There are many possible reasons for auditor switches. Auditor changes may be efficient responses to changes in client characteristics, such as mergers or expanding service needs. However, it is alleged that some firms switch auditors to obtain a favorable audit opinion. This practice has been termed "opinion shopping." Opinion shopping begins when the client's current auditors refuse to treat a material accounting or reporting issue in a manner desired by management because the auditors perceive such reporting as a violation of generally accepted accounting principles. In these circumstances, management may replace its current auditors with new auditors that are more receptive to management's view of accounting and reporting issues.

Companies registered with the SEC may, of course, change auditors at their discretion. However, the SEC requires public companies switching auditors to identify, on Form 8-K, disagreements with their auditors and whether the audit report contained an adverse opinion, a disclaimer, or was qualified during the last two years. This requirement is worthwhile, but critics have argued that the definition of "disagreement" was not well defined and that this vagueness has allowed many auditor-client disagreements to go unreported.

This article reports the results of an investigation of how often client-auditor disagreements have been reported on Form 8-K. Form 8-K abstracts are available on the Mead Data Central EXCHANGE on-line data base system. In addition to 8-K abstracts, the EXCHANGE data base encompasses analyses from leading banking, brokerage, and research firms on finance, economy, demographics of countries, business prospects of companies, and industries.

The On-Line Search Strategy

Exhibit 1 shows the search strategy and the results. With just the "key words" of 8K or 8-K, over 7,000 abstract reports for 1985-87 were identified at the first pass. By using the key search words of change, switch, hire, replace, dismiss, terminate, or disagree in conjunction with the words accountant, auditor, CPA, etc., the number of abstracts was reduced to 178 reports. Abstracts range from 20 to 200 words with the average about 80 words. Thirteen abstracts represented "false hits," leaving 165 usable reports. A false hit is a report which is captured in the search because of the key words, but does not directly relate to the issue of interest being explored. Each of the remaining 165 abstracts was individually examined. Exhibit 1 illustrates the number of auditor changes, disagreements, and opinions that was qualified, adversed, or disclaimed.

Search Results

During the entire three year reporting period, only eight disagreements were reported, six of them by Big Eight firms. Furthermore, from 1985 to 1987, only three of those firms, Coopers & Lybrand, Peat Marwick Main, and Touche Ross, were specifically identified as reporting disagreements with their SEC clients. Does this mean that during this period the other firms never disagreed with their SEC clients? The answer is no. First, it is not uncommon for clients to reluctantly follow the auditor's advice and then fire the auditors or the auditors may quit because management is perceived to be lacking integrity. Under the old SEC rules, such disagreements would not have been reported. Under the new SEC rules, these disagreements will have to be reported. Second, an important limitation when using on-line data base systems is that regardless of how comprehensive the search strategy may appear to be, a risk always exists that conclusions based on the data may not be representative of the entire population or that relevant examples may not have been located by the specific search strategy.

The New SEC Requirements

The new SEC rules attempt to better define disagreements. Disagreements "include any differences of opinion concerning any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure, which if not resolved to the satisfaction of the former accountant, would have caused it to make reference in connection with its report to the subject of the disagreement" (40 SEC Docket 1141). However, initial differences of opinion based on incomplete facts or preliminary information are not considered to be disagreements if those differences are later resolved by obtaining additional relevant facts or information. When switching auditors, clients will now be required to provide a description of: . Disagreements or reportable events where the former auditor advised the company and questioned the accuracy or reliability of the company's financial statements, internal controls, management's representation, or prior audits. . Whether the audit committee discussed each of the disagreements or reportable events with the former auditors. . Issues discussed with the new auditor during the company's two most recent fiscal years and any subsequent interim period before the new auditor's appointment and the new auditor's and former auditor's views regarding the issues. . Whether the former auditor's report for either of the past two years contained an adverse opinion, a disclaimer, or was qualified or modified with a discussion of the nature of the opinion. . Whether the former auditor resigned, declined to stand for reelection, or was dismissed. . Whether the decision to change auditors was acted on by the audit committee or board of directors. . Any management- imposed limits on the former auditor to respond to the inquiries of the new auditor regarding each disagreement and reportable event.

The SEC has also proposed rules to reduce from 15 to five days the time for a company to file a Form 8-K regarding a change in its auditors, reducing from 30 to 10 days the time for filing the former auditor's letter, and allowing the auditor to provide an interim letter to the former SEC client highlighting specific areas of concern, following it up with a more detailed letter within the 10-day period.

Conclusion

The review of Form 8-K abstracts indicates that in the past some types of disagreements may have gone unreported. The new rules help to better spell out the meaning of disagreements. disclosure of disagreements between companies and their former auditors acts as an early warning of potentially troublesome areas and provides the auditor with a forum to disclose concerns on important accounting, auditing or financial reporting issues.

TABLE : EXHIBIT 1 FORM 8-K: AUDITOR SWITCHES