 

mandatory audit firm rotation expected not to be able to recover the costs 

within a more limited tenure as auditor of record. Therefore, they would 

pass the costs on to the public companies through higher audit fees. 

Similarly, about 89 percent of Fortune 1000 public companies believed that 

mandatory audit firm rotation would lead to higher audit fees over time. 30

With the likely more frequent opportunities to compete for providing audit 

services to public companies under mandatory audit firm rotation, about 79 

percent of Tier 1 firms expect to incur increased marketing costs 

associated with their efforts to acquire audit clients, and about 79 percent 

of the Tier 1 firms expect to pass these costs on to the public companies 

through higher audit fees.

As shown in figure 6, most of the Tier 1 firms expecting higher marketing 

costs estimated that the cost would add at least more than 1 percent to 

their initial year audit fees, and about 37 percent of these Tier 1 firms31

believed their additional marketing costs would be more than 10 percent of 

their initial year audit fees.

30 Many Fortune 1000 public companies commented that mandatory audit firm rotation 

would lead to higher audit fees as the public accounting firms would want to recoup their 

additional costs within the limited time as auditor of record that would be established under 

mandatory audit firm rotation. Also, they stated there would be no incentive for the public 

accounting firms to absorb the additional costs since mandatory audit firm rotation would 

preclude long-term business relationships as the auditor of record.

31 The 95 percent confidence interval for the estimate of these Tier 1 firms that expect more 

than a 10 percent increase ranges from 29 percent to 45 percent. Also, as shown in figure 6, 

the 95 percent confidence interval for the estimate of Tier 1 firms who have no basis or 

experience to estimate what their increase would be ranges from 15 percent to 27 percent.
Page 30 GAO-04-216 Public Accounting Firms

Figure 6: Tier 1 Firms Expecting Additional Expected Marketing Costs under 

Mandatory Audit Firm Rotation Compared to Initial Year Audit Fees

A number of Tier 1 firms commented that they would have to spend more 

time marketing auditing services, including writing new proposals to 

compete for audit services. About 85 percent of Fortune 1000 public 

companies expected that public accounting firms would likely incur 

additional marketing costs under mandatory audit firm rotation, and about 

92 percent of these Fortune 1000 public companies believed the costs 

would be passed on to them.

In addition to higher audit fees, nearly all Fortune 1000 public companies 

believed they would incur selection costs in hiring a new auditor of record 

under mandatory audit firm rotation. As shown in figure 7, most of those 

Fortune 1000 public companies expected the selection costs to be at least 6 

percent or higher as a percentage of initial year audit fees. 

Less than 1 percent

More than 1 percent

No basis or experience

More than 5 percent

More than 10 percent

19% 37%

30%

12%

2%

Source: GAO analysis of survey data.
Page 31 GAO-04-216 Public Accounting Firms

Figure 7: Fortune 1000 Public Companies’ Expected Selection Costs as a 

Percentage of Initial Year Audit Fees

In addition, nearly all Fortune 1000 public companies expected to incur 

some additional initial year auditor support costs under mandatory audit 

firm rotation. As shown in figure 8, nearly all of those Fortune 1000 public 

companies believed their additional support costs would be 11 percent or 

higher as a percentage of initial year audit fees. 

0 5 10 15 20 25 100

23

1

8

11

14

20

23

Source: GAO analysis of survey data.

20 percent or more

More than 15 percent

but less than 20 percent

More than 10 percent

but less than 15 percent

More than 5 percent

but less than 10 percent

Less than 5 percent

None

No basis to know

Percentage

Likely selection costs
Page 32 GAO-04-216 Public Accounting Firms

Figure 8: Fortune 1000 Public Companies’ Expected Support Costs as a Percentage 

of Initial Year Audit Fees

Tier 1 firms’ views on the likelihood of public companies incurring 

selection costs and additional auditor support costs were similar to the 

views of Fortune 1000 public companies.

To provide some perspective on the possible impact of higher audit-related 

costs (audit fees, company selection, and support cost) on public company 

operating costs, we analyzed financial reports filed with the SEC for a 

selection of large and small public companies for the most recent fiscal 

year available—one of each from 23 broad industry sectors, such as 

agriculture, manufacturing, and information services. Where available, for 

each industry sector, we selected a public company with annual revenues 

of more than $5 billion and a public company with annual revenues of less 

than $1 billion. The audit fees reported by the larger public companies we 

selected ranged from .007 percent to .11 percent of total operating costs

0 5 10 15 20 25 30

28

8

8

5

11

17

23

Source: GAO analysis of survey data.

More than 40 percent

but less than 50 percent

More than 30 percent

but less than 40 percent

More than 20 percent

but less than 30 percent

50 percent or more

More than 10 percent

but less than 20 percent

Less than 10 percent

No basis to estimate

Percentage

Support costs

100
Page 33 GAO-04-216 Public Accounting Firms

and averaged .04 percent. The audit fees reported by the smaller public 

companies we selected ranged from 0.017 percent to 3.0 percent and 

averaged 0.08 percent.32 

Utilizing the predominant responses33 from Tier 1 firms, we estimate the 

additional first year audit costs following a change in auditor to likely range 

from 21 percent to 39 percent more than annual costs of recurring audits of 

the same client. In addition, we estimate the additional firm marketing 

costs under mandatory audit firm rotation to likely range from 6 percent to 

11 percent of the firm’s initial year audit fees. Based on the predominant 

responses from Fortune 1000 public companies, we also estimate the 

additional public company selection costs to range from 1 percent to 14 

percent of the new auditor’s initial year audit fees and possible additional 

public company support costs to range from 11 percent to 39 percent of the 

new auditor’s initial year audit fees. Utilizing these ranges, we estimate that 

following a change in auditor under mandatory audit firm rotation, the 

possible additional first year audit-related costs could range from 43 

percent to 128 percent higher than the likely recurring audit costs had there 

been no change in auditor. We also calculated a weighted average 

percentage for each additional cost category using all responses from Tier 

1 firms and Fortune 1000 public companies (as opposed to the predominant 

responses only). Using the resulting weighted averages for all responses, 

we calculated the potential additional first year audit-related costs to be 

102 percent higher than the likely recurring audit costs had there been no 

change in auditor. This illustration is intended only to provide insights into 

how Tier 1 firms and Fortune 1000 public companies reported that 

mandatory audit firm rotation could affect the initial year audit costs and is 

not intended to be representative. 

Competition-Related 

Issues

Although mandatory audit firm rotation is generally considered by its 

proponents as a means of enhancing auditor independence and audit 

quality, mandatory rotation may also provide increased opportunities for 

32 The public company annual reports for the most recent fiscal year available (either 2002 

or 2003) did not disclose any auditor selection or support costs that the companies may 

have incurred.

33 We established the various ranges used for this analysis based on our analysis of the 

responses from Tier 1 firms and Fortune 1000 public companies. In establishing the ranges, 

we used survey responses consisting of the predominant responses (at least 68 percent) of 

those received.
Page 34 GAO-04-216 Public Accounting Firms

some public accounting firms to compete to provide audit services to 

public companies. About 52 percent of Tier 1 firms believed that 

mandatory audit firm rotation would increase the opportunity to compete 

for public company audits and 30 percent were uncertain whether 

opportunities to compete to provide audit services would increase or 

decrease. 

However, when asked how mandatory audit firm rotation would likely 

affect the number of firms actually willing and able to compete for public 

company audits, about 54 percent of Tier 1 firms said mandatory rotation 

would likely decrease the number of firms competing for audits of public 

companies, 14 percent expected an increase in the number of firms, and 22 

percent expected no effect on the number of firms competing. 

Although nearly all Tier 1 firms planned to register with the PCAOB to 

provide audit services to public companies,34 about 24 percent of Tier 1 

firms that currently provide audit services were uncertain whether they 

would continue to provide audit services to public companies if mandatory 

audit firm rotation were required.35 Firms in Tier 2 that responded to our 

survey showed more uncertainty regarding whether to register with the 

PCAOB, with about two-thirds planning to continue to provide audit 

services to public companies and most of the remaining respondents 

uncertain if they would continue to provide audit services to public 

companies.36 However, if mandatory audit firm rotation were required, 55 

percent of the Tier 2 firms that responded to our survey that currently 

provide audit services to public companies were uncertain whether they 

would continue to provide the audit services to public companies, and 

another 12 percent said they would discontinue providing audit services to 

public companies.37

34 As of October 22, 2003, 89 percent of those Tier 1 firms that responded to our survey have 

registered with the PCAOB or have applications pending.

35 In total, these Tier 1 firms that were uncertain whether they would continue to provide 

audit services to public companies if mandatory audit firm rotation were required audit 586 

public companies.

36 As of October 22, 2003, 80 percent of these Tier 2 firms that responded to our survey have 

registered with the PCAOB or have applications pending. 

37 In total, these Tier 2 firms that would discontinue providing audit services to public 

companies if mandatory audit firm rotation were required audit 154 public companies.
Page 35 GAO-04-216 Public Accounting Firms

The view of many Tier 1 firms that mandatory audit firm rotation may lead 

to fewer firms willing and able to compete for public company audits, 

which would lead to higher audit fees, should also be considered along 

with the results of our study of consolidation of the Big 8 firms into the 

current Big 4 firms.38 In that respect, we previously reported that the Big 4 

audit over 78 percent of all U.S. public companies and 99 percent of public 

company annual sales. However, we found no empirical evidence of 

impaired competition. Further, we previously reported that smaller public 

accounting firms were unable to successfully compete for the audits of 

large national and multinational public companies because of factors such 

as lack of capacity and capital limitations.39

About 83 percent of Tier 1 firms and 66 percent of Fortune 1000 public 

companies stated that under mandatory audit firm rotation, the market 

share of public company audits would either become more concentrated in 

a small number of larger public accounting firms or the already highly 

concentrated market share would remain about the same. About 44 

percent of Tier 1 firms believed that incentives to create or maintain large 

firms would be increased while 32 percent believed mandatory audit firm 

rotation would have no effect on incentives to create or maintain large 

firms.

About 52 percent of Fortune 1000 public companies were at least 

somewhat concerned that the dissolution of Arthur Andersen LLP, resulting 

now in the Big 4 public accounting firms, would significantly limit the 

options their companies have in selecting a capable auditor of record. 

Under mandatory audit firm rotation, the number of Fortune 1000 public 

companies expressing such concern increased to 79 percent.

About 48 percent of Tier 1 firms believed mandatory audit firm rotation 

would decrease the number of firms willing and able to compete for audits 

of public companies in specialized industries, while 29 percent of Tier 1 

firms believed mandatory audit firm rotation would have no effect. As 

noted in our July 2003 report, we found that in certain specialized 

industries, the number of firms with expertise in auditing those industries 

38 GAO-03-864.

39 A number of Tier 1 firms responding to our survey on mandatory audit firm rotation 

commented that the increased costs likely to be incurred by the firms under mandatory 

audit firm rotation could result in many smaller firms being unable to compete or absorb the 

increased costs, resulting in smaller firms leaving the market for providing audit services.
Page 36 GAO-04-216 Public Accounting Firms

can limit the number of choices such public companies have to two public 

accounting firms. Contributing to this situation is that many public 

companies will use only Big 4 firms for audit services. Also, public 

companies may have fewer choices in the future as auditor independence 

rules under the Sarbanes-Oxley Act prohibiting the auditor of record from 

also providing certain nonaudit services could further reduce the number 

of eligible auditors. In that respect, mandatory audit firm rotation would 

further affect the number of eligible auditors. For example, if a public 

company in a specialized industry has only three or four choices for its 

auditor of record, the current auditor of record is not eligible to repeat as 

auditor of record under mandatory audit firm rotation, and another firm is 

not eligible because it provided prohibited nonaudit services that affect 

auditor independence to the public company, then the number of eligible 

firms would be reduced to one or two firms.

About 35 percent of Fortune 1000 public companies were at least 

somewhat concerned that the Sarbanes-Oxley Act auditor independence 

requirements would significantly limit their options in selecting a capable 

auditor of record. However, 53 percent of Fortune 1000 public companies 

expressed such concern if mandatory audit firm rotation were required. 

The Sarbanes-Oxley Act requires the audit committee to hire, compensate, 

and oversee the public accounting firm serving as auditor of record for the 

public company. About 92 percent of the Fortune 1000 audit committee 

chairs stated that their public companies currently use Big 4 firms as 

auditor of record, and 94 percent of those that do stated that they would 

not realistically consider using non-Big 4 firms as the public companies’ 

auditor of record. Table 1 provides reasons given by the audit committee 

chairs for only using Big 4 firms and the importance of those reasons to 

them. 
Page 37 GAO-04-216 Public Accounting Firms

Table 1: Audit Committee Chairs’ Reasons for Limiting Consideration to Only Big 4 Firms 

Source: GAO analysis of survey data.

Although the Sarbanes-Oxley Act now makes the audit committee 

responsible for hiring the public company’s auditor of record, 96 percent of 

Fortune 1000 public companies currently using Big 4 firms also stated that 

they would not realistically consider using non-Big 4 firms as the 

companies’ auditor of record. They generally gave the same reasons as the 

audit committee chairs. 

Overall Views on 

Mandatory Audit Firm 

Rotation

In our surveys, we asked public accounting firms, public companies, and 

their audit committee chairs to provide their overall views on the potential 

costs and benefits that may result under mandatory audit firm rotation. 

About 85 percent of Tier 1 firms, 92 percent of Fortune 1000 public 

companies, and 89 percent of Fortune 1000 audit committee chairs 

believed that costs are likely to exceed benefits.

Our surveys also requested views whether the Sarbanes-Oxley Act auditor 

independence and related audit quality requirements could also achieve the 

intended benefits of mandatory audit firm rotation. The act, as 

implemented by SEC rules, requires the mandatory rotation of both lead 

and reviewing audit engagement partners after 5 years and after 7 years for 

other partners with significant involvement in the audit engagement. Other 

related provisions of the act concerning auditor independence and audit 

quality include prohibiting the auditor of record from also providing certain 

nonaudit services, requiring audit committee preapproval of audit and 

Numbers in percentages

Reasons for limiting consideration to only Big 4 

firms

Very great 

importance

Great 

importance

Moderate

importance

Some 

importance

Little or no 

importance

Don’t 

know

Expectations of the capital markets 48 34 14 1 3 0

Public company geographic/global operations 53 27 10 4 6 0

Public company operations require specialized 

industry skills/knowledge 39 36 18 6 1 0

Public company contractual obligations (e.g. with 

banks or lenders) 15 28 25 5 20 7

Requirement of the public company’s board of 

directors 23 35 19 7 13 3

Sufficiency of audit firm resources 68 26 4 2 0 0

Audit firm’s name and reputation 35 41 18 4 2 0
Page 38 GAO-04-216 Public Accounting Firms

nonaudit services not otherwise prohibited and related public disclosures, 

establishing certain auditor reporting requirements to the audit committee, 

requiring time restrictions before certain auditors could be hired by the 

client as employees, expanding audit committee responsibilities, and 

establishing the PCAOB as an independent nongovernmental entity 

overseeing registered public accounting firms in the audit of public 

companies.

About 66 percent of Tier 1 firms believe the audit partner rotation 

requirements sufficiently achieve the intended benefits of a “fresh look” of 

mandatory audit firm rotation. Another 27 percent of the Tier 1 firms 

believe that the audit partner rotation requirements may not be as effective 

as mandatory audit firm rotation in achieving the intended benefits of a 

“fresh look,” but is a better choice given the higher cost of mandatory audit 

firm rotation. Fortune 1000 public companies and audit committee chairs 

responding to our survey expressed similar views.

We asked those Tier 1 firms and Fortune 1000 public companies and their 

audit committee chairs who did not believe that the partner rotation 

requirement by itself sufficiently achieved the intended benefits of 

mandatory audit firm rotation to consider the auditor independence, audit 

quality, and partner rotation requirements of the Sarbanes-Oxley Act as 

implemented by SEC rules and their views on whether these requirements 

in total would likely achieve the intended benefits of mandatory audit firm 

rotation when fully implemented. About 25 percent40 of these Tier 1 firms 

believed these requirements of the Sarbanes-Oxley Act, when fully 

implemented, would sufficiently achieve the intended benefits of 

mandatory audit firm rotation, while 63 percent41 believed these 

requirements would only somewhat or minimally achieve the intended 

benefits of mandatory audit firm rotation when fully implemented. 

Conversely, 76 percent42 of Fortune 1000 public companies and 72 percent43

40 The 95 percent confidence interval surrounding this estimate ranges from 17 percent to 39 

percent.

41 The 95 percent confidence interval surrounding this estimate ranges from 48 percent to 72 

percent.

42 The 95 percent confidence interval surrounding this estimate ranges from 62 percent to 86 

percent.

43 The 95 percent confidence interval surrounding this estimate ranges from 58 percent to 84 

percent.
Page 39 GAO-04-216 Public Accounting Firms

of their audit committee chairs believed these requirements would 

sufficiently achieve the intended benefits of mandatory audit firm rotation. 

Combining the responses to the above two questions for those who 

believed either the partner rotation requirements or the partner rotation 

requirements coupled with the other Sarbanes-Oxley Act auditor 

independence and audit quality requirements would sufficiently achieve 

the benefits of mandatory audit firm rotation shows that about 75 percent 

of the Tier 1 firms, 95 percent of Fortune 1000 public companies, and about 

92 percent of the audit committee chairs believe these requirements, when 

fully implemented, would sufficiently achieve the benefits of mandatory 

audit firm rotation.

Most Tier 1 firms and Fortune 1000 public companies and their audit 

committee chairs believe the Sarbanes-Oxley Act auditor independence 

and audit quality requirements, when fully implemented, would sufficiently 

achieve the benefits of mandatory audit firm rotation, and most of these 

groups when asked their overall opinion on mandatory audit firm rotation 

did not support mandatory rotation.44 A minority within these groups 

supports the concept of mandatory audit firm rotation, but believes more 

time is needed to evaluate the effectiveness of the various Sarbanes-Oxley 

Act requirements for enhancing auditor independence and audit quality. 

(See fig. 9.)

44 Comments from a number of the Tier 1 firms primarily reiterated their previously stated 

views regarding the costs and benefits of mandatory audit firm rotation and that the SEC’s 

recent audit partner rotation requirements better balance the need for a “fresh look” without 

eliminating the auditor of record’s institutional knowledge of the client. They also reiterated 

that the Sarbanes-Oxley Act should be given time to work and rebuild investors’ confidence. 

Similar comments were received from many of the Fortune 1000 public companies’ chief 

financial officers and their audit committee chairs who also stressed the additional costs of 

mandatory audit firm rotation.
Page 40 GAO-04-216 Public Accounting Firms

Figure 9: Support for Mandatory Audit Firm Rotation

Overall Views of Other 

Knowledgeable 

Individuals on 

Mandatory Audit Firm 

Rotation

As part of our review, we spoke to a number of knowledgeable individuals 

to obtain their views on mandatory audit firm rotation to provide additional 

perspective on issues addressed in the survey. These individuals had 

experience in a variety of fields, such as institutional investment; regulation 

of the stock markets, the banking industry, and the accounting profession; 

and consumer advocacy. Generally, the views expressed by these 

knowledgeable individuals were consistent with the overall views 

expressed by survey respondents.45 Most did not favor implementing a 

requirement for mandatory audit firm rotation at this time because they 

7

17

76

0

4

8

88

0 2

7

90

1

0

10

20

30

40

50

60

70

80

90

100

Supports Supports concept 

but more time is

needed with

Sarbanes-Oxley 

requirements

Does not

support 

Other

Percentage

Tier 1 firms

Fortune 1000 public companies

Fortune 1000 audit committees

Source: GAO analysis of survey data.

Support for mandatory audit firm rotation

45 SEC and PCAOB officials informed us that they have not taken a position on the merits of 

mandatory audit firm rotation.
Page 41 GAO-04-216 Public Accounting Firms

believe the costs of implementing such a requirement outweigh the benefits 

and greater experience with implementing the requirements of the 

Sarbanes-Oxley Act should be gained prior to adding new requirements.

Many individuals acknowledged that conceptually, audit firm rotation 

could provide certain benefits in the areas of auditor independence and 

audit quality. For example, audit firm rotation may increase the perception 

of auditor independence because long-term relationships between the 

auditor of record and the client that could undermine independence would 

not likely develop under the limited term as auditor of record. Some 

individuals also believe that under mandatory audit firm rotation, the 

auditor might be less likely to succumb to management pressure to accept 

questionable accounting practices because the incentive to keep the client 

is gone and another audit firm would be looking at the firm’s work in the 

future. Some also believed that audit quality may also be increased through 

a change in auditors because a new auditor of record would provide a 

"fresh look" at an entity’s financial reporting practices and accounting 

policies. In addition, some individuals noted that mandatory audit firm 

rotation might cause a company to reexamine its audit needs and seek 

more knowledgeable and experienced audit firm personnel when 

negotiating for a new auditor of record.

The individuals we spoke to, however, acknowledged a number of practical 

concerns related to mandatory audit firm rotation, one of the most 

important being the limited number of audit firms available from which to 

choose. For example, some companies, especially those with 

geographically diverse operations or those operating in certain industries, 

may be somewhat limited in the choice of auditing firms capable of 

performing the audit. Not all audit firms have offices or staff located in all 

the geographic areas, whether domestically or internationally, where the 

clients conduct their operations, nor do all audit firms have personnel with 

certain industry knowledge to be able to perform audits of clients that 

operate in specific environments.

Similar to the views of Fortune 1000 public companies and audit committee 

chairs, individuals we spoke to noted that large companies are often 

limited to choices among the Big 4 firms. In some cases, the choices are 

further restricted because the accounting profession has become 

segmented by industry, and a lack of industry-specific knowledge may 

preclude some firms from performing the audits. For a company that is 

limited to use of Big 4 firms, it was viewed that selection may also be 

restricted because an audit firm providing certain nonaudit services or 
Page 42 GAO-04-216 Public Accounting Firms

serving as a company’s internal auditor is prohibited by independence rules 

from also serving as that company’s auditor of record. In some cases, a 

company may also be limited in its choice of firms if an audit firm audits 

one of the company’s major competitors and the public company decides 

not to use that firm as its auditor of record. 

With regard to the use of a Big 4 firm, some individuals believe that 

although a new auditor provides a "fresh look" at an audit engagement, the 

Big 4 audit firms have somewhat similar cultures and methodologies for 

performing audits, and as a result, the benefit of a "fresh look" is more 

limited today than it was in the past when the firms had different cultures 

and employed a greater variety of methodologies.

Many individuals we spoke with also noted that when a change in auditor 

of record occurs, a learning curve, which can last a year or more, exists 

while the new auditor becomes familiar with the client’s operations, thus 

increasing the audit risk associated with the engagement. Although a new 

auditor provides a "fresh look" for the audit, concern was raised that a new 

auditor may challenge the previous auditor’s judgments in an overly 

aggressive manner because the new auditor is not familiar with the client’s 

operations or accounting policies, and this poses a problem for the public 

company because the previous auditor is not present to explain the 

rationale for those judgments. It was viewed that in some cases, these are 

matters of professional judgment rather than actual errors and that such a 

situation could result in increased tension between the client and new 

auditor of record.

Some individuals we spoke with expressed concern that if mandatory audit 

firm rotation were implemented, the audit firm may rotate its most 

qualified staff off the engagement during the later years of audit tenure 

because the audit firm might focus its resources on obtaining or providing 

services to new clients. These individuals believe that such a practice 

would increase audit risk, as did most Tier 1 firms and Fortune 1000 public 

companies. Some individuals also expressed concern that toward the end 

of audit tenure, an audit firm might shift its attention to marketing nonaudit 

services the firm could provide when it was no longer the auditor of record, 

which may be counter to the intended benefits of mandatory audit firm 

rotation.

Individuals we spoke with also noted other implementation issues with 

mandatory audit firm rotation. For example, they viewed mandatory audit 

firm rotation as increasing costs to a company, not only in terms of higher 
Page 43 GAO-04-216 Public Accounting Firms

audit fees but also in additional selection and support costs. In particular, 

many individuals we spoke with, as did most Tier 1 firms and Fortune 1000 

public companies, believed that when a company rotates auditors, a certain 

amount of disruption occurs and the company spends a significant amount 

of resources—both financial and human—educating the new auditor about 

company operations and accounting matters. Individuals we spoke with 

expressed concern not only that these additional audit, selection, and 

support costs are ultimately passed on to shareholders but also that audit 

committees may lose control of selecting the best auditors to provide the 

best quality to shareholders since the incumbent firm would not be eligible 

to compete to provide audit services for some period of time.

Some individuals we spoke with noted that they have already observed a 

heightened sense of corporate responsibility and better corporate 

governance as a result of a change in behavior brought about by the large 

corporate failures in recent years. Overall, the majority of knowledgeable 

individuals we spoke with believe that a requirement for mandatory audit 

firm rotation should not be implemented at this time.46 However, some 

individuals suggested that regulators could require a change in the auditor 

of record as an enforcement action if conditions warrant such a measure. 

Most individuals we spoke with believe that the cost of requiring 

mandatory audit firm rotation would exceed the benefits because of the 

various practical concerns noted. Rather, these individuals believe that 

greater experience with the existing provisions of the Sarbanes-Oxley Act 

should be gained and the results assessed before the need for the 

mandatory audit firm rotation is considered. Many individuals we spoke 

with believe that individual Sarbanes-Oxley Act provisions, such as audit 

firm partner rotation and the increased responsibilities of the audit 

committee, are not a substitute for mandatory audit firm rotation, but taken 

collectively, they could accomplish many of the same intended benefits of 

mandatory audit firm rotation to improve auditor independence and audit 

quality. For example, some individuals believe that the existing SarbanesOxley Act provisions related to audit committees have already resulted in 

more time spent on audit committee activities and greater contact and 

frequency of meetings with auditors. These individuals commented that 

audit committees now ask more questions of auditors because of a 

46 Individuals we spoke with that generally supported mandatory audit firm rotation 

included representatives of entities that currently have mandatory audit firm rotation 

policies, a consumer advocacy group, two individuals associated with oversight of the 

accounting profession, an individual knowledgeable in the regulation of public companies, 

and an expert in corporate governance.
Page 44 GAO-04-216 Public Accounting Firms

heightened sense of accountability for the performance, accuracy, 

reliability, and integrity of everything the independent auditors are doing. 

Survey Groups Views 

on Implementing 

Mandatory Audit Firm 

Rotation if Required 

and Other Alternatives 

for Enhancing Audit 

Quality

If mandatory audit firm rotation were required a number of implementing 

factors affecting the structure of the requirement would need to be decided 

by policy makers (e.g., the Congress and regulators). The following 

provides the views of Tier 1 firms, Fortune 1000 public companies, and 

their audit committee chairs on certain implementing factors, regardless of 

whether they supported mandatory audit firm rotation. 

• Most believed that the auditor of record’s tenure should be limited to 

either 5 to 7 years or 8 to 10 years.

• Nearly all believed that when the incumbent auditor of record is 

replaced, the public accounting firm should not be permitted to compete 

for audit services for either 3 or 4 years or 5 to 7 years.

• Nearly all believed that the audit committee should be permitted to 

terminate the business relationship with the auditor of record at any 

time if it is dissatisfied with the firm’s performance. Likewise, most 

believed that the public accounting firm should be able to terminate its 

relationship with the audit committee/public company at any time if it is 

dissatisfied with the working relationship.

• Nearly all believed that implementation of mandatory audit firm rotation 

should be staggered on a reasonable basis to avoid a significant number 

of public companies changing auditors simultaneously.

• Most Tier 1 firms believed that mandatory audit firm rotation should not 

be applied uniformly to all public companies regardless of their nature 

or size. In contrast, most Fortune 1000 public companies and their audit 

committee chairs believed mandatory audit firm rotation should be 

applied to all public companies regardless of nature or size. However, 

most other domestic and mutual fund companies that responded to our 

survey believed mandatory audit firm rotation should not be applied 

uniformly, and their audit committee chairs who responded to our 

survey were split on the subject.

• The Tier 1 firms and Fortune 1000 audit committee chairs who believed 

that mandatory audit firm rotation should not be applied uniformly 

more frequently selected the larger public companies rather than the 
Page 45 GAO-04-216 Public Accounting Firms

smaller public companies to be subject to mandatory audit firm rotation. 

However, Fortune 1000 public companies were divided on their 

selection of sizes of public companies that should be subject to 

mandatory audit firm rotation.

See appendix II for additional details of the responses.

Our research of studies, other documents, and survey development 

activities concerning issues related to mandatory audit firm rotation 

identified the following other practices for potentially enhancing auditor 

independence and audit quality:

• the audit committee periodically holding an open competition for 

providing audit services,

• requiring audit managers to periodically rotate off the engagement for 

providing audit services to the public company,

• the audit committee periodically obtaining the services of a public 

accounting firm to assist it in overseeing the financial statement audit or 

to conduct a forensic audit in areas of the public company’s financial 

statement process that present a risk of fraudulent financial reporting, 

and

• the audit committee hiring the auditor of record on a noncancelable 

multiyear basis in which only the public accounting firm could 

terminate the business relationship for cause during the contract period.

Although many Tier 1 firms, Fortune 1000 public companies, and their audit 

committee chairs saw some benefit in each of the alternative practices, in 

general, they most frequently reported that the alternative practices would 

have limited or little benefit. The most notable exception involved the 

practice in which an audit committee would hire an auditor of record on a 

noncancelable multiyear basis, for which most Fortune 1000 public 

companies and their audit committee chairs reported that the practice 

would have no benefit. (See table 5 in app. III.) 

Regarding practices other than mandatory audit firm rotation that may 

have potential value to enhance auditor independence and audit quality, the 

Sarbanes-Oxley Act provides the PCAOB with the authority to set auditing 

and related attestation, ethics, independence, and quality control standards 

for registered public accounting firms and for conducting inspections to 
Page 46 GAO-04-216 Public Accounting Firms

determine compliance of each registered public accounting firm with the 

rules of the PCAOB, the SEC, or professional standards in connection with 

the performance of audits, the issuance of audit reports, and related 

matters involving public companies. In that respect, the PCAOB’s 

inspection program for registered public accounting firms could also 

provide the PCAOB with the opportunity to provide a “fresh look” at the 

auditor of record’s performance regarding auditor independence and audit 

quality. For example, the inspections could include factors potentially 

affecting auditor independence, such as length of the auditor’s tenure, 

partners or managers of the audit firm who recently left the firm and are 

now employed by the public company in financial reporting roles, and 

nonaudit services provided by the auditor of record, as suggested by the 

Conference Board Commission on Public Trust and Private Enterprise in 

its January 9, 2003, report. Also, the inspections could consider the 

auditor’s work in high-risk areas of the public company’s operations and 

related financial reporting. Further, the inspections can serve to provide 

some degree of transparency of their overall results and enforcement of 

PCAOB and SEC requirements that may be useful for audit committees to 

consider. 

Auditor Experience in 

Restatements of annual 

Financial Statements 

Filed with the SEC for 

2001 and 2002

With the dissolution of Arthur Andersen LLP in 2002, Tier 1 firms reported 

replacing Anderson, as auditor of record, for more than 1,200 public 

company clients since December 31, 2001. Such volume of change in 

auditors provided an unprecedented opportunity to gain some actual 

experience with the potential value of the “fresh look” provided by a new 

auditor. Since many of these public companies had to replace Andersen as 

their auditor of record during 2002, the number of changes in their auditor 

of record effectively represented a partial form of mandatory audit firm 

rotation. We identified all annual restatements of financial statements filed 

on a Form 10-KA and any annual restatements included in an annual Form 

10K filing with the SEC by Fortune 1000 public companies for 2001 and 

2002 through August 31, 2003, and focused on which restatements were 

attributable to errors or fraud where the previous financial statements did 

not comply with GAAP and identified whether there was a change in the 

auditor of record.

We found that 28, or 2.9 percent, of the 960 Fortune 1000 public companies 

changed their auditor of record during 2001, and 204, or 21.3 percent, of the 

companies changed their auditor during 2002. The significant increase 

from 2001 through 2002 was primarily due to the dissolution of Andersen. 

Our analysis showed that the Fortune 1000 public companies filed 43 
Page 47 GAO-04-216 Public Accounting Firms

restatements during those 2 years that were due to errors or fraud. The 

financial statements affected ranged from years 1997 to 2002. The 

misstatement rates of these public companies’ previously issued 

statements of net income ranged from a 6.7 percent overstatement of net 

income for 2000 to a 37.0 percent understatement of net loss for 2001.

The restatement rates due to errors or fraud among the 43 Fortune 1000 

public companies that changed their auditor of record were 10.7 percent in 

2001 and 3.9 percent in 2002 compared to restatement rates of 2.5 percent 

in 2001 and 1.2 percent in 2002 for companies that did not change auditors. 

Although the data indicate that the overall restatement rate is 

approximately 4.5 times higher for 2001 and 3.25 times higher for 2002 for 

the companies that changed their auditor of record as compared to those 

companies that did not change auditors, caution should be taken as further 

analysis would be needed to determine whether the restatements are 

associated with the “fresh look” attributed to mandatory audit firm 

rotation. In that respect, for the majority of the restatements, the public 

information filed with the SEC and included in the SEC’s Electronic Data 

Gathering, Analysis, and Retrieval (EDGAR) system did not provide 

sufficient information to determine whether company management, the 

auditor of record, or regulators identified the error or fraud, and in those 

cases in which there was a change in the auditor of record, whether the 

predecessor auditor or the successor auditor identified the problem and 

whether it was identified before or after the change in auditor of record. 

Also, the recent corporate financial reporting failures have greatly 

increased the pressures on company management and their auditors 

regarding honest, fair, and complete financial reporting. See appendix IV 

for additional details of our analysis.

Regarding further analysis to determine whether restatements are 

associated with the “fresh look,” we believe such additional future research 

could potentially add value to better predict the benefits of mandatory 

audit firm rotation and the future need for mandatory audit firm rotation. 

See the observations section of this report for our views on mandatory 

audit firm rotation considering the Sarbanes-Oxley Act’s requirements for 

enhancing auditor independence and audit quality and other factors to 

consider in evaluating the need for mandatory audit firm rotation. 
Page 48 GAO-04-216 Public Accounting Firms

Experience of Foreign 

Countries with 

Mandatory Audit Firm 

Rotation

To obtain other countries’ current or previous experience with or 

consideration of mandatory audit firm rotation, we surveyed the securities 

regulators of the Group of Seven Industrialized Nations (G-7), which 

included the United Kingdom, Germany, France, Japan, Canada, and Italy. 

In addition to the G-7 countries’ securities regulators, we also surveyed the 

following members of the International Organization of Securities 

Commissions (IOSCO)47: Australia, Austria, Belgium, Brazil, China, Hong 

Kong, Luxembourg, Mexico, the Netherlands, Singapore, Spain, Sweden, 

and Switzerland.48 The IOSCO members represent these foreign countries’ 

organizations with duties and responsibilities which are similar to the SEC 

in the United States. We received responses from 11 of the 19 countries’ 

securities regulators surveyed.

Italy and Brazil reported having mandatory audit firm rotation for public 

companies, and Singapore reported the requirement for banks that are 

incorporated in Singapore. Austria also reported that beginning in 2004, 

mandatory audit firm rotation will be required for the auditor of record of 

public companies. Spain and Canada reported that they previously had 

mandatory audit firm rotation requirements. Generally, reasons reported 

for requiring mandatory audit firm rotation related to auditor 

independence, audit quality, or increased competition for providing audit 

services. Reasons for abandoning the requirements for mandatory audit 

firm rotation related to its lack of cost-effectiveness, cost, and having 

achieved the objective of increased competition for audit services. Many of 

the survey respondents also reported either requiring or considering audit 

partner rotation requirements that are similar to the requirements of the 

Sarbanes-Oxley Act. See appendix V for additional information on the 

survey respondents’ experiences and consideration of mandatory audit 

firm rotation and audit partner rotation.

47 IOSCO is an international association of securities regulators that was created in 1983 to 

promote high standards of regulation in order to maintain just, efficient, and sound markets, 

promote the development of domestic markets, establish standards and an effective 

surveillance of international securities transactions, and promote the integrity of the 

markets by a rigorous application of the standards and by effective enforcement against 

offenses.

48 Based on our review of literature concerning mandatory audit firm rotation, we found that 

Saudi Arabia was identified as presently requiring mandatory audit firm rotation of public 

companies. While Saudi Arabia is not an IOSCO member, we attempted to administer our 

survey to the Saudi Arabian Monetary Authority, Saudi Arabia’s financial supervisory 

authority, but did not receive a response.
Page 49 GAO-04-216 Public Accounting Firms

GAO Observations The Sarbanes-Oxley Act contains significant reforms intended to enhance 

auditor independence and audit quality, which are viewed by the groups of 

stakeholders we surveyed or held discussions with as likely to sufficiently 

achieve the same intended benefits as mandatory audit firm rotation when 

fully implemented. In that respect, the SEC’s regulations to implement the 

auditor independence and audit quality requirements of the act have only 

recently been issued, and the PCAOB is in the process of implementing its 

inspection program. Therefore, we believe it will take at least several years 

to gain some experience with the effectiveness of the act’s requirements 

concerning auditor independence and audit quality.

We believe that it is critical for both the SEC and the PCAOB, through its 

oversight and enforcement programs, to formally monitor the effectiveness 

of the regulations and programs intended to implement the Sarbanes-Oxley 

Act. This information will be valuable in considering whether changes, 

including mandatory audit firm rotation, may be needed to further protect 

the public interest. We noted that survey responses from Tier 1 firms show 

that the potential for lawsuits or regulatory action is a major incentive for 

the firms to appropriately deal with public company management in 

resolving financial reporting issues. We believe that the SEC’s and 

PCAOB’s rigorous enforcement of regulations and other requirements will 

be critical to the effectiveness of the act’s requirements.

It is clear that the likely additional costs associated with mandatory 

rotation have influenced the views of Tier 1 firms and Fortune 1000 public 

companies and their audit committee chairs to not support mandatory 

rotation. However, we believe that these additional costs need to be 

balanced with the need to protect the public interest, especially 

considering the recent significant accountability breakdowns and their 

impact on investors and other interested parties. Although expecting to 

have zero financial reporting/audit failures is not a realistic expectation, 

Enron, WorldCom, and others have recently demonstrated that a single 

financial reporting/audit failure of a major public company can have 

significant consequences to shareholders and other interested parties. We 

believe it is fairly certain that mandatory audit firm rotation would result in 

selection costs and additional support costs for public companies. Also, 

most Tier 1 firms and Fortune 1000 public companies believe that 

mandatory audit firm rotation would also result in higher audit fees, 

primarily due to higher initial years’ audit costs.
Page 50 GAO-04-216 Public Accounting Firms

If public accounting firms under mandatory audit firm rotation have (1) a 

shorter tenure as auditor of record to recover higher initial year audit costs 

and (2) fewer opportunities to also sell nonaudit services due to the 

Sarbanes-Oxley Act requirements concerning prohibited nonaudit services, 

then we believe it is reasonable to assume, as public accounting firms and 

public companies have done, that the higher initial year audit costs 

associated with a new auditor are likely to be passed on to the public 

companies, along with increased marketing costs. However, competition 

among public accounting firms for providing audit services should to some 

extent also affect audit fees. Therefore, we believe it is uncertain at this 

time how these dynamics would play out in the market for audit services 

and their effect on audit fees over the long term. However, if intensive 

price competition were to occur, the expected benefits of mandatory audit 

firm rotation could be adversely affected if audit quality suffers due to audit 

fees that do not support an appropriate level of audit work. 

We believe that mandatory audit firm rotation may not be the most efficient 

way to enhance auditor independence and audit quality, considering the 

costs of changing the auditor of record and the loss of auditor knowledge 

that is not carried forward to the new auditor. We also believe that the 

potential benefits of mandatory audit firm rotation are harder to predict 

and quantify while we are fairly certain there will be additional costs. In 

that respect, mandatory audit firm rotation is not a panacea that totally 

removes pressures on the auditor in appropriately resolving financial 

reporting issues that may materially affect the public companies’ financial 

statements. Those pressures are likely to continue even if the term of the 

auditor is limited under any mandatory rotation process. Furthermore, 

most public companies will only use the Big 4 firms for their auditor of 

record for a variety of reasons, including the firms’ having sufficient 

industry knowledge and resources to audit their companies and 

expectations of the capital markets to use Big 4 firms. These public 

companies may only have 1 or 2 choices for their auditor of record under 

any mandatory rotation system. However, over time a mandatory audit 

firm rotation requirement may result in more firms transitioning into 

additional industry sectors if the market for such audits has sufficient 

profit margins.

The current environment has greatly increased the pressures from 

regulators and investors on public company management and public 

accounting firms to have financial statements issued by public companies 

that comply with GAAP and provide full disclosure. These pressures and 

the reforms of the Sarbanes-Oxley Act provide incentives to have financial 
Page 51 GAO-04-216 Public Accounting Firms

reporting that is honest, fair, and complete and that serves the public 

interest. If such reporting is widely and consistently achieved then the 

likelihood of the “fresh look” serving to identify financial reporting issues 

that may materially affect financial statements that were either overlooked 

or not appropriately dealt with by the previous auditor of record will be 

reduced. However, it is uncertain at this time if the current climate and 

pressures for accurate and complete financial reporting and for restoring 

public trust will be sustained over the long term. 

Regarding the need for mandatory audit firm rotation, we believe the most 

prudent course at this time is for the SEC and the PCAOB to monitor and 

evaluate the effectiveness of the Sarbanes-Oxley Act’s requirements for 

enhancing auditor independence and audit quality, and ultimately restoring 

investor confidence. In that respect, the PCAOB’s inspection program for 

registered public accounting firms could also provide an opportunity to 

provide a “fresh look,” which would enhance auditor independence and 

audit quality through the program’s inspection activities, and may provide 

new insights regarding (1) public companies’ financial reporting practices 

that pose a high risk of issuing materially misstated financial statements for 

the audit committees to consider and (2) possibly either using the auditor 

of record or another firm to assist in reviewing these areas. In addition, 

future research on the potential benefits of mandatory audit firm rotation 

as suggested by our analysis of restatements of financial statements may 

also be valuable to consider along with the evaluations of the effectiveness 

of the Sarbanes-Oxley Act.

Further, we also believe that currently audit committees, with their 

increased responsibilities under the Sarbanes-Oxley Act, can play a very 

important role in enhancing auditor independence and audit quality. In that 

respect, the Conference Board Commission on Public Trust and Private 

Enterprise in its January 9, 2003, report stated that auditor rotation is a 

useful tool for building shareholder confidence in the integrity of the audit 

and of the company’s financial statements. The commission advocated that 

audit committees consider rotating audit firms when there are 

circumstances that could call into question the audit firm’s independence 

from management. The circumstances that merited consideration included 

when (1) significant nonaudit services are provided to the company by the 

auditor of record (even if they have been approved by the audit 

committee), (2) one or more former partners or managers of the audit firm 

are employed by the company, or (3) lengthy tenure of the auditor of 

record, such as over 10 years—which our survey results show is prevalent 

at many Fortune 1000 public companies. In such cases, we believe audit 
Page 52 GAO-04-216 Public Accounting Firms

committees need to be especially vigilant in the oversight of the auditor and 

in considering whether a “fresh look” is warranted. We also believe that if 

audit committees regularly evaluate whether audit firm rotation would be 

beneficial, given the facts and circumstances of their companies’ situation, 

and are actively involved in helping to ensure audit independence and audit 

quality, many of the intended benefits of audit firm rotation could be 

realized at the initiative of the audit committee rather than through a 

mandatory requirement.

However, audit committees need to have access to adequate resources, 

including their own budgets, to be able to operate with the independence 

necessary to effectively perform their responsibilities under the SarbanesOxley Act. Further, we believe that an audit committee’s ability to operate 

independently is directly related to the independence of the public 

company’s board of directors. It is not realistic to believe that audit 

committees will unilaterally resolve financial reporting issues that 

materially affect a public company’s financial statements without vetting 

those issues with the board of directors. Also, the ability of the board of 

directors to operate independently may also be affected in corporate 

governance structures where the public company’s chief executive officer 

also serves as the chair of the board of directors. Like audit committees, 

boards of directors also need to be independent and to have adequate 

resources and access to independent attorneys and other advisors when 

they believe it is appropriate. Finally, for any system to function effectively, 

there must be incentives for parties to do the right thing, adequate 

transparency to provide reasonable assurance that people will do the right 

thing, and appropriate accountability when people do not do the right 

thing. 

Agency Comments and 

Our Evaluation

We provided copies of a draft of this report to the SEC, AICPA, and PCAOB 

for their review. Representatives of the AICPA and the PCAOB provided 

technical comments, which we have incorporated where applicable. 

Representatives of the SEC had no comments.

We are sending copies of this report to the Chairman and Ranking Minority 

Member of the House Committee on Energy and Commerce. We are also 

sending copies of this report to the Chairman of the Securities and 

Exchange Commission, the Chairman of the Public Company Accounting 
Page 53 GAO-04-216 Public Accounting Firms

Oversight Board, and other interested parties. This report will also be 

available at no charge on GAO’s Web site at http://www.gao.gov.

If you or your staffs have any questions concerning this report, please 

contact me at (202) 512-9471 or John J. Reilly, Jr., Assistant Director, at 

(202) 512-9517. Key contributors are acknowledged in appendix VI.

Jeanette M. Franzel

Director, Financial Management and Assurance
Page 54 GAO-04-216 Public Accounting Firms

Appendix I

Objectives, Scope, and Methodology AAppenednxidexiIs

As mandated by Section 207 of the Sarbanes-Oxley Act of 20021 and as 

agreed with your staff, to perform our study and review of the potential 

effects of requiring mandatory rotation of registered public accounting 

firms, we 

1. identified and reviewed research studies and related literature that 

addressed issues concerning auditor independence and audit quality 

associated with the length of a public accounting firm’s tenure and the 

costs and benefits of mandatory audit firm rotation; 

2. analyzed the issues we identified to 

• develop detailed questionnaires to obtain the views of public accounting 

firms and public company chief financial officers and their audit 

committee chairs on the potential effects of mandatory audit firm 

rotation, 

• hold discussions with officials of other interested stakeholders, such as 

institutional investors, federal banking regulators, U.S. stock exchanges, 

state boards of accountancy, the American Institute of Certified Public 

Accountants (AICPA), the Securities and Exchange Commission (SEC), 

and the Public Company Accounting Oversight Board (PCAOB), to 

obtain their views on the issues associated with mandatory audit firm 

rotation, and 

• obtain information from other countries on their experiences with 

mandatory audit firm rotation; and

3. identified restatements of annual 2001 and 2002 financial statements of 

Fortune 1000 public companies due to errors or fraud that were 

reported to the SEC during 2002 and 2003 through August 31, 2003, to 

• determine whether the restatement occurred before or after a change in 

the public companies’ auditor of record, and 

• test the value of the “fresh look” commonly attributed to mandatory 

audit firm rotation.

1

 Pub. L. No. 107-204, 116 Stat. 745, 775.
Appendix I

Objectives, Scope, and Methodology

Page 55 GAO-04-216 Public Accounting Firms

We conducted our work in Washington, D.C., between November 2002 and 

November 2003 in accordance with U.S. generally accepted government 

auditing standards.

Identifying Research 

Studies Concerning Auditor 

Independence and Audit 

Quality

To identify existing research related to mandatory audit firm rotation, we 

utilized several methods including general Internet searches, requests from 

the AICPA library, the AICPA’s Web site (www.aicpa.org), the American 

Accounting Association’s Web site (http://accounting.rutgers.edu/raw/aaa/), 

the SEC’s Web site (www.sec.gov), requests from GAO’s internal library 

resources, and suggestions provided by communities of interest. Also, 

many studies were identified through bibliographies of previously 

identified research. We used the following keywords in our searches: 

“mandatory audit firm rotation,” “mandatory auditor rotation,” 

“compulsory audit firm rotation,” “compulsory auditor rotation,” “auditor 

rotation,” “auditor change(s),” and “auditor switching.”

We identified a total of 80 studies, articles, position papers, and reports 

from our searches. We then applied the following criteria to these studies. 

We focused on studies that (1) were mostly published no earlier than 1980, 

(2) contained some original data analyses, and (3) focused on some aspect 

of mandatory audit firm rotation. Using these criteria, 27 studies were 

subjected to further methodological review to evaluate the design and 

approach of the studies, the quality of the data used, and the 

reasonableness of the studies’ conclusions and to determine if any 

limitations of a study were of sufficient severity to call into question the 

reasonableness of the conclusion. We eliminated 10 of these studies 

because they were actually position papers or literature summaries, and 

did not include any original data analyses. One additional study was 

eliminated because of fundamental methodological flaws.

Of the remaining 16 studies that were subjected to a high-level 

methodological review, 7 have major caveats that should be considered 

along with the results of the studies, while the other 9 have some more 

minor methodological limitations, such as limited application to the 

subject; limited data availability; or insufficient information on issues 

including choice of samples, response rates, and nonresponse analyses. In 

developing the survey instruments covering issues concerning auditor 

independence and audit quality associated with the length of a public 

accounting firm’s tenure and the costs and benefits of mandatory audit firm 

rotation, we primarily used the studies from among this latter group of 9 as 

listed below. 
Appendix I

Objectives, Scope, and Methodology

Page 56 GAO-04-216 Public Accounting Firms

The Relationship of Audit Failures and Audit Tenure, by Jeffrey 

Casterella of Colorado State University, W. Robert Knechel of University of 

Florida and University of Auckland, and Paul Walker of the University of 

Virginia, November 2002.

Auditor Rotation and Retention Rules: A Theoretical Analysis (Rotation 

Rules), by Eric C. Weber of Northwestern University, June 1998.

Audit-Firm Tenure and the Quality of Financial Reports, by Van E. 

Johnson of Georgia State University, Inder K. Khurana of the University of 

Missouri-Columbia, and J. Kenneth Reynolds of Louisiana State University, 

Winter 2002.

“The Effects of Auditor Change on Audit Fees: Tests of Price Cutting and 

Price Recovery”, The Accounting Review, by D.T. Simon, and J.R. Francis, 

April 1988.

“Does Auditor Quality and Tenure Matter to Investors?” Evidence from the 

Bond Market. Sattar Mansi of Virginia Polytechnic Institute, William F. 

Maxwell of University of Arizona, and Darius P. Miller of Kelley School of 

Business, February 2003 paper under revision for the Journal of 

Accounting Research.

An Analysis of Restatement Matters: Rules, Errors, Ethics, for the Five 

Years Ended December 31, 2002, The Huron Consulting Group, January 

2003.

The Commission on Auditors’ Responsibilities: Report of Tentative 

Conclusions, The Cohen Commission (an independent commission 

established by the AICPA), 1977. (Limited to Section 9, “Maintaining the 

Independence of Auditors, Rotation of Auditors”).

“Audit Fees and Auditor Change; An Investigation of the Persistence of Fee 

Reduction by Type of Change”, Journal of Business Finance and 

Accounting, by A. Gregory, and P. Collier, January 1996.

“Auditor Changes and Tendering: UK Interview Evidence”, Accounting, 

Auditing and Accountability Journal, v11n1, V. Beattie, and S. Fearnley, 

1998.
Appendix I

Objectives, Scope, and Methodology

Page 57 GAO-04-216 Public Accounting Firms

Obtaining the Views of 

Public Accounting Firms 

and Public Company Chief 

Financial Officers and Their 

Audit Committee Chairs on 

Mandatory Audit Firm 

Rotation

We analyzed the issues identified from our review of studies, articles, 

position papers, and reports to develop an understanding of the 

background and related advantages and disadvantages of mandatory audit 

firm rotation. We developed three separate survey instruments 

incorporating a variety of issues related to auditor independence, audit 

quality, mandatory audit firm rotation and the potential effects on audit 

costs, audit fees, audit quality, audit risk, and competition that may arise 

with a mandatory audit firm rotation requirement. In addition, these survey 

instruments solicited views on the impact of specific provisions of the 

Sarbanes-Oxley Act intended to enhance auditor independence and audit 

quality, other practices for enhancing audit quality, views on implementing 

mandatory audit firm rotation, and overall opinions on requiring mandatory 

audit firm rotation.

We performed field tests of the survey instruments to help ensure that the 

survey questions would be understandable to different groups of 

respondents, eliminate factual inaccuracies, and obtain feedback and 

recommendations to improve the surveys. We took the feedback and 

comments we received into consideration in developing our final survey 

instruments. Specifically, during March and April of 2003, we performed 

field tests of the survey instrument for public accounting firms with eight 

different public accounting firms, including two of the Big 4 firms, two 

national firms, and four regional or local firms. During May 2003, we 

conducted field tests of the survey instrument for public company chief 

financial officers with four public companies, including two Fortune 1000 

companies and two commercial banks not included in the Fortune 1000. 

We tailored the survey instrument for public company audit committee 

chairpersons by incorporating the feedback and comments we received 

from the chief financial officers during the field tests we performed with 

public companies.
Appendix I

Objectives, Scope, and Methodology

Page 58 GAO-04-216 Public Accounting Firms

Surveys of Public 

Accounting Firms

Section 207 of the Sarbanes-Oxley Act mandated that GAO study the 

potential effects of mandatory audit firm rotation of registered public 

accounting firms, referring to public accounting firms that would be 

registered with the new PCAOB. During the January 2003 time frame when 

we were framing the population, since the PCAOB was in the process of 

getting organized and becoming operational, there were no public 

accounting firms registered with the PCAOB at that time.2

 Therefore, we 

coordinated with the AICPA to establish a population of public accounting 

firms that would most likely register with the PCAOB. The AICPA provided 

a complete list of the more than 1,100 public accounting firms that were 

registered with the AICPA’s Securities and Exchange Commission Practice 

Section (SECPS)3

 as of January 2003. Prior to the restructuring of the 

SECPS, AICPA bylaws required that all members that engage in the 

practice of public accounting with a firm auditing one or more SEC clients 

join the SECPS. Public accounting firms that did not have any SEC clients 

could join the SECPS voluntarily. Based on the information submitted in 

their 2001 annual reports, these SECPS member firms collectively had 

nearly 15,000 SEC clients.4

 Therefore, the public accounting firms 

registered with the SECPS at that time were used to frame an alternative 

source of public accounting firms that perform audits of issuers registered 

with the SEC.

Based on the AICPA-provided SECPS membership list and the number of 

SEC clients reported in these SECPS member firms’ 2001 annual reports, of 

1,117 SECPS members, 696 firms had 1 or more SEC clients and 421 firms 

were SECPS members but did not audit any public companies. The 696 

2

 The PCAOB established the process for public accounting firms to register with the 

PCAOB starting in April 2003, with public accounting firms having an initial opportunity to 

register with the PCAOB no later than October 22, 2003. As of October 22, 2003, according to 

the PCAOB, there were 598 public accounting firms registered with the PCAOB and 55 

public accounting firms that had applications pending the PCAOB’s review.

3

 The AICPA’s SECPS was a part of the former self-regulatory system. SECPS was overseen 

by the former Public Oversight Board (POB), which represented the public interest on all 

matters affecting public confidence in the integrity of the audit process. The SECPS 

required AICPA member accounting firms registered with the SECPS to subject their 

professional practices to peer review and oversight by the POB and SEC. The AICPA 

recently announced a new voluntary membership called the Center for Public Company 

Audit Firms that restructures and replaces the SECPS, which had several of its functions 

absorbed into the PCAOB. 

4

 According to SEC records, there were nearly 18,000 issuers registered with the SEC as of 

February 2003.
Appendix I

Objectives, Scope, and Methodology

Page 59 GAO-04-216 Public Accounting Firms

members of the SECPS collectively audited 14,928 of the 17,956 issuers 

registered with the SEC. Since approximately 3,000 issuers were audited 

by public accounting firms that were not members of the SECPS, we 

obtained a list from the SEC that included the names of over 1,000 public 

accounting firms that performed the audits of public companies registered 

with the SEC. We compared the 696 SECPS member firms to all of the 

public accounting firms that were included in the SEC’s list in order to 

identify the non-SECPS member public accounting firms, which were 

mainly consisted of foreign public accounting firms or domestic firms that 

are not AICPA members. Since the PCAOB has indicated that it will not 

exempt foreign public accounting firms that audit issuers registered with 

the SEC from registering with the PCAOB, we included non-SECPS 

member public accounting firms that reported to the SEC that they had 10 

or more SEC clients in the population.

Stratification of Public 

Accounting Firm Population

In order to identify differences in views on the potential effects of 

mandatory audit firm rotation for respondents that vary based on the size 

of the public accounting firm, location (e.g., domestic versus foreign firms) 

and other factors, we stratified the population into three tiers based on the 

number of SEC clients reported to the SECPS in the SECPS member firms’ 

2001 annual reports and the aforementioned SEC data for non-SECPS 

member public accounting firms: 

1. Tier 1 firms: 92 SECPS member and 5 non-SECPS public accounting 

firms that had 10 or more 2001 SEC clients in 2001, 

2. Tier 2 firms: 604 SECPS member firms that had from 1 to 9, 2001 SEC 

clients in 2001, and 

3. Tier 3 firms: 421 SECPS member firms that reported having no SEC 

clients. 

The basis for selecting public accounting firms with 10 or more SEC clients 

was twofold. First, the 92 SECPS member firms included in Tier 1 

collectively had approximately 90 percent of all of the SEC clients reported 

to the SECPS in the member firms’ 2001 annual reports. Second, the public 

accounting firms with 10 or more SEC clients were viewed to collectively 

have the most experience and knowledge about changing auditors for 

public company clients and accordingly were considered to have a great 

interest in the potential effects of mandatory audit firm rotation. Tier 2 was 

established because the 604 SECPS member firms with 1 to 9 SEC clients 
Appendix I

Objectives, Scope, and Methodology

Page 60 GAO-04-216 Public Accounting Firms

comprises approximately 10 percent of the total SEC clients reported to the 

the SECPS in member firms’ 2001 annual reports and were also considered 

to have a great interest in, as well as important views on, the potential 

effects of mandatory audit firm rotation based on their experience and 

knowledge of being auditors for public companies. Lastly, we included the 

421 SECPS member public accounting firms that had no SEC clients in Tier 

3 of our population in order to determine if there would be greater or less 

interest in providing financial statement audit services to public companies 

if mandatory audit firm rotation were required. We requested that the 

public accounting firms’ chief executive officers or managing partners, or 

their designated representatives, complete the survey.

Method of Administration In order to conduct our survey, we selected a 100 percent certainty sample 

of Tier 1 public accounting firms consisted of all 92 SECPS member firms 

and all 5 non-SECPS member firms. In addition, we selected separate 

random samples from each of the two remaining strata. We created two 

separate Web sites for the public accounting firm surveys. The top tier 

firms were surveyed independently of the second and third tiers because 

the Tier 1 survey was administered jointly with another study dealing with 

consolidation of major public accounting firms since 1989 as mandated by 

Section 701 of the Sarbanes-Oxley Act.5

 The survey for the Tier 2 and Tier 3 

firms, which dealt only with the potential effects of mandatory audit firm 

rotation, was created at a separate Web site. A unique password and user 

ID was assigned to each selected public accounting firm in our sample to 

facilitate completion of the survey online. The surveys were made 

available to the Tier 1 firms during the week of May 27, 2003, and the 

surveys to the Tier 2 and Tier 3 firms were made available during the week 

of June 12, 2003. Both survey Web sites remained open until September 

2003. Responses to surveys completed online were automatically stored on 

GAO’s Web sites. From August through September 2003, we performed 

follow-up efforts to increase the overall response rates by telephoning the 

selected public accounting firms that had not completed the survey, and 

requested that they take advantage of the opportunity to express their 

views on this important issue by doing so. 

Lastly, in order to gain knowledge about whether the views of the Tier 1 

public accounting firms that did not complete our survey were materially 

5

 U.S. General Accounting Office, Public Accounting Firms: Mandated Study on 

Consolidation and Competition, GAO-03-864 (Washington, D.C.: July 30, 2003).
Appendix I

Objectives, Scope, and Methodology

Page 61 GAO-04-216 Public Accounting Firms

different from the overall views of the Tier 1 public accounting firms that 

completed our survey, we asked the following key questions of those public 

accounting firms that did not complete our survey and that we contacted 

during our telephone follow-up efforts. Specifically, we asked whether 

their firms believed the benefits of mandatory audit firm rotation would 

exceed the costs of implementing such a requirement and whether their 

firms would support requiring mandatory audit firm rotation. As more fully 

described in the body of this report, the overall views expressed by the Tier 

1 public accounting firms that completed our survey generally indicated 

that the costs of mandatory audit firm rotation would exceed the benefits 

and that their firms were not in favor of supporting such a requirement. 

The views of the Tier 1 public accounting firms that did not complete our 

survey and that we contacted in our telephone follow-up efforts were 

generally consistent with the overall views of the Tier 1 public accounting 

firms that completed our survey. 

Public Accounting Firm 

Survey Results

As disclosed in our survey instruments, all survey results were to be 

compiled and presented in summary form only as part of our report, and 

we will not release individually identifiable data from these surveys, unless 

compelled by law or required to do so by the Congress. We received 

responses from 74 of the 97 Tier 1 firms, or 76.3 percent.6

 Because of the 

more limited participation of Tier 2 firms (85, or 30.1 percent) and Tier 3 

firms (52, or 21.9 percent) in our survey, we are not projecting their 

responses to the population of firms in these tiers. The presentation of this 

report focuses on the responses from the Tier 1 firms, but any substantial 

differences in their overall views and those reported to us by either Tier 2 

or 3 firms are discussed where applicable. 

Table 2 summarizes the population, sample sizes, and overall responses 

received for all three tiers of public accounting firms surveyed on the 

potential effects of mandatory audit firm rotation.

6

 Estimates of Tier 1 firms are subject to sampling errors of no more than plus or minus 7 

percentage points (95 percent confidence level) unless otherwise noted, as well as to 

possible nonsampling errors generally found in surveys.
Appendix I

Objectives, Scope, and Methodology

Page 62 GAO-04-216 Public Accounting Firms

Table 2: Public Accounting Firms’ Population, Sample Sizes, and Survey Response 

Rates

Source: GAO survey data.

Surveys of Public Company 

Chief Financial Officers and 

Audit Committee Chairs

As a part of fulfilling our objective to study the potential effects of 

mandatory audit firm rotation, we obtained the views on the advantages 

and disadvantages and related costs and benefits from a random sample of 

chief financial officers and audit committee chairs of public companies 

registered with the SEC. We solicited the views of chief financial officers 

of public companies because they were considered to be very 

knowledgeable about the issues involving financial statement audits of 

public companies. We also solicited the views of audit committee chairs 

because under the Sarbanes-Oxley Act, the audit committee has expanded 

responsibilities for monitoring and overseeing public companies’ financial 

reporting and the financial statement audit process. We obtained such 

views by administering a survey to randomly selected samples of public 

company chief financial officers and their audit committee chairs. 

Section 207 of the Sarbanes-Oxley Act defines “mandatory rotation” as the 

imposition of a limit on the period of years for which a particular registered 

public accounting firm may be the auditor of record for a particular issuer. 

Therefore, in framing the population from which we planned to draw our 

sample of public companies, we researched what the definition of an 

“issuer” is with the SEC, with GAO’s General Counsel, and the AICPA’s 

SECPS. The primary purpose of conducting this research was to determine 

whether mutual funds (or mutual fund complexes) and other types of 

investment companies such as investment trusts, should be included in the 

population. Based on discussions with the Director of the SEC’s Office of 

Investment Management, mutual funds and investment trusts are issuers 

that are required to file periodic reports with the SEC under the Securities 

Exchange Act of 1934 or the Investment Company Act of 1940. Also, 

officials in the SEC’s Office of Investment Management indicated that there 

are nearly 10,000 individual mutual funds grouped into 877 mutual fund 

complexes (also known as families). A mutual fund complex is 

Tier 1 firms Tier 2 firms Tier 3 firms Totals

Population size 97 604 421 1,122

Sample size 97 282 237 616

Total responses 74 85 52 211

Response rate 76.3% 30.1% 21.9% - - - 
Appendix I

Objectives, Scope, and Methodology

Page 63 GAO-04-216 Public Accounting Firms

responsible for hiring the auditor of record, either collectively or 

individually, for the individual mutual funds that are included in the family 

or complex. As such, investment trusts and the 877 mutual fund complexes 

were included in our population for the purpose of administering our 

survey.

We obtained lists of public company issuers from the SEC in developing the 

population as follows: The SEC’s Office of Corporation Finance provided a 

list of 17,079 public companies from the SEC’s Electronic Data Gathering, 

Analysis, and Retrieval (EDGAR) system. This list included registrants that 

were listed as current issuers registered with the SEC as of February 2003 

and included 14,938 domestic public companies (including investment 

trusts) and 2,141 foreign public companies (i.e., companies that are 

domiciled outside of the United States but are registered with the SEC). 

Our comparison of this SEC list to a separate list of Fortune 1000 

companies identified an additional 32 public companies that were added to 

the original list of 17,079, bringing the total population to an adjusted total 

of 17,111. As noted above, we also obtained a complete list of 877 mutual 

fund complexes from the SEC that included current issuers registered with 

the SEC’s Office of Investment Management. Therefore, the population of 

public company issuers as of February 2003 totaled 17,988, consisted of 

17,111 public companies and 877 mutual fund complexes.

Stratification of Chief 

Financial Officer and Audit 

Committee Chair 

Population

In order to identify differences in views on the potential effects of 

mandatory audit firm rotation based on differences in company industry, 

size, or geographic location, we stratified the population into the following 

three strata: (1) domestic Fortune 1000 companies, (2) other (non-Fortune 

1000) domestic companies and mutual fund complexes, and (3) foreign 

companies. 

Fortune 1000 stratum: Based on Fortune’s list of the Fortune 1000 as of 

March 2003, we identified 960 public companies in the Fortune 1000; the 

remaining 40 companies were privately owned. Since private companies 

are not subject to SEC rules or the Sarbanes-Oxley Act’s provisions, these 

40 companies were not included in the stratum. We used the file provided 

by the SEC listing the 17,079 domestic and foreign public companies to 

extract a separate stratum of the 960 public companies in the Fortune 1000. 

In addition, in comparing Fortune’s list of the Fortune 1000 to the SEC’s 

listing of public companies, we identified 32 additional companies that 

were included in the Fortune 1000 but which were not included in the SEC 

list. In connection with framing the Fortune 1000 stratum, we added these 
Appendix I

Objectives, Scope, and Methodology

Page 64 GAO-04-216 Public Accounting Firms

32 companies to the list of domestic and foreign public companies provided 

to us by the SEC to ensure that it was complete. 

Foreign company stratum: Using the “state code” identifier included in 

the adjusted SEC list of 17,111 domestic and foreign public companies, we 

extracted a separate stratum of 2,141 foreign companies. 

Other domestic companies and mutual fund complexes stratum: After 

extracting the 960 domestic Fortune 1000 public companies and the 2,141 

foreign public companies from the adjusted SEC list of 17,111 domestic and 

foreign public companies, a separate stratum of 14,010 non-Fortune 1000 

public companies was created from the SEC file representing the “other 

domestic” public companies. These 14,010 other domestic public 

companies (which included investment trusts) were combined with the 877 

mutual fund complexes provided by the SEC’s Office of Investment 

Management to create a total population for this stratum of 14,887. 

Method of Administration In order to conduct these surveys, we selected a separate random sample 

from each of the three public company strata. We mailed a survey package 

to the chief financial officer of each public company issuer included in our 

sample. This survey package provided the chief financial officer with the 

option of completing the enclosed hard copy of the survey and returning it 

in the mail to our Atlanta Field Office or of completing the survey online. 

We created a Web site with the public company survey for the chief 

financial officers. A unique password and user ID was assigned to each 

selected company in our sample of companies to facilitate completion of 

the survey online. In addition, a separate survey directed to the chair of 

the audit committee (or head of an equivalent body) was included in the 

mail survey package. The chief financial officer was asked to forward this 

survey to the audit committee chair. The survey for the public company 

audit committee chairs was not made available online. As such, these 

surveys could only be completed on hard copy and returned to our Atlanta 

Field Office. The survey packages were mailed to all 1,171 public 

companies in June 2003. The survey Web site for public company chief 

financial officers remained open until September 2003. The cutoff date for 

accepting mailed surveys from public company chief financial officers and 

audit committee chairs was September 2003. Responses to surveys 

completed online were automatically stored into GAO’s Web sites, and 

mailed survey responses of chief financial officers and audit committee 

chairs were entered into a separate compilation database by GAO 

contractor personnel who were hired to perform such data inputting. From 
Appendix I

Objectives, Scope, and Methodology

Page 65 GAO-04-216 Public Accounting Firms

August through September 2003, we also performed follow-up efforts to 

increase the overall response rates by telephoning public company chief 

financial officers, who had not completed or returned the survey, and 

requesting that the chief financial officer and the audit committee chair 

complete our survey and return it to us.

Public Company Survey 

Results

As disclosed in our surveys, all survey results were to be compiled and 

presented in summary form only as part of our report, and we will not 

release individually identifiable data from these surveys, unless compelled 

by law or required to do so by the Congress. Of the 330 Fortune 1000 public 

companies sampled, we received responses from 201, or 60.9 percent, of 

their chief financial officers and 191, or 57.9 percent, of their audit 

committee chairs.7

 Because of limited participation of the other domestic 

companies and mutual funds (131, or 29.1 percent, of their chief financial 

officers and 96, or 21.3 percent, of their audit committee chairs) and the 

foreign public companies (99, or 25.3 percent, of their chief financial 

officers and 63, or 16.1 percent, of their audit committee chairs), we are not 

projecting their responses to the population of companies in these strata. 

The presentation of this report focuses on the responses from the Fortune 

1000 public companies’ chief financial officers and their audit committee 

chairs, but any substantial differences in their overall views and those 

reported to us by the other groups of public companies we surveyed is 

discussed where applicable.

Tables 3 and 4 summarize the population, sample size, and survey 

responses received for all three strata of public company chief financial 

officers and their audit committee chairs surveyed on the potential effects 

of mandatory audit firm rotation.

7

 The estimates from these surveys are subject to sampling errors of no more than plus or 

minus 6 percentage points (95 percent confidence level) unless otherwise noted, as well as 

to possible nonsampling errors generally found in surveys. 
Appendix I

Objectives, Scope, and Methodology

Page 66 GAO-04-216 Public Accounting Firms

Table 3: Public Company Chief Financial Officers’ Population, Sample Sizes, and 

Survey Response Rates 

Source: GAO survey data.

Table 4: Public Company Audit Committee Chairs’ Population, Sample Sizes, and 

Survey Response Rates

Source: GAO survey data.

Additional Survey 

Considerations

We initially requested information from all 97 Tier 1 firms (firms with 10 or 

more SEC clients). We received responses from 74 of them. We conducted 

follow-up with a limited number of the nonrespondents and did not find 

substantive differences between the respondents and the nonrespondents 

on key questions related to mandatory audit firm rotation. We requested 

information from 330 Fortune 1000 public companies and their audit 

committee chairs and received 201 and 191 responses from them, 

respectively. While we did not conduct follow-up with the nonrespondents 

from our surveys of Fortune 1000 public companies and their audit 

committee chairs, we had no reason to believe that respondents and 

nonrespondents to our original samples from these strata would 

substantively differ on issues related to mandatory audit firm rotation. 

Therefore, we analyzed respondent data from the Tier 1 and Fortune 1000 

public companies and their audit committees as probability samples from 

these respective populations. 

Fortune 1000 

companies

Domestic public 

companies and 

mutual funds

Foreign public 

companies Totals

Population size 960 14,887 2,141 17,988

Sample size 330 450 391 1,171

Total responses 201 131 99 431

Response rate 60.9% 29.1% 25.3% - - -

Fortune 1000 

companies

Domestic public 

companies and 

mutual funds

Foreign public 

companies Totals

Population size 960 14,887 2,141 17,988

Sample size 330 450 391 1,171

Total responses 191 96 63 350

Response rate 57.9% 21.3% 16.1% - - - 
Appendix I

Objectives, Scope, and Methodology

Page 67 GAO-04-216 Public Accounting Firms

Survey results based on probability samples are subject to sampling error. 

Each of the three samples (Tier 1 and Fortune 1000 public companies and 

their audit committee chairs) is only one of a large number of samples we 

might have drawn from the respective populations. Since each sample 

could have provided different estimates, we express our confidence in the 

precision of our three particular samples’ results as 95 percent confidence 

intervals. These are intervals that would contain the actual population 

values for 95 percent of the samples we could have drawn. As a result, we 

are 95 percent confident that each of the confidence intervals in this report 

will include the true values in the respective study populations. All 

percentage estimates from the survey of Tier 1 firms have sampling errors 

not exceeding +/- 7 percentage points unless otherwise noted. All 

percentage estimates from the surveys of Fortune 1000 public companies 

and their audit committee chairs have sampling errors not exceeding +/- 6 

percentage points unless otherwise noted. Also, estimated percentages for 

subgroups of Tier 1 firms and Fortune 1000 public companies and their 

audit committee chairs often have sampling errors exceeding these 

thresholds, which are noted where they are reported. In addition, all 

numerical estimates other than percentages have sampling errors of not 

more than +/- 14 percent of the value of those numerical estimates.

Despite our judgment that respondents and nonrespondents do not differ 

on issues related to mandatory audit firm rotation, our survey estimates 

may nevertheless contain errors to the extent that there truly are 

differences between these groups on issues related to this topic.

The practical difficulties of conducting any survey also introduce other 

types of nonsampling errors. Differences in how a particular question is 

interpreted and differences in the sources of information available to 

respondents can also be sources of nonsampling errors. We included steps 

in both the data collection and data analysis stages to minimize such 

nonsampling errors. These steps included developing our survey questions 

with the aid of our survey specialists, conducting pretests of the public 

accounting firm and public company questions and questionnaires, 

verifying computer analysis by an independent analyst, and double 

verification of survey data entry where applicable.

Discussions Held with 

Officials of Other Interested 

Stakeholders

To supplement the responses to our survey, we identified other 

knowledgeable individuals associated with a broad range of communities 

of interest and conducted telephone or in-person discussions to obtain 

their views on mandatory audit firm rotation. The communities of interest 
Appendix I

Objectives, Scope, and Methodology

Page 68 GAO-04-216 Public Accounting Firms

included significant institutional investors (pension funds, mutual funds, 

and insurance companies), self-regulatory organizations (such as stock 

exchanges), consumer advocacy groups, regulators (state boards of 

accountancy, banking regulators), the AICPA, the SEC, the PCAOB, and 

recognized experts in corporate governance. 

The questions for these discussions were based on key questions from the 

surveys for public accounting firms and public companies. The results of 

the discussions were compiled and presented in summary form only as part 

of our report, and we will not release individually identifiable data from 

these discussions, unless compelled by law or required to do so by the 

Congress.

Obtaining Information from 

Other Countries on Their 

Experiences with 

Mandatory Audit Firm 

Rotation

In order to obtain other countries’ current or previous experience with or 

consideration of mandatory audit firm rotation, we administered surveys to 

the securities regulators of the Group of Seven Industrialized Nations (G7), which included the United Kingdom, Germany, France, Japan, Canada, 

and Italy. In addition to the G-7 countries’ securities regulators, we also 

administered surveys to the following members of the International 

Organization of Securities Commissions (IOSCO)8

: Australia, Austria, 

Belgium, Brazil, China, Hong Kong, Luxembourg, Mexico, the Netherlands, 

Singapore, Spain, Sweden, and Switzerland. The IOSCO members 

represent these foreign countries’ organizations with duties and 

responsibilities similar to those of the SEC in the United States. 

We administered the surveys to these foreign countries’ securities 

regulators in December 2002. From July and through October 2003, we 

performed follow-up efforts to increase the overall response rates by 

sending e-mail messages to the foreign countries’ securities regulators in 

our sample who had not completed the survey and requested that they do 

so. We received responses from 11 of the 19 countries’ securities 

regulators surveyed. 

8

 IOSCO is an international association of securities regulators that was created in 1983 to 

promote high standards of regulation in order to maintain just, efficient, and sound markets; 

promote the development of domestic markets; establish standards and an effective 

surveillance of international securities transactions; and promote the integrity of the 

markets by rigorously applying the standards and by effectively enforcing them. 
Appendix I

Objectives, Scope, and Methodology

Page 69 GAO-04-216 Public Accounting Firms

Identifying Restatements of 

Annual Financial 

Statements for Fortune 1000 

Public Companies due to 

Errors or Fraud

To obtain some insight into the potential value of the “fresh look” provided 

by a new auditor of record, we analyzed the rate of annual financial 

statement restatements reported to the SEC by Fortune 1000 public 

companies during 2002 and 2003 through August 31, 2003. We particularly 

focused on restatements for 2001 and 2002 and compared the financial 

statement restatement rates of those Fortune 1000 public companies that 

changed their auditor of record to those of Fortune 1000 public companies 

that did not change their auditor of record during this period. 

In connection with performing this analysis, we separately tracked the 

Fortune 1000 public companies that changed auditors from the public 

companies that did not change auditors during 2001 and 2002. Financial 

statement restatements filed for changes in accounting principles or 

changes in organizational business structure (e.g., stock splits, mergers and 

acquisitions), reclassifications, or to compliance with SEC reporting 

requirements are not necessarily indications of compromised audit quality 

or auditor independence. However, financial statement restatements due 

to errors or fraud raise doubt about the integrity of management’s financial 

reporting practices, the quality of the audit, or the auditor’s independence. 

Therefore, the focus of our analysis was on annual financial statement 

restatements (hereinafter referred to as “restatements”) due to errors or 

fraud. Since not all restatements are indications of errors or fraud, we
Appendix I

Objectives, Scope, and Methodology

Page 70 GAO-04-216 Public Accounting Firms

reviewed Form 10-KAs9

 (amended 10-K filings), Form 8-Ks, and any related 

SEC enforcement actions to determine if the restatements were due to 

errors or fraud. The primary purpose of this test was to determine whether 

the rate of restatements due to errors or fraud of companies that changed 

auditors was higher or lower than the rate of restatements due to errors or 

fraud of companies that did not change auditors.

For each of the Fortune 1000 companies, we searched SEC’s EDGAR 

system for Form 10-KA filings submitted to the SEC during 2002 and 2003 

through August 31, 2003, that amended either 2001 or 2002 financial 

statements to identify annual financial statement restatements. We 

determined if there had been a change in auditor from 2001 through 2002 by 

reviewing the name of the auditor of record on the audit opinion included 

in the Form 10-KA filed for 2001 and 2002, and also noted what type of audit 

opinion was issued on the 2001 and 2002 financial statements. This 

allowed us to identify the restatements associated with Fortune 1000 public 

companies that changed auditors and the restatements of Fortune 1000 

public companies that did not change auditors. We compared the level of 

restatements for Fortune 1000 public companies that changed auditors to 

the level of restatements of Fortune 1000 public companies that did not 

change auditors.

9

 We focused on Form 10-KA filings because they include the actual restatements of 

previously issued annual financial statements included in the original Form 10-K. While 

amended quarterly filings (Form 10-QA) and Form 8-K filings may include disclosures of a 

public company’s intention to restate previously issued annual financial statements, we did 

not consider Form 10-QA or Form 8-K filings for the purpose of identifying restatements of 

annual financial statements. Public companies may announce via a Form 10-Q or a Form 8-

K that the company is going to restate in the near future, but then not file restated financial 

statements with the SEC because it may file for bankruptcy or become delisted. Therefore, 

we intentionally limited our review of the SEC’s EDGAR system to identifying restatements 

of annual financial statements that were filed with the SEC during 2002 and 2003 through 

August 31, 2003. However, we also identified annual restatements of those Fortune 1000 

public companies that included restatements in their annual Form 10-K filings. In addition, 

some public companies (such as Freddie Mac, WorldCom, Qwest, and Enron) and their 

auditors may still be in the process of determining the required adjustments and developing 

appropriate disclosures before they can file the restatement of previously issued annual 

financial statements via Form 10-KA to the SEC. Lastly, since we reviewed the Form 10-KA 

filings for 2002 that had been submitted to the SEC through August 31, 2003, the results of 

our analysis reflect restatements that have been submitted to the SEC through that date and 

therefore do not include or reflect restatements that may be filed in the future by any public 

companies that plan to restate previously issued financial statements or any public 

companies that may not yet be aware of a need to restate previously issued annual financial 

statements.
Appendix I

Objectives, Scope, and Methodology

Page 71 GAO-04-216 Public Accounting Firms

For each of the restatements identified above, we reviewed underlying 

Form 10-KA (amended 10-K filings), Form 8-Ks, and any related SEC 

enforcement actions to quantify the dollar effect of the restatements and to 

determine if the restatements were due to errors or fraud. We 

differentiated restatements caused by errors or fraud from restatements 

caused by changes that were not indications of compromised audit quality 

or auditor independence, such as changes in accounting principles, 

mergers, stock splits, and reclassifications using appropriate classification 

criteria. In addition, we attempted to ascertain from the above sources 

whether company management, the predecessor auditor, or the successor 

auditor identified the error or fraud, and where applicable, whether it was 

identified before or after the change in auditor.

After categorizing the 2001 and 2002 Fortune 1000 public companies’ 

annual financial statement restatements and annual financial statement 

filings into (1) companies that did not change auditors and filed a 

restatement, (2) companies that did not change auditors and did not file a 

restatement, (3) companies that changed auditors and filed a restatement, 

and (4) companies that changed auditors and did not file a restatement, we 

compared the rates of restatements among and between these groups.
Page 72 GAO-04-216 Public Accounting Firms

Appendix II

Implementation of Mandatory Audit Firm 

Rotation, if Required ApendxiI

If mandatory audit firm rotation were required, a number of implementing 

factors affecting the structure of the requirement would need to be 

decided. As a component of our surveys of public accounting firms, public 

companies, and their audit committee chairs, we asked them to provide 

their views on various implementing factors, regardless of whether they 

supported mandatory audit firm rotation, including

• the limit on the incumbent firm’s audit tenure period,

• the “cooling off” period before the incumbent firm could again compete 

to provide audit services to the public company,

• under what circumstances either the audit committee or the public 

accounting firm could terminate the relationship for providing audit 

services,

• whether mandatory audit firm rotation should be implemented on a 

staggered basis, and

• whether mandatory audit firm rotation should be required for audits of 

all public companies, and if not, to which public companies should it be 

applied.

Time Limit on the Auditor of 

Record’s Tenure

Regarding the limit on the auditor of record’s tenure under mandatory audit 

firm rotation, about 47 percent of Tier 1 firms stated that the limit should be 

8 to 10 years. Fortune 1000 chief financial officers and audit committee 

chairs selected 8 to 10 years about as often as 5 to 7 years as the limit on 

the auditor of record’s tenure. Tiers 2 and 3 firms and other public 

companies’ audit committee chairs that responded to our surveys generally 

favored an audit tenure of 5 to 7 years.

Time Limit Before the 

Auditor of Record Could 

Compete to Provide Audit 

Services to the Public 

Company Previously 

Audited

Most Tier 1 firms and Fortune 1000 public company chief financial officers 

and their audit committee chairs believed the “cooling off” period under 

mandatory audit firm rotation should be 3 or 4 years before the auditor of 

record could again compete to provide audit services to the public 

company previously audited. 
Appendix II

Implementation of Mandatory Audit Firm 

Rotation, if Required

Page 73 GAO-04-216 Public Accounting Firms

Circumstances When the 

Audit Committee or the 

Auditor of Record Could 

Terminate the Business 

Relationship Providing 

Audit Services

Nearly all Tier 1 firms and Fortune 1000 public company chief financial 

officers and their audit committee chairs stated that the audit committee 

under mandatory audit firm rotation should be permitted to terminate the 

auditor of record at any time if it is dissatisfied with the public accounting 

firm’s performance or working relationship. Most Tier 1 firms and Fortune 

1000 public company chief financial officers and their audit committee 

chairs also believed that the auditor of record should be able to terminate 

its relationship with the audit committee/public company at any time if the 

public accounting firm is dissatisfied with the working relationship.

Period for Implementing 

Mandatory Audit Firm 

Rotation

Nearly all Tier 1 firms and Fortune 1000 public company chief financial 

officers and their audit committee chairs believed that mandatory audit 

firm rotation should be implemented over a period of years (staggered) to 

avoid a significant number of public companies changing auditors 

simultaneously.

Public Companies for Which 

Auditor of Record Should 

Be Subject to Mandatory 

Audit Firm Rotation

About 70 percent of Tier 1 firms believed that mandatory audit firm 

rotation should not be applied uniformly for audits of all public companies 

regardless of their nature or size. In contrast, about 81 percent of Fortune 

1000 public companies and 65 percent of their audit committee chairs 

believed that mandatory audit firm rotation should be applied uniformly for 

audits of all public companies regardless of the nature or size. Most chief 

financial officers of other domestic and mutual fund public companies who 

responded to our survey believe mandatory audit firm rotation should be 

applied uniformly, and their audit committee chairs were split on the 

subject. Comments that we received from many of the Tier 1 firms, 

Fortune 1000 public companies, and their audit committee chairs that 

supported requiring that mandatory audit firm rotation be applied 

uniformly generally took the view that there should be a level playing field 

and that the benefits and the costs of mandatory audit firm rotation should 

be applied to all public companies. In contrast, those who commented 

opposing requiring mandatory audit firm rotation for all public companies 

generally took the view that the smaller public companies are less complex 

and the costs of mandatory audit firm rotation would be more burdensome 

for the smaller companies. 

We asked those public accounting firms and public company chief financial 

officers and their audit committee chairs who believed mandatory audit 

firm rotation should not be applied uniformly to all public companies to 
Appendix II

Implementation of Mandatory Audit Firm 

Rotation, if Required

Page 74 GAO-04-216 Public Accounting Firms

select by company nature and size to which companies mandatory audit 

firm rotation should apply. Tier 1 firms and Fortune 1000 audit committee 

chairs more frequently selected the larger public companies. However, 

Fortune 1000 chief financial officers were about evenly split in their views 

regardless of the size of the public company. Chief financial officers and 

their audit committee chairs of other domestic and mutual fund public 

companies, as well as foreign public company chief financial officers and 

their audit committee chairs, who responded to our survey more frequently 

selected the larger public companies.
Page 75 GAO-04-216 Public Accounting Firms

Appendix III

Potential Value of Practices Other Than 

Mandatory Audit Firm Rotation for Enhancing 

Auditor Independence and Audit Quality ApendxiI

We asked public accounting firms, public companies’ chief financial 

officers, and their audit committee chairs to provide their views on the 

potential value of the various following alternative practices we identified 

through our research and other inquiries made in developing our surveys 

versus the value of other than mandatory audit firm rotation for enhancing 

auditor independence and audit quality.

• The audit committee periodically holding an open competition for 

providing audit services: Having the audit committee periodically hold 

an open competition for public accounting firms to serve as the public 

company’s auditor of record, in which the incumbent auditor of record 

could also compete, could potentially enhance auditor independence 

and audit quality by letting the incumbent firm know that it does not 

have unlimited tenure as the auditor of record and a lock on the 

associated revenues, and that another firm may be selected to provide a 

“fresh look” at the company’s financial reporting process, practices, and 

financial statements. Also, the public company has an opportunity to 

see the quality of personnel that another public accounting firm could 

provide. However, the public company will incur some costs in holding 

such a competition and, if another firm is selected, may incur additional 

initial years’ audit fees and will have additional auditor support costs to 

assist the new auditor of record in understanding the company’s 

operations, systems, and financial reporting practices.

• Requiring audit managers to periodically rotate off the engagement 

for providing audit services to the public company: Audit manager is a 

senior position reporting to the engagement audit partner with 

responsibility for assisting the engagement audit partner in planning, 

conducting, and reporting on the audit of the public company’s financial 

statements. Larger audits will likely have multiple audit managers and 

audit partners participating in the audit. Conceptually, periodically 

changing audit managers brings a “fresh look” to the audit assignment 

and the associated potential benefits. However, there is an associated 

learning curve that is likely to cause both the public accounting firm and 

the public company to incur some additional costs. Some public 

accounting firms commented that this practice already occurs as a 

result of career enhancement policies and practices of the firms.

• The audit committee periodically obtaining the services of a public 

accounting firm to assist it in overseeing the financial statement 

audit or to conduct a forensic audit in areas of the public company’s 

financial reporting process that present a risk of fraudulent financial 
Appendix III

Potential Value of Practices Other Than 

Mandatory Audit Firm Rotation for 

Enhancing Auditor Independence and Audit 

Quality

Page 76 GAO-04-216 Public Accounting Firms

reporting: Overseeing the auditor of record’s conduct of the financial 

statement audit is a significant responsibility that is especially 

challenging depending on the size and complexity of a public company. 

Having another public accounting firm as needed to assist the audit 

committee brings a “fresh look” to help the audit committee understand 

the public company’s operations, systems, and financial reporting 

practices and the underlying internal controls and risks. Also, as areas 

are identified that may have greater risk of fraudulent financial 

reporting, the audit committee may wish to have a public accounting 

firm conduct a forensic audit to provide both a “fresh look” and a more 

penetrating audit of transactions and related internal controls and 

financial reporting practices in areas of high risk. Additional costs will 

be incurred by the audit committee, and some degree of coordination 

and cooperation of the incumbent audit firm will be necessary, which 

will also add to the audit committee’s responsibilities.

• Requiring that the auditor of record be hired on a noncancelable 

multiyear basis, although the public accounting firm could terminate 

the relationship for cause during the contract period: Having the audit 

committee hire the auditor of record on a multiyear basis that only the 

auditor of record can cancel potentially enhances auditor independence 

and audit quality by assisting the auditor in dealing with any pressures 

from management in appropriately dealing with financial reporting 

practices that may materially affect the financial statements. However, 

this practice takes away flexibility of the audit committee to replace the 

auditor of record within the period of the contract should the audit 

committee be dissatisfied with the auditor of record’s performance.

Although many Tier 1 firms, Fortune 1000 public companies, and their audit 

committee chairs saw some benefit in each of the alternative practices, in 

general, they most frequently reported that the alternative practices would 

have limited or little benefit. The most notable exception involved the 

practice in which audit committee would hire the auditor of record on a 

noncancelable multiyear basis, for which most Fortune 1000 public 

companies and their audit committee chairs reported that the practice 

would have no benefit. (See table 5.) 
Appendix III

Potential Value of Practices Other Than 

Mandatory Audit Firm Rotation for 

Enhancing Auditor Independence and Audit 

Quality

Page 77 GAO-04-216 Public Accounting Firms

Table 5: Views on Potential Value of Other Practices for Enhancing Auditor Independence and Audit Quality

Source: GAO analysis of survey data.

Numbers in percentages

Significant or very 

positive benefit 

Limited or 

little benefit No benefit

Practice 1: Audit committee periodically holding open competition for 

providing audit services

Tier 1 firms 11 44 45

Fortune 1000 public companies 11 53 36

Fortune 1000 audit committee chairs 23 53 24

Practice 2: Requiring periodic rotation of audit managers

Tier 1 firms 14 57 29

Fortune 1000 public companies 24 48 28

Fortune 1000 audit committee chairs 42 46 12

Practice 3: Audit committee periodically obtaining service of a public 

accounting firm to assist in overseeing the financial statement audit

Tier 1 firms 20 53 27

Fortune 1000 public companies 10 42 48

Fortune 1000 audit committee chairs 13 59 28

Practice 4: Audit committee periodically obtaining service of a public 

accounting firm to conduct a forensic audit

Tier 1 firms 30 46 24

Fortune 1000 public companies 13 50 37

Fortune 1000 audit committee chairs 19 61 20

Practice 5: Audit committee hiring auditor of record on a noncancelable 

multiyear basis

Tier 1 firms 22 48 30

Fortune 1000 public companies 5 34 61

Fortune 1000 audit committee chairs 6 37 57
Page 78 GAO-04-216 Public Accounting Firms

Appendix IV

Restatements of Annual Financial Statements 

for Fortune 1000 Public Companies Due To 

Errors or Fraud ApendxiIV

To obtain some insight into the potential value of the “fresh look” provided 

by a new auditor of record, we analyzed the rate of annual financial 

statement restatements reported to the Securities and Exchange 

Commission (SEC) by Fortune 1000 public companies during 2002 and 

2003 through August 31, 2003. We particularly focused on restatements for 

2001 and 2002 and compared the financial statement restatement rates of 

those Fortune 1000 public companies that changed their auditor of record 

to those Fortune 1000 public companies that did not change their auditor of 

record during this period. 

Historically, only about 3 percent of public companies change auditors in 

any given year.1

 However, we observed that 2.9 percent (28 out of 9602) of 

the Fortune 1000 public companies changed auditors during 2001 and 21.3 

percent (204 out of 960) of the Fortune 1000 public companies changed 

auditors during 2002. The significant increase from 2001 through 2002 was 

primarily due to the dissolution of Arthur Andersen LLP in 2002, which was 

caused, in part, by its criminal indictment for obstruction of justice 

stemming from its role as auditor of Enron Corporation. Since many of 

these public companies had to replace Andersen as their auditor of record 

during 2002, the number of changes in their auditor of record effectively 

represented a partial form of mandatory audit firm rotation. 

Tables 6 and 7 summarize the occurrence of the reported Fortune 1000 

public companies’ restatement filings.

1

 R. Doogar (University of Illinois, Urbana-Champaign) and R. Easley and D. Ricchiute 

(University of Notre Dame), “Switching Costs, Audit Firm Market Shares and Merger 

Profitability,” (Nov. 20, 2001), which was discussed in GAO-03-864, cited a level of 2.7 

percent annual client switching of auditors based on prior research the authors performed 

using 1981-1997 Compustat data. 

2

 We identified 960 public companies included in the Fortune 1000 for the purpose of 

developing our sampling approach for administering the public company surveys, that is, in 

framing the upper stratum of the population universe.
Appendix IV

Restatements of Annual Financial 

Statements for Fortune 1000 Public 

Companies Due To Errors or Fraud

Page 79 GAO-04-216 Public Accounting Firms

Table 6: Summary Results of the Fortune 1000 Public Companies That Changed 

Auditors

Source: GAO analysis of restatements.

Table 7: Summary Results of the Fortune 1000 Public Companies That Did Not 

Change Auditors

Source: GAO analysis of restatements.

The combined restatement rates from tables 6 and 7 for all Fortune 1000 

public companies, including those that changed auditors and those that 

retained their auditor of record, was 2.9 percent in 2001 (28 restatements 

out of the 960 Fortune 1000 public companies) and 1.9 percent in 2002 (18 

restatements out of the 960 Fortune 1000 public companies). The overall 

restatement rates are higher in 2001 than the comparable levels of 

restatements observed in 2002. This may be due to the fact that our 

analysis was limited to restatements submitted to the SEC on Form 10-KA 

filings for 2001 and 2002 through August 31, 2003. Some of the Fortune 

1000 public companies that had not filed restatements with the SEC as of 

August 31, 2003, may still do so in the future. Additionally, because some 

companies may require considerable amounts of time and effort to unravel 

complex accounting and financial reporting issues (e.g., WorldCom, which 

is in the process of working its way out of bankruptcy proceedings, and the 

Federal Home Loan Mortgage Corporation, better known as Freddie Mac, 

which is working to restate 3 years of previously issued financial 

Number of companies with restatements due to 2001 2002

Rules based changes

Errors

Fraud

0 

3

0

0

7

1

Restatements related to companies that changed auditors 3 8

Fortune 1000 public companies that changed auditors 28 204

Restatement rate for companies that changed auditors 10.7% 3.9%

Number of companies with restatements due to 2001 2002

Rules based changes

Errors

Fraud

2

21

2

1

8

1

Restatements related to companies that did not change auditors 25 10

Fortune 1000 public companies that did not change auditors 932 756

Restatement rate for companies that did not change auditors 2.7% 1.3%
Appendix IV

Restatements of Annual Financial 

Statements for Fortune 1000 Public 

Companies Due To Errors or Fraud

Page 80 GAO-04-216 Public Accounting Firms

statements), it is reasonable to expect that additional restatements will be 

included in Form 10-KAs or other filings that had not been submitted to the 

SEC as of August 31, 2003. 

Financial statement restatements filed for changes in accounting principles 

or changes in organizational business structure (e.g., stock splits, mergers 

and acquisitions), reclassifications, or compliance with SEC reporting 

requirements, referred to as “rules based changes,” are not necessarily 

indications of compromised audit quality or auditor independence. 

However, financial statement restatements due to errors or fraud raise 

doubt about the integrity of management’s financial reporting practices, the 

quality of the audits, and the auditor’s independence. Therefore, the 

following focus of our analysis was on annual financial statement 

restatements (hereinafter referred to as “restatements”) due to errors or 

fraud. 

The rate of restatement due to errors or fraud for Fortune 1000 public 

companies that changed auditors were 10.7 percent in 2001 and 3.9 percent 

in 2002 compared to restatement rates due to errors or fraud of 2.5 percent 

in 2001 and 1.2 percent in 2002 for companies that did not change auditors. 

Although the data indicate that the overall restatement rate is 

approximately four3

 times higher in 2001 and three times higher in 20024 for 

those Fortune 1000 public companies that changed auditors than for those 

companies that did not change auditors, caution should be exercised as 

further analysis would be needed in order to determine whether the 

restatements are associated with the “fresh look” of the new auditor 

attributed to mandatory audit firm rotation. In that respect, in some cases 

we were able to determine from our review of the Form 10-KAs, any related 

Form 8-Ks, and the results of Internet news searches, that the restatements 

were identified as a result of an SEC investigation or an enforcement 

action. However, for the majority of the restatements we identified, the 

information included in the SEC’s EDGAR system did not provide sufficient 

information to ascertain whether company management, and in those 

3

 The 10.7 percent rate of restatements due to errors or fraud of the Fortune 1000 public 

companies that changed auditors in 2001 was approximately 4.25 times higher than the 2.5 

percent rate of restatements due to errors or fraud of the Fortune 1000 public companies 

that did not change auditors.

4

 The 3.9 percent rate of restatements due to errors or fraud of the Fortune 1000 public 

companies that changed auditors in 2002 was approximately 3.25 times higher than the 1.2 

percent rate of restatements due to errors or fraud of the Fortune 1000 public companies 

that did not change auditors.
Appendix IV

Restatements of Annual Financial 

Statements for Fortune 1000 Public 

Companies Due To Errors or Fraud

Page 81 GAO-04-216 Public Accounting Firms

cases where there was a change in auditor, the predecessor auditor, or the 

successor auditor identified the error or fraud and whether it was identified 

before or after the change in auditor. Also, the recent corporate financial 

reporting failures have greatly increased the pressures on management and 

auditors regarding honest, fair, and complete financial reporting.

Effect of Restatements Due 

to Errors or Fraud

The phrase in an auditor’s unqualified opinion, “present fairly, in all 

material respects, in conformity with generally accepted accounting 

principles,” indicates the auditor’s belief that the financial statements taken 

as a whole are not materially misstated. An auditor plans an audit to obtain 

reasonable assurance of detecting misstatements that could be large 

enough, individually or in the aggregate, to be quantitatively material to the 

financial statements.5

 Financial statements are materially misstated when 

they contain misstatements the effect of which, individually or in the 

aggregate, is important enough to cause them not to be presented fairly, in 

all material respects, in conformity with generally accepted accounting 

principles. As previously noted, misstatements can result from errors or 

fraud. As defined in Financial Accounting Standards Board Statement of 

Financial Concepts No. 2, materiality represents the magnitude of an 

omission or misstatement of an item in a financial report that, in light of 

surrounding circumstances, makes it probable that the judgment of a 

reasonable person relying on the information would have been changed or 

influenced by the inclusion or correction of the item. 

Table 8 summarizes the net dollar effect of the restatements due to errors 

or fraud on the reported net income (loss) of all 43 companies’ previously 

issued annual financial statements for the fiscal years, calendar years, or 

both ended from 1997 through 2002.6

5

 Although the auditor should be alert for misstatements that could be qualitatively material, 

it ordinarily is not practical to design procedures to detect them. Section 326 of the AICPA’s 

Statement on Auditing Standards states that “an auditor typically works within economic 

limits; his or her opinion, to be economically useful, must be formed within a reasonable 

length of time and at reasonable cost.”

6

 The restatement of one of the 43 companies that submitted restatements due to errors or 

fraud related to financial statements that were originally issued in 1995. However, we were 

unable to quantify the dollar effect of the restatements associated with these financial 

statements because the SEC’s EDGAR system did not include financial statements filed 

prior to 1997.
Appendix IV

Restatements of Annual Financial 

Statements for Fortune 1000 Public 

Companies Due To Errors or Fraud

Page 82 GAO-04-216 Public Accounting Firms

Table 8: Summary of Net Dollar Effect of Restatements Due to Errors and Fraud

Source: GAO analysis of restatements.

The misstatement rates associated with these 43 companies’ previously 

issued statements of net income (loss), which ranged from a 6.7 percent 

overstatement of net income (loss) for 2000 to a 37.0 percent 

understatement of net income (loss) for 2001, would clearly be considered 

material enough to have affected the fair presentation of the results of 

operations included in these 43 companies’ financial statements. 

Accordingly, it is probable that the judgment of a reasonable person relying 

on the information included in these companies’ previously issued financial 

statements would have been changed or influenced by the inclusion of 

omitted information or correction of misstated items due to errors or fraud.

Dollars in millions

1997 1998 1999 2000 2001 2002

Net effect of restatements ($69.2) ($71.2) ($1,387.0) ($821.4) ($456.3) ($124.8)

Net income (loss), 

previously reported $337.4 $316.4 $11,054.7 $12,234.2 ($1,234.4) ($640.2)

Misstatement rate (20.5)% (22.5)% (12.5)% (6.7)% (37.0)% (19.5)%
Page 83 GAO-04-216 Public Accounting Firms

Appendix V

International Experience with Mandatory 

Audit Firm Rotation ApendxiV

Italy Italy has required mandatory audit firm rotation of listed companies since 

1975 in which the audit engagement may be retendered (recompeting for 

providing audit services) every 3 years and the same public accounting firm 

may serve as the auditor of record for a maximum of 9 years. In addition, 

there is a minimum time lag of 3 years before the predecessor auditor can 

return. The mandatory audit firm rotation requirement was intended to 

safeguard the independence of public accounting firms. In a meeting with 

IOSCO Standing Committee one member, the Italian representative from 

Commissione Nazionale per le Societa e la Borsa (CONSOB), the Italian 

securities regulator, indicated that Italy’s experience with mandatory audit 

firm rotation has been a good one, noting that mandatory audit firm 

rotation gives the appearance of independence, which is considered very 

important to maintaining investor confidence. However, it was also noted 

that there have been negative impacts, when after 3 years, there is fee 

pressure by the listed company on the audit firm that contributes to 

reduced audit fees. In responding to our survey, CONSOB’s representative 

indicated that there has been a progressive reduction in audit fees, which 

has given rise to concern over audit firms’ ability to maintain adequate 

levels of audit services and quality control. 

Research in Italy1

 concludes that mandatory audit firm rotation carries 

significant threats to audit quality from competitive pressures. However, 

the CONSOB raised concerns about the study’s methodology, accuracy, 

data used, and appropriateness of the conclusions. Our review of the 

executive summary of the study also identified potential limitations on the 

reliability of data used and methodological concerns that created 

uncertainties about the study’s conclusions.2

 Italy has also considered 

partner rotation; however, because Italy is currently considering reducing 

the maximum auditor tenure from 9 years to 6 years, partner rotation has 

not been given further consideration. 

1

 SDA Universita Bocconi Corporate Finance and Real Estate Department and 

Administration and Control Department, The Impact of Mandatory Audit Rotation on 

Audit Quality and on Audit Pricing: The Case Of Italy (Executive Summary).

2

 The authors of the SDA Universita Bocconi study did not respond to our request to provide 

us additional information about the reliability of data that were used and the methodological 

approach. 
Appendix V

International Experience with Mandatory 

Audit Firm Rotation

Page 84 GAO-04-216 Public Accounting Firms

Brazil Brazil enacted a mandatory audit firm rotation requirement in May 1999 

with a 5-year maximum term and minimum time lag of 3 years before the 

predecessor auditor of record can return. The Comissao de Valores 

Mobiliarios (CVM), which is the Brazilian Securities Commission, indicated 

that the primary reason mandatory audit firm rotation was enacted was to 

strengthen audit supervision following accounting fraud at two banks 

(Banco Economico and Banco Nacional). Brazil does not have a partner 

rotation requirement, as the CVM believes that the requirement of rotating 

audit firms is stronger than changing partners within firms. However, as a 

component of its mandatory audit firm rotation requirement, Brazil 

prohibits an individual auditor who changes audit firms to audit the same 

corporations previously audited.

Singapore Starting in March 2002, the Monetary Authority of Singapore stipulated that 

banks incorporated in Singapore should not appoint the same public 

accounting firm for more than 5 consecutive financial years. However, this 

requirement does not apply to foreign banks operating in Singapore. Banks 

incorporated in Singapore that have had the same public accounting firm 

for more than 5 years have until 2006 to change their audit firms. While a 

“time out” period is not stipulated, banks incorporated in Singapore shall 

not, except with the prior written approval of the Monetary Authority of 

Singapore, appoint the same audit firm for more than 5 consecutive years. 

In addition, listed companies are required under the Listing Rules of the 

Singapore Exchange to rotate audit partners-in-charge every 5 years. 

The primary reason Singapore instituted mandatory audit firm rotation for 

local banks was to promote the independence and effectiveness of external 

audits. In addition, mandatory audit firm rotation for local banks was cited 

by Singapore’s officials as a measure to help (1) safeguard against public 

accounting firms having an excessive focus on maintaining long-term 

commercial relationships with the banks they audit, which could make the 

firms too committed or beholden to the banks, (2) maintain the 

professionalism of audit firms—where with long-term relationships, audit 

firms run the risk of compromising their objectivity by identifying too 

closely with the banks’ practices and cultures, and (3) bring a fresh 

perspective to the audit process—where with long-term relationships, 

public accounting firms might become less alert to subtle but important 

changes in the bank’s circumstances. 
Appendix V

International Experience with Mandatory 

Audit Firm Rotation

Page 85 GAO-04-216 Public Accounting Firms

Austria In Austria, Austrian Commercial Law will require mandatory audit firm 

rotation every 6 years to strengthen the quality of audits and to enhance 

auditor independence by limiting the time of doing business between the 

audited company and its auditor of record. The 6-year mandatory audit 

firm rotation requirement will become effective from the beginning of the 

year 2004, and there will be a minimum time lag of 1 year before the 

predecessor auditor of record can return. Austria does not have a partner 

rotation requirement; however, anyone who serves as the audit partner of a 

public company for 6 consecutive years will not be allowed to continue to 

serve in that capacity by becoming employed by the company’s successor 

auditor. 

United Kingdom In January 2003, the United Kingdom adopted the recommendations of the 

Co-ordinating Group on Audit and Accounting Issues (CGAA)3

 to 

strengthen the audit partner rotation requirements by reducing the 

maximum period for rotation of the lead audit partner from 7 years to 5 

years. The United Kingdom also adopted CGAA’s recommendation to limit 

the maximum period for rotation of the other key audit partners to 7 years. 

According to the CGAA report, the rotation of the audit engagement 

partner has been a requirement in the United Kingdom for many years, and 

the United Kingdom concluded that the requirements for the rotation of 

audit partners played an important role in upholding auditor independence. 

With respect to the issue of mandatory audit firm rotation, the United 

Kingdom supports CGAA’s recommendations, which concluded that the 

balance of advantage is against requiring the mandatory rotation of audit 

firms. The primary arguments against mandatory audit firm rotation, as 

cited in the CGAA report, include the possible negative effects on audit 

quality and effectiveness in the first years following a change, the 

substantial costs resulting from a requirement to switch auditors regularly, 

the lack of strong evidence of a positive impact on audit quality, the 

potential difficulty or impossibility of identifying a willing and able audit 

firm that can accept the audit without violating independence requirements 

3

 The CGAA was established by the Chancellor of the Exchequer and the Secretary of State 

for Trade and Industry to ensure that there is a coordinated and comprehensive work 

program for individual regulators to review the United Kingdom’s current regulatory 

arrangements for statutory audit and financial reporting, avoiding any unnecessary overlap; 

commission additional work or reviews if judged appropriate; and reach a view on the 

adequacy of the proposals, and, if appropriate, make specific recommendations.
Appendix V

International Experience with Mandatory 

Audit Firm Rotation

Page 86 GAO-04-216 Public Accounting Firms

in a concentrated listed company audit market, and competitive 

implications of such a requirement. However, CGAA also recommended 

that audit committees should consider changing their auditor of record 

when the audit tenure is from 15 years to 20 years.

France In France, audit partner rotation had been required since 1998 by the 

French Code of Ethics of the accounting profession. However, the 

requirement was not enforceable because the Code of Ethics had not 

specified any maximum length for mandatory rotation of audit partners. In 

August 2003, France promulgated the French Act on Strengthening of 

Financial Security, which makes it illegal for an audit partner to sign more 

than six annual audit reports. The main requirement that serves as an 

alternative to mandatory audit firm rotation is the French requirement of 

having two firms engaged in the audit of entities issuing consolidated 

financial statements, which has been a requirement since 1985 and has 

been reincluded in the August 2003 promulgation of the French Act on 

Strengthening of Financial Security. According to the Deputy Chief 

Accountant of the Commission des Operations de Bourse, mandatory audit 

firm rotation is not required in France primarily because of concern over 

the potential impairment of audit quality due to the new auditor’s lack of 

knowledge of the company’s operations. 

Spain The Comision Nacional del Mercaso de Valores (CNMV)—the agency in 

charge of supervising and inspecting the Spanish stock markets and the 

activities of all the participants in those markets—indicated that from 1989 

through 1995, Spain had a mandatory audit firm rotation requirement with 

a maximum audit term of 9 years, which included mandatory retendering 

every 3 years. The main objectives of this former requirement were to 

enhance auditors’ independence and promotion of fair competition. 

However, in 1995, the Spanish “Company Law” and the Spanish “Audit Law” 

were amended, effectively eliminating the mandatory audit firm rotation 

requirement, by allowing that “after the expiration of the initial period 

(minimum 3 years, maximum 9 years), the same auditor could be re-hired 

by the shareholders on an annual basis.” The Director of the CNMV 

indicated that the 9-year mandatory audit firm rotation requirement was 

abandoned since the main objective of increased competition among audit 

firms had been achieved and because of listed companies’ increased 

training costs incurred with a complete new team of auditors from a new 

public accounting firm. In November 2002, the Spanish “Audit Law” was 

amended to introduce a new requirement under which “all audit-engaged 
Appendix V

International Experience with Mandatory 

Audit Firm Rotation

Page 87 GAO-04-216 Public Accounting Firms

team” members (including audit partners, managers, supervisors, and 

junior staff) have to rotate every 7 years in certain types of companies, 

which include all listed companies, companies subject to public 

supervision, and companies with annual revenues over 30 million euros. 

The Netherlands In January 2003, the Royal Nederlands Instituut van Register Accountants 

(NIvRA) and Nederlandse Orde van Accountants-Administratieconsulenten 

(NOvAA) of the Netherlands, which are the bodies that represent the 

accounting profession in the Netherlands and are responsible for the 

qualifications and regulation of the accounting profession, adopted the 

recommendation of CGAA to strengthen the audit partner rotation 

requirements by reducing the maximum period for rotation of the 

engagement audit partner from 7 years to 5 years and to limit the maximum 

period for rotation of the other key audit partners to 7 years. The adoption 

of these measures by both NIvRA and NOvAA made these requirements a 

part of the code of conduct for auditors. A representative of the 

Netherlands Authority for the Financial Markets indicated that the Dutch 

government is in the process of promulgating these audit partner rotation 

regulations into law, where the requirement will only apply to public 

interest entities.

Japan In Japan, the Amended Certified Public Accountant Law was passed in May 

2003, and beginning on April 1, 2004, audit partners and reviewing partners 

will be prohibited from being engaged in auditing the same listed company 

over a period of 7 consecutive years. Mandatory audit firm rotation has 

never been required in Japan, and public companies have never been 

encouraged to voluntarily pursue audit firm rotation. While Japan agreed 

with the December 2002 report issued by the Subcommittee on Regulations 

of Certified Public Accountants of the Financial System Council that 

mandatory audit firm rotation will need further consideration in the future, 

Japan’s securities regulator stated that mandatory audit firm rotation was 

not supported because of the concerns that it (1) may cause confusion 

given the concentration of audit business held by large public accounting 

firms, (2) is not required in other major countries other than Italy, (3) may 

significantly lower the quality of audits due to the need to arrange newly 

organized audits, and (4) would result in greater cost of implementation 

under the current concentration of audit business held by large public 

accounting firms.
Appendix V

International Experience with Mandatory 

Audit Firm Rotation

Page 88 GAO-04-216 Public Accounting Firms

Canada There are currently no Canadian requirements for mandatory audit firm 

rotation. However, mandatory audit firm rotation was included in banking 

legislation shortly after the 1923 failure of the Home Bank and up to the 

December 1991 revision of the Bank Act. The Bank Act required that two 

firms audit a chartered bank, but that the same two firms could not 

perform more than two consecutive audits. As a result, one of the two 

firms would have to rotate off the audit for a minimum of 2 years.

According to Canadian officials, in practice this requirement was 

implemented in two different ways. Some banks appointed a panel of three 

audit firms with one of the three firms being a permanent auditor while the 

other two firms rotated every 2 years. Other banks appointed a panel of 

three audit firms and rotated among the three firms. Generally, the firm 

that was in its “off year” did not completely step away from the audit of the 

bank and would maintain at least a watch on developments in the bank’s 

business and financial reporting to ensure that it was knowledgeable 

enough to step back in when it rotated on again.

One of the primary benefits of the system was believed to be that the use of 

two firms facilitated an independent review of the loan portfolio. This new 

perspective was generally considered to be a useful safeguard, and it was 

believed that the second firm would not bring with it an element of 

additional cost. The rotation element of the system was considered to 

bring with it an additional element of security by ensuring that issues were 

reviewed regularly by auditors with a fresh perspective, thus minimizing 

the risk of a problem festering because an issue was decided on and not 

reevaluated. 

Since the 1923 failure of the Home Bank, the dual auditor requirement with 

mandatory audit firm rotation for one of the two audit firms every 2 years 

was in place for over 60 years and was considered to be one of the key 

safeguards in the bank governance system. However, in 1985 two regional 

banks in the province of Alberta failed despite the existence of the dual 

auditor system. A subsequent government inquiry into the failures found 

that the Office of the Inspector General of Banks, now the Office of the 

Superintendent of Financial Institutions (OSFI), heavily relied on the 

external auditors and recommended the need for some direct examination 

by the supervisor of the quality of banks’ loan portfolios. Until 1991, only 

Canadian banks were required to rotate their auditor of record. In 1991, in 

line with a push for harmonized supervision, banking legislation was 

amended to reduce the requirement to one audit firm, and the mandatory 

audit firm rotation requirement was abandoned with the revision of the 
Appendix V

International Experience with Mandatory 

Audit Firm Rotation

Page 89 GAO-04-216 Public Accounting Firms

Bank Act. According to Canadian officials, one of the reasons for the 

abandonment was that many argued that the cost was not matched by the 

benefits and it was noted that Canada seemed to be largely alone in the 

world imposing such a system. There were few strong advocates for 

retaining the system, but questions were raised as to whether it was in fact 

a valuable element of protecting the safety and soundness of the banking 

system. 

Mandatory audit firm rotation is not currently being considered in Canada. 

Instead, as of July 2003, mandatory rotation of audit partners for all public 

companies was being considered by Canada’s securities regulator, 

supported by a new model of independent oversight and inspection of 

auditors of public companies. The accounting profession, through the 

Public Interest and Integrity Committee of the Canadian Institute of 

Chartered Accountants and in collaboration with provincial institutes, is 

considering developing an updated independence standard that considers 

certain requirements of the Sarbanes-Oxley Act for Canadian application to 

listed financial institutions regulated by OSFI. This independence standard 

will focus on mandatory rotation of the engagement partner rather than the 

firm auditing a listed enterprise regulated by OSFI, as well as other key 

members of the firm involved with the audit. According to Canadian 

officials, extending this requirement to nonlisted financial institutions is 

under consideration but the outcome will not be known for some time.

Germany In Germany, according to the German Commercial Code, a qualified auditor 

or certified accounting firm, beginning with annual financial statements 

issued after December 31, 2001, may not be an auditor of a stock 

corporation that has issued officially listed shares if it employs a certified 

accountant who has signed the certification concerning the examination of 

the annual financial statements or the consolidated financial statements of 

the corporation more than six times in the 10 years prior to the fiscal year 

to be examined. According to German officials, the principle of audit 

partner rotation has proven to be successful, and there are no plans to 

switch to a model based on mandatory audit firm rotation because the 

purpose of guaranteeing an independent audit of the financial statements 

of a company can be efficiently achieved by audit partner rotation. 

However, in order to improve investor protection and company integrity, 

Germany’s federal government published a 10-point paper, which included 

a planned amendment to the corresponding Commercial Code regulations 

to shorten the period of time after which an auditor of record must rotate 
Appendix V

International Experience with Mandatory 

Audit Firm Rotation

Page 90 GAO-04-216 Public Accounting Firms

to every 5 years and to include all responsible audit partners in the rotation 

requirement.
Page 91 GAO-04-216 Public Accounting Firms

Appendix VI

GAO Contacts and Staff Acknowledgments ApendxiVI

GAO Contacts Jeanette M. Franzel, (202) 512-9471

John J. Reilly, Jr., (202) 512-9517

Staff 

Acknowledgments

In addition to those individuals named above, William E. Boutboul, 

Cheryl E. Clark, Robert W. Gramling, Wilfred B. Holloway, 

Michael C. Hrapsky, Catherine M. Hurley, Charles E. Norfleet, 

Judy K. Pagano, Sidney H. Schwartz, Jason O. Strange, 

Partricia A. Summers, and Walter K. Vance made key contributions to this 

report.

(194346)
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