Implications of late auditor resignations

Before investing in a company, we have to examine its operational and financial performance carefully, and the audited financial statements are important bases that give us a clearer picture of the financial conditions of the company. Auditors play a pivotal role in ensuring audit quality. When there is a late auditor change, we have to be mindful of the reasons leading to the resignation and their potential impact to a company’s financial reporting and accounts.

Changes in auditor appointments are not uncommon amongst listed companies. Listed companies usually appoint their auditors at the annual general meetings (AGMs) that must be held within 6 months after the financial year-end.

Auditor resignations that occur just a month before or even after the end of the financial year are referred to as late resignations. The Accounting and Financial Reporting Council (AFRC) first published an open letter in relation to the subject matter in October 2022. Since then, 51 listed companies with a 31-December year end have had late auditor resignations, a decrease of 32% from 75 during the same period last year. Although the situation has improved, it is still a cause for concern.

The primary concerns of late auditor resignations are that not only will the incoming auditor have limited time to plan and conduct a proper audit, but, more importantly, audit committees may not have enough time to properly investigate any issues caused by the resignations, and to appoint new auditors that can deliver a high-quality audit on a timely basis.

Investors should read the announcements of listed companies and understand more about the late auditor change and make their own assessments as outlined below:

Consider the real reasons of resignation

The key reasons of late auditor resignation for the listed companies, as disclosed in listed companies’ announcements, are summarised in the table below:

Is "disagreement over audit fees" just a convenient reason?

"Disagreement over audit fees" is often used as the reason for auditor resignation, and for investors, it is important to consider whether this is just a convenient reason or if there are any other explanations. For example, are there any changes to the company's financial reporting processes that might have led to the auditor re-evaluating the effort and resources required?

Sometimes auditors may have disagreements with management over audit issues. Investors may question whether the change in auditor was due to the listed company being reluctant to resolve certain audit issues, what these audit issues are, and their potential impact.

Is "corporate governance" being misused as a reason for auditor resignation?

Certain listed companies have attributed auditor changes to the rotation of audit firms as good corporate governance. Investors should bear in mind that a proper rotation will take place after the conclusion of the annual audit, at the time of the AGM, instead of mid-cycle. Such changes should have been flagged well in advance, thereby providing shareholders with the ability to scrutinize and question the selection and appointment of the incoming auditor. In view of the above, this inevitably gives rise to concerns that whether listed entities are using this as a generic reason for auditor changes.

Investors should read the announcement and annual report to understand how the listed companies and their audit committees have selected and appointed incoming auditors, particularly how they were satisfied that the incoming auditor had the competency and resources to conduct a proper audit within a short period of time.

This is especially important as the AFRC noticed that the majority of late auditor appointments for listed companies with significant operations in Mainland China or overseas were taken up by auditors whose relevant experience and available resources appeared to be disproportionate to these audits.

While investors may not always be able to obtain direct answers from the management on the above questions, they should be cognizant of the potential risks by keeping a close eye on these issues. Shareholders of listed companies should attend AGMs, pose questions and vote their shares on auditor selection and remuneration.

The Accounting and Financial Reporting Council is an independent body established under the Accounting and Financial Reporting Council Ordinance. As an independent regulator, AFRC spearheads and leads the accounting profession to constantly raise the level of quality of professional accountants, and thus protects the public interest.

For more information about the statutory functions of the AFRC, please visit https://www.afrc.org.hk.

• AFRC expresses its growing concern over late auditor resignations
• AFRC reiterates expectations on auditor changes
• AFRC Guidelines for Effective Audit Committees – Selection, Appointment and Reappointment of Auditors