VZCZCXRO9224
RR RUEHCHI RUEHDT RUEHHM
DE RUEHJA #1693/01 1701003
ZNR UUUUU ZZH
R 191003Z JUN 07
FM AMEMBASSY JAKARTA
TO RUEHC/SECSTATE WASHDC 5162
RUEATRS/DEPT OF TREASURY WASHDC
INFO RUEHZS/ASSOCIATION OF SOUTHEAST ASIAN NATIONS
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEHKO/AMEMBASSY TOKYO 0554
RUEHBJ/AMEMBASSY BEIJING 4126
RUEHBY/AMEMBASSY CANBERRA 0836
RUEHUL/AMEMBASSY SEOUL 4078
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 JAKARTA 001693 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
DEPT FOR EAP/MTS AND EB/IFD/OMA 
TREASURY FOR IA-BAUKOL 
COMMERCE FOR 4430/GOLIKE 
DEPARTMENT PASS FEDERAL RESERVE SAN FRANCISCO- FINEMAN 
DEPARTMENT PASS EXIM BANK 
 
E.O. 12958: N/A 
TAGS: EFIN EINV ECON PGOV ID
 
SUBJECT: INDONESIA - AUDIT FIRM ROTATION RULE HURTS BUSINESS 
CLIMATE 
 
¶1.  (SBU) Summary: Indonesia is one the few countries in the world 
requiring companies to appoint a new auditor every five years, a 
practice known as Audit Firm Rotation.  The practice of rotating 
individuals, or Audit Partner Rotation, is widespread across the 
globe.  Accounting firms and their clients uniformly criticize the 
GOI's requirement for audit firm rotation as unfriendly to business. 
 Our industry contacts told us they hope to amend draft legislation, 
which will soon be before Parliament, to abolish the firm rotation 
requirement.  They said they have requested that Trade Minister 
Pangestu and Vice President Kalla intervene on their behalf.  Audit 
rotation may also create complications for U.S. firms with 
Indonesian subsidiaries.  End Summary. 
 
Background: Audit Firm Rotation 
------------------------------- 
 
¶2. (U) Many oversight bodies around the globe have expressed concern 
that an accounting firm responsible for auditing the financial 
statements of a company for too many years will lead to a decline in 
audit quality.  An auditor can become too close to the company, grow 
stale from repetition, or fall prey to pressure to retain the 
client.  Many audit firms counter that a long term relationship 
improves the audit.  Many accountants and regulators say the best 
way around possible conflicts of interest is to rotate the audit 
partner every few years, while leaving the audit firm in place. 
That way, the individual who has the final authority regarding 
decisions on accounting positions taken by the client changes, but 
institutional knowledge of the client is carried forward by the 
other accountants who remain.  Audit firms are partnerships, not 
corporations.  It generally takes over a decade to reach partner, at 
which time one is required to buy-in to the partnership.  If a court 
finds an audit firm liable for audit mistakes, it is possible that 
the partnership could go bust and the partners will have nothing. 
Thus, audit partners tend to take the responsibility seriously. 
 
Indonesia Requires Firm Rotation 
-------------------------------- 
 
¶3. (SBU) We met with auditors from two of the local "Big 4" 
accounting firms, retired auditors, the president of the Indonesian 
Institute of Accountants (known by its Indonesian acronym IAI), and 
obtained position papers from local business chambers.  The 
regulation requiring audit firm rotation is based on the 2002 
Ministry of Finance (MOF) Decree No. 423/KMK.06/2002 and a draft 
Public Accountants Law.  Companies are currently operating under the 
decree which requires audit partner rotation after three years and 
audit firm rotation after five years.  This is a requirement for all 
companies subject to audit, even if not listed on the stock 
exchange.  The proposed law requires both partner and firm rotation 
at the five-year mark.  The proposed law may go to parliament next 
year.  Additionally for listed companies in Indonesia, Capital 
Market Supervisory Agency (BAPEPAM) decree No. 20/2002 regarding the 
Independence of Accountants providing Audit Services in the Capital 
Market includes a five year audit firm rotation cycle rule.  Our 
contacts tell us the Ministry of Finance made the audit firm 
rotation requirements without fully consulting IAI or local 
industry. 
 
Local Auditors' Reaction: 
Inefficiency and Complexity 
--------------------------- 
 
¶4. (SBU) The accountants we spoke with were universally against the 
audit firm rotation requirement.  It does not enhance independence 
or improve audit quality, but actually increases cost and reduces 
quality, they argued.  They said they accepted formalized audit 
partner rotation, since personnel rotate naturally on an engagement 
due to promotions, retirements, and reassignments.  An audit partner 
at one of the "Big 4" said it takes three years just to become fully 
functioning.  Indonesian firms can also be complex, with far-flung 
branches and multi-layered structures.  An effective audit requires 
institutional knowledge: continuity allows the auditor to see 
year-to-year changes and adjust audit risk accordingly.  All of this 
is lost if the audit firm is capriciously replaced, our contacts 
said. 
 
 
JAKARTA 00001693  002 OF 003 
 
 
¶5. (SBU) Partners at another "Big 4" audit firm stated that the 
Indonesian rules took auditing to another level beyond the much 
maligned U.S. Sarbanes Oxley Act, by increasing complexity for both 
the audit firm and the client.  They said the audit firm rotation 
time frames appeared arbitrary and felt that there was insufficient 
dialogue between the MOF and auditing industry.  They also echoed 
the comments on the loss of efficiency. 
 
Local Business Chamber Reaction: 
Restriction of Free Market 
-------------------------------- 
 
¶6. (SBU) The International Business Chamber (IBC), the European 
Business Chamber (Eurocham), and the Accounting Department at the 
University of Indonesia wrote to various ministries (Finance, Trade, 
and Justice) in December 2006 and February 2007 regarding the draft 
public accountants law.  Minister of Trade Mari Pangestu responded 
to the IBC in March 2007 that, "All relevant parties and 
stakeholders should sit down together and discuss the draft law." 
The business chambers also raised the point that Indonesian company 
law specifically gives shareholders the right to appointing auditors 
of an Indonesian company.  Mandatory audit firm rotation undermines 
this right of the shareholders and restricts the free market in 
audit services, they said. 
 
Indonesian Institute of Accountants: 
Raising Issue to the Vice President 
----------------------------------- 
 
¶7. (SBU) The President of the IAI Ahmadi Hadibroto said Audit Firm 
Rotation has more disadvantages than benefits.  He said the IAI has 
protested the requirement since its inception.  Hadibroto said that 
the audit firm rotation requirement in the Ministerial Decree 
appeared without warning.  Prior versions of the draft law discussed 
between MOF and IAI made no mention of audit firm rotation 
requirements.  Hadibroto also said that multiple MOF officials with 
overlapping oversight roles and a lingering suspicion of auditors 
since the financial crisis have led to four years of deadlock in 
seeking to overturn the requirement. 
 
¶8. (SBU) The IAI had approached Vice President Jusuf Kalla in late 
May about the problems it is having with the decree and the MOF. 
Kalla appeared sympathetic to the IAI's concerns, according to 
Hadibroto, but only asked that IAI to send him a letter with details 
for discussion.  Hadibroto is optimistic that the IAI still has time 
to beat back the audit firm rotation requirement since the draft law 
will probably not go to Parliament this year. 
 
Getting Around the Rules 
------------------------ 
 
¶9. (SBU) Like many regulations in Indonesia, the MOF decree has a 
loophole that allows an audit firm to continue to audit the same 
client in spite of the rotation requirement.  An audit firm simply 
needs to change its name and alter the partner composition so that 
the new firm has more than 50% new partners.  Additionally, the 
registered Indonesian name is what has to change.  If a firm is part 
of a global network, the brand name does not have to change, only 
the local name.  The audit partners at global firms dismissed such 
reorganizations as unnecessary complications.  However, they told us 
that some firms are beginning to do complex reorganizations to 
continue with their clients.  Two or three partners firms cannot 
easily reorganize, however, leading to audit fieldwork performed by 
one firm but signed off by another to get around the rules. 
 
¶10. (SBU) Hadibroto noted that it is now almost five years since the 
five-year audit firm rotation requirement went into force, so the 
decree will soon affect audit firms directly.   However, he said 
that many mergers and reorganizations took place on paper in the 
aftermath of the decree's implementation.  Thus, the same faces, 
albeit under a new audit firm name, will continue to audit the same 
company even as the five-year mark arrives. 
 
Indonesia in a Small Club 
------------------------- 
 
 
JAKARTA 00001693  003 OF 003 
 
 
¶11. (U) Only Indonesia and Italy require audit firm rotation in a 
strict sense.  Spain and Turkey adopted audit firm rotation 
requirements, but subsequently dropped them.  South Korea and 
Singapore started to require audit firm rotation, but Singapore 
dropped the idea to extend audit rotation to other industries after 
negative experiences in the banking sector, and South Korea granted 
exemption for companies with overseas shareholders or where the 
company is listed on a foreign stock exchange.  In Italy, Bocconi 
University studied audit firm rotation and found that it is 
"detrimental to audit quality, but does seem to have a positive 
effect on improving public confidence in the corporate sector" 
according to the New York State Society of CPAs.  The U.S. 
Securities and Exchange Commission (SEC) requires that companies 
subject to the Sarbanes Oxley Act rotate lead and concurring audit 
partners every five years, with other significant audit partners 
required to rotate after seven years. 
 
Conclusion: Audit Sector Struggling 
----------------------------------- 
 
¶12. (SBU) The outlook for the health of the auditing sector in 
Indonesia is not positive.  Our industry contacts tell us they hope 
that the firm rotation requirement is removed from the draft law 
before the law goes before parliament.  They wish to avoid extended 
debate with parliamentarians who may not know much about accounting 
and want to appear that they are standing up to big business. 
Compounding their woes, our contacts say fewer Indonesian university 
graduates chose to go into accounting with each passing year. 
Auditors told us that in the last ten years only 500 new Indonesian 
Certified Public Accountants received their licenses.  Furthermore, 
the IAI states that 50% of licensed accountants in Indonesia are 
over 50 years old.  These circumstances will create a shortage of 
qualified accountants within a decade. 
 
¶13. (SBU) U.S. companies with Indonesian subsidiaries should also 
take note.  The auditor for these companies is usually the same 
around the world.  If the U.S. company's Indonesian subsidiary is 
not large enough to be material to the companies operations, the 
U.S. headquarters is usually unconcerned with who audits the company 
in Indonesia.  However, if the Indonesian subsidiary is material to 
the financial reporting of the U.S. firm and the local auditor 
changes to a firm beyond the control of the global auditor, U.S. 
headquarters may face additional audit fees for the global auditor 
to revisit the work of the Indonesian auditor.  If the audit firm 
rotation requirement does become law, it will create a negative 
impact on audit quality, transparency and business competitiveness 
in Indonesia. 
 
HEFFERN