Abstract
The purpose of this study is to examine the Audit
Firm Rotation and Audit Quality Evidence from Nigeria Banks. The main objective
of the study is to examine the extent audit firm rotation significantly affects
audit quality, and to evaluate the relationship between board independence and
audit quality. The debate on audit quality firm rotation is not a settled
mater. This study intended to assess the applicability of the mandatory auditor
rotation concept in the Nigerian bank sector so as to enhance and improve audit
quality, from the findings of both the literature as well as the field survey,
it was discovered that audit firm rotation significantly affect audit quality.
It was concluded that rotation is a good solution to enhance and maintain the
auditor independence by decreasing the audit firm’s dependence on the client.
Recommendations were made amongst others that regulatory bodies e.g. CBN, FRSC
should help make laws that will reduce audit firm rotation and help improve
audit quality, the Central Bank of Nigeria should think of other ways
to address concern about audit quality.
TABLE OF CONTENTS
Title
Page i
Certification
ii
Dedication
iii
Acknowledgements
iv
Abstract
vi
Table
of Contents vii
Chapter One:
Introduction
1.1
Background to the Study 1
1.2
Statement of Problems 4
1.3
Research Questions 5
1.4
Objectives of the Study 6
1.5
Statement of Hypothesis 6
1.6
Significance of the Study 7
1.7
Scope of the Study 8
1.8
Limitation of the Study 8
1.9
Definition of Terms 8
Chapter
Two: Review of Related Literature
2.1 Introduction
10
2.2 Concept
of Audit Quality 11
2.3 Audit
Quality and Audit Firm Rotation 14
2.4 Audit
Quality and Audit Fees 21
2.5 Audit
Qualities and Company
Size 25
2.6
Audit
Quality and Board Independence
26
2.7 Theoretical
Framework 29
Chapter
Three: Research Method and Design
3.1
Introduction 33
3.2
Research Design 33
3.3
Description of Population of the Study 34
3.4
Sample Size 34
3.5
Sampling Techniques 34
3.6
Sources of Data Collection 35
3.7
Method of Data Presentation 35
3.8
Method of Data Analysis 35
Chapter
Four: Data Presentation, Analysis and Interpretation
4.1 Introduction 38
4.2 Data Presentation 38
4.3 Data Analysis 39
4.4 Hypothesis Testing 43
Chapter
Five: Summary of Findings, Conclusion and
Recommendations
5.1
Introduction 46
5.2 Summary of Findings 46
5.3
Conclusion 47
5.4
Recommendations 47
References
49
CHAPTER ONE
INTRODUCTION
1.1 Background to the
Study
Audit
quality has attracted enormous attention since the financial reporting scandals
in major corporations such as Enron and WorldCom in the United State of America
as well as Parmalat in Italy. It is defined as the auditor’s ability to
discover a breach in the client’s accounting system combined with the auditor’s
willingness to report such breach (DeAngelo,1981;Watts & Zimmerman,1981). Riyatno
(2007), defines audit quality as something that is abstract, difficult to
measure and can only be perceived by the users of audit services. Thus, there
is no uniform definition of audit quality. While Dc Angelo (1981) as cited in
Ebrahim (2001) defines audit quality as the combined probability to detect and
report material errors in financial statements, Palmrose (1988) defines audit
quality in terms of the level of assurance since the purpose of an audit is to
provide reasonable assurance to users on financial statements.
The
reporting scandals that have rocked the globe has made the auditing profession
attempt to improve audit quality issuing standards focused on corporate
governance. Empirical studies (Arrunada & Paz1 Ares,1997; Brody &
Moscove,1998;Healey & Kim,2003) have tried to examine ways or avenues for
the improvement of audit quality.
The
2006 consolidation of banking sector in Nigerian brought about the introduction
of mandatory audit firm rotation as part of banks’ code of corporate governance
with the aim of further strengthening audit quality. Mandatory audit firm
rotation became topical after the simultaneous sack of 8 banks chiefs by the
governor of Central Bank of Nigeria in 2009, and the imposition of external
auditors rotation after 10 years of engagement by the apex bank. It was also
said by the apex bank that for the avoidance of doubt, the maximum period of 10
years shall include the period an audit firm, which later merged/changed name,
first commenced audit assignment in the bank.
Mandatory
rotation of external auditors requires audit firms to be rotated after a
specified number of years irrespective of the quality, independence of the
audit firm, the willingness of the shareholders and the management to keep the
firm. Azizhakhani (1967), explains that mandatory rotation of auditors was first
introduced during the Mckesson Robbins accounting scandal in the late 1930s.
However, it took another turn after Enron financial scandal and the compromise
of Author Andersen. There was a meeting held by U.S senate where the issue of
the audit profession and the benefit of audit firm rotation to audit quality
was discussed. Some participants at the meeting agreed with the idea that audit
firm rotation improves audit objectivity and that long-term relationships between
companies and their auditors tends to reduce auditors’ independence and
quality. They further agreed that a client maybe a significant source of
revenue for an auditor and the auditor may be reluctant to jeopardize the
revenue stream as he would not want to bite the very hand that feeds him
(Hoyle, 1978).
Firm
rotation may also help to prevent large scale corporate collapse. The estimated
market capitalization loss of the collapses of WorldCom, Tyco, Quest, Enron and
Computer Associates was put at $US460 (Jackson, Moldrich & Roebuck, 2007).
They also argued that audit quality is diminished with long audit tenure, that
mandatory rotation will reduce familiarity threat, ensures auditors
independence and provides a greater skepticism and a fresh perspective that may
be lacking in long-standing audit or client relationship (Firth, Rui & Wu,
2010; Hyeeso, 2004).
1.2
Statement of Problem
Different
studies (Arrunada & Paz-Ares, 1997; Brody & Moscove, 1998; Dopuch, King
& Schwartiz, 2001; Myers & Omer, 2003) have tried to examine possible
explanatory variables for the state of audit quality. The presence of audit
failures in the world has brought a great deal of disappointment to
stakeholders and investors, and longevity of audit firm tenure has also been linked
with fraudulent financial reporting which reduces the audit firm rotation
improves audit quality as auditors may need to be experts in their area and
acquire client-specific knowledge overtime (Ghosh & Moon, 2005; Defond & Francis, 2005;
Jenkins & Velury, 2008). This means that audit quality is lower during the
early years of the auditor-client relationship and increases with length of
audit firm rotation due to the reduction in information communication between
auditor and client (Azizkhani, Monroe& Shailer, 2006).
Therefore,
this study extends and contributes to the body of research using data from
Nigerian banks to investigate the likely impact of audit firm rotation on audit
quality.
1.3
Research Questions
Specifically,
the following research questions are put forward:
1.
To what extent does audit firm
rotation significantly affect audit quality?
2. What is the relationship between company
size and audit quality?
3. How do audit fees affect audit quality?
4. What is the relationship between board
independence and audit quality?
1.4
Objectives of the Study
The
broad objective of this study is to examine the impact of audit firm rotation
on audit quality. The specific objectives of the study are to:
1. Examine the extent audit firm rotation
significantly affects audit quality;
2. Determine the relationship between company
size and audit quality;
3. Investigate how audit fees affects audit
quality; and
4. Evaluate the relationship between board
independence and audit quality.
1.5
Research Hypotheses
The
hypotheses stated below are raised in order to actualize the objectives of this
study.
Hypothesis
One
HO: Audit firm rotation
contributes negatively to the quality of audit assignment.
HI: Audit firm rotation
contributes positively to the quality of audit assignment.
Hypothesis Two
HO: There is no significant
relationship between the firm’s size and audit quality.
HI: There is significant
relationship between the firm’s size and audit quality.
Hypothesis Three
HO: There is no significant
relationship between board independence and audit quality.
HI: There is significant
relationship between board independence and audit quality.
Hypothesis Four
HO: There is no significant
relationship between affecting audit quality.
HI: There is significant
relationship between affecting audit quality.
1.6
Significance of the Study
This
study provides useful insight into improving audit quality in banks operating
in Nigeria. Some interest groups that will benefit from this study are:
1. Regulatory bodies e.g. CBN, FRCN: This will
help them to make laws that relates to audit firm rotation and help improve
audit quality
2. Audit firms: This will make audit firms
understand the significance or otherwise of audit firm rotation.
1.7
Scope of the
Study
This
study is focused on audit firm rotation and audit quality of banks in Nigeria.
Data is gotten from financial statements of 15 banks within the period 2005-2011. All the banks used are
quoted on the floor of the Nigerian Stock Exchange.
1.8
Limitation of the Study
Since
this study focused on Nigeria banks, the findings thereof might not be
applicable to other companies in a different sector because of the individual
peculiarity of different industries or sectors.
1.9 Definition of Terms
1.
Audit
quality: The accounting quality of the financial used, these
number can either be derived from an audit by a third party, classified as
‘audited’ or ‘reviewed’ or derived from within the company classified as
unaudited.
2.
Auditing:
An
official examination and verification of accounts and records, especially of
financial account.
3.
Audit
firm rotation: An audit firm rotation is the aim of
this review is to identify, consider and evaluate the existing evidence on
mandatory of the audit firm rotation.
4.
Audit
fee: An audit fee consist of fees billed for professional
services rendered for the audit of our financial statement and review of the
interim financial statement included in quarterly reports and services that are
normally provided in uniack connection with statutory and regulations.
5.
Audit
Report: An audit report is the formal opinion of audit
finding, the reports writing is the end result of an audit performance by an
auditor.
6.
Bankruptcy:
A
legally declared or recognized condition of insolvency of a person or
organization.
7.
Shareholders:
It is an owner of share in an company or business.
8.
Stakeholder
theory: Stakeholder theory is a theory of organization
management and business ethics that address moral and values in managing an
organization.
9.
Financial
Statement: A financial statement or financial
report is a formal record of the financial activities of a business or other
entity.
10. Integrity: The
quality of being honest and having string moral principles.
11. Organization: A
group of people who form a business, club etc.
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