An Investigation on Reliance of Auditor’s Independence on the Credibility of Financial Reporting Quality of Corporate Organization

An Investigation on Reliance of Auditor’s Independence on the Credibility of Financial Reporting Quality of Corporate Organization

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Chapter one on An Investigation on Reliance of Auditor’s Independence on the Credibility of Financial Reporting Quality of Corporate Organization

INTRODUCTION

BACKGROUND TO THE STUDY

The auditing profession performs a role in giving reasonable assurance to the public and users’ of financial statements, specifically investors and creditors, of the reliability and credibility of a firms’ financial statements. To fulfil this role, there are several principles that auditors should espouse. One of the most important principles is independence. By demonstrating their independence, auditors’ opinions on financial statements will be valued by the users. In essence, auditor independence refers to an absence of interest by the auditor in the auditing assignment, thereby avoiding material bias that could affect the reliability and credibility of the financial statements. The auditing profession promotes the principle of independence to define, defend, and extend the profession.

Auditor independence also refers to the independence of the internal auditor or of the external auditor from parties that may have a financial interest in the business being audited. Independence requires integrity and objective approach to the audit process. The concept requires the auditor to carry out his or her work freely and in an objective manner.

Financial statements apart from stating the financial position of an organization, provides other information such as the value added, changes in equity if any and cash flows of the enterprise within a defined period time to which it relates (Iyoha and Faboyede, 2011). This information is useful to a wide range of users making informed economic decisions. The quality of financial reporting is indispensable to the need of users who requires them for investment and other decision making purposes. Financial reports can only be regarded as useful if it represents the “economic substance” of an organization in terms of relevance, reliability, comparability and aids interpretation simplicity (Penman, 1984). Ahmed (2003), stated that useful accounting information derived from qualitative financial reports help in efficient allocation of resources by reducing dissemination of information asymmetry and improving pricing of securities. The user of financial statement which include: shareholders, government, creditors, investors, etc. All rely on the audited financial statement in other to make informed decision. Therefore the credibility and reliability of this statement is necessary.

The basic purpose of financial statements in the view of Meigs and Meigs (1981) is to assist decision makers in evaluating the financial strength, profitability and the future prospects of a business entity. The basic objective for preparing financial statement is to provide information useful for making economic decisions. The objective of an audit of financial statements is to enable the auditor express an opinion whether the financial statements are prepared in all material respects and also in accordance with auditing standard. In recent times, auditors have been put under pressure to ensure that their reports constitute assurance to investors that their funds are put into good use and properly accounted for.  In Nigeria, every incorporated company is required to appoint an external auditor, who is required to render an independent opinion on the financial statements; whether or not they show a true and fair view. The Companies and Allied Matters Act (1990) states that every auditor of a company shall have a right of access, at all times, to the books, accounts and vouchers of the company and to such information and explanations as may be necessary in the course of an audit. 

The auditor shall make a report to the members of the company on the accounts examined by them.  The auditor in performing his duties is expected to exercise all care, diligence and skills as is reasonably necessary in each particular circumstance. Furthermore, there has been much discussion about the independence of Auditors; the leadership of the auditing standards board, the public oversight board, the independence standards board, and most recently the proposed independence rules promulgated by the Securities and Exchange Commission (SEC) have all attempted to clarify and strengthen auditor independence.  Also in the medieval era financial reporting were not necessary and hence financial statements were not prepared neither used to make decisions. But with the recent development every firm are expected to prepare and report their financial statement in order to know the financial position of the organisation so that stakeholders can make decisions.

Audit report is the medium through which the auditor expresses his opinion on the financial statement examined by him.  Due to familiarity, threat of replacement of an auditor, provision of book-keeping services by the auditor and many other factors, the auditor may want to issue an unqualified audit report even when the situation on ground proved otherwise.  This situation raises doubt about the independence of an auditor. Independence is the cornerstone of accountability.  The challenge is that corporate management hires, fires, and pays both their internal and external auditors.  Auditors, therefore, develop good relationships with management to keep the job of the client.  They may not, therefore, be independent of the corporate management. Most studies on Auditor independence have concentrated on it as a financial reporting issue. But financial reporting is one aspect of the total impact of auditor independence. Much more significant is the impact of a set of standards on a company’s organisation, philosophy, business structure compliance to the standards, performance management, and internal control and so on.

 STATEMENT OF PROBLEM

In Nigeria, there have been a number of audit failures, some leading to the restatement of figures in the financial statements.  For example, Lever Brothers, African Petroleum and Cadbury, just to mention a few important ones. Although, it has not been proved by any detailed investigation that these audit failures were due to impairment of auditor’s independence it could reasonably be suspected to be a contributing factor (Adelaja, 2009). Financial reports as stated in Igben (1999) are meant to be a formal record of business activities and these reports are meant to provide an overview of the financial position and profitability in both short and long term of companies to the users of these financial statements such as shareholders, managers, employees, tax analyst, banks, etc. But in recent times, the financial manipulations, weak internal control systems, ignorance on the part of the board of directors and audit committee, manipulation on the part of the reporting auditor and other fraudulent activities that occur within companies, creating a negative goodwill to the general public.

A typical example of a financial statement malfunction is the popular case of Enron. Secondly, concerns have been expressed about the conflict of interest between the statutory role of the auditor and the other services it may undertake for a client (UK House of Common Treasury Committee, 2008).  Also, a number of worrisome audit failures have been recorded across the world: Enron, in the US, Northern Rock in the United Kingdom, Metagelshaft in Germany, Parmalat in Italy; Lever Brothers and Cadbury in Nigeria.  Audit firm tenure has also been linked with fraudulent financial reporting.  If empirical studies are not carried out with respect to specific environmental factors and necessary policies are not implemented to address shortcomings, the problem of auditor independence may be exacerbated with likely grave consequences for the nascent Nigerian Capital Market. Finally, it is widely accepted that independence is the most priceless asset in the auditing profession and the basic principle that underpins the reputation of the auditing profession in the public eye. By conducting an auditing work independently, auditors protect the public’s confidence in such services. Despite this, several firms’ scandals, directly or indirectly involving auditors, have damaged public confidence in auditor independence. These scandals have taken place not just in one country but across the world, these scandals have caused the public suffering huge losses and have also damaged the reputation of the auditors and the auditing profession. Although these scandals cannot solely be attributed to the failures of the auditors, the public perceived that a large part of the responsibility lay with them. This is because the public expects the auditing profession to perform not just as watchdogs that give them reasonable assurance but also as bloodhounds that track out everything even when there is nothing to provoke auditors’ suspicion. Moreover, it is also widely believed that these scandals took place because of the auditors’ lack of independence, as a result of accommodating their clients’ interests during audits.

 OBJECTIVES OF THE STUDY

The aim of this study is to evaluate and investigate the extent of reliance on auditor’s independence on the credibility of financial reporting quality of corporate organization. Specifically, the study intends to:

i.  To know how auditors’ independence affects the financial statement of a limited liability company.

ii.  To assess the factors that affects an auditor’s independence.

iii. To determine an auditor’s right or wrong judgement will affect the credibility of the financial reporting quality.

iv. To identify the acts and standards that regulates the attitude of auditors.

v. To examine the duties, powers, and functions of an auditor.

vi. To assess how a wrongly audited financial statement affects a limited liability company.

vii. Ascertain the adequacy of professional and regulatory stipulations on audit independence in Nigeria

RESEARCH QUESTIONS 

The following research question were asked to guide the study, whereas answer to the following questions will be sought as a basis for testing the hypotheses:

1.  Does auditors’ independence affect the credibility of a financial statement?

2.  What are the duties, powers, and rights of an auditor?

3.  Does an auditor’s right or wrong judgement affect the credibility of a financial reporting quality?

4.  Are there factors that affect auditors’ independence?

5.  Do auditors always operate within the framework of accounting standard and other regulations?

6.  Are the professional and regulatory stipulations on audit independence in Nigeria adequate?

STATEMENT OF HYPOTHESIS

The hypotheses proposed in this study are stated in the null as follows:

HYPOTHESIS ONE

Ho:  There is no significance relationship between auditor’s independence and credibility of the financial reporting quality.

HYPOTHESIS TWO

Ho: Non-audit services do not have a significant effect on the quality of financial reporting in Nigeria.

 SIGNIFICANCE OF THE STUDY

This research study aims to contribute both theoretically to the literature, and practically to the auditing profession, it shall seeks to provide ordinary insight on area concerned with auditor independence, and explored the possibility of relationship between the levels of auditors’ reputation awareness and their independence. It also aim to contribute to the extant literature on auditor independence by increasing the understanding of situations that potentially threaten auditor independence including social pressures, self-interest, familiarity, and intimidation. In addition, this research study offers factors that may theoretically and practically enhance and protect auditor independence. The study has the potential of encouraging auditors and users of financial information to see the need for audit independence.  It will enable clients appreciate the enormity of the auditor’s job and factors that can affect his job.  The outcome of the study will assist audit firms and management or directors of companies to further appreciate the need to comply with the relevant Statement of Accounting Standard (SAS) and the International Financial Reporting Standards (IFRS). This study hopes to provide relevant literature on audit independence. Finally, this study is also expected to serve as input to regulators and other stakeholders of corporate financial reporting to establish policies relating to corporate financial reporting, particularly in the Nigerian context, since empirical evidence on this issue is limited in the country. It would also be useful to student of tertiary institution writing their final year project as well as lecturers.

SCOPE OF THE STUDY

The scope of this study covers the reliance of audit independence on the credibility of financial reporting quality in Nigeria.  However, due to logistics, this study has been limited to Five auditing companies located in Kwara State, Nigeria.  The researcher felt that the findings of the study will be applicable to other Nigerian companies, audit firms and users of financial information which operate in the same social, economic, political and legal environment.

 LIMITATION OF THE STUDY

The following limitations of the study are as follows:

Time: – This is the first limitation that affected the research study badly because carrying out the study requires time and one can’t afford to miss lecture and embark on a journey to the cost study.

Finance: – It is another limitation because the study requires enough funds to carry out the research and without the funds the study will not be fruition.

Uncooperative staff: – Some of the staff was very uncooperative and some even refused to accept my questionnaire and those that accepted, some of them did not summit back their questionnaire.

 DEFINITION OF TERMS

1. Audit independence is defined as an auditor’ unbiased mental attitude in making decisions throughout the audit and financial reporting.

2. Auditor:  Auditor is a qualified accountant who also passed a professional examination. Such a person must be of good conduct and have a vast knowledge and able to understand a practical business, endeavor always to grasp the technicalities and business, methods of any concern whose account he undertakes to audit.3. External Audit: This is an audit carried out by an independent person who is not an employee of the enterprise.

4. Audit quality means how well an audit detects and report material misstatements in financial statements, the detection aspects are a reflection of auditor competence, while reporting is a reflection of ethics or auditor integrity, particularly independence.

5. Financial statements (or financial report) are the formal records of the financial activities of a business, person, or other entity. This is a generic term for profit and loss account, balance sheets, cash flow statement, five year financial summary, value added statement, income and expenditure account, statement of accounting policy etc

6. Audit Committees: An audit committee is a selected number of members of a company’s board of directors whose responsibilities include helping the auditors remain independent of management.

7. Investigative independence protects the auditor’s ability to implement the strategies in whatever manner they consider necessary. Basically, auditors must have unlimited access to all company information.

8. Self Interest Threat:   This is a threat to auditors’ objectivity sterns from a financial or other self interest conflict which could result from a direct interest or indirect interest in a client for losing the audit assignment.

9.  Objectivity: refers to the need to maintain impartial judgment (e.g. not developing analysis to support a decision that the accountant knows is not correct. 

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