ABSTRACT
External auditors conduct an independent examination of a firm’s financial statements, records and supporting documents and give opinion about the truth and fairness of the reports, and that the report is free from material misstatements and errors. While, this can be considered as a good control mechanism for ensuring the quality of corporate financial reporting, there is a great concern by the regulatory authorities and other stakeholders in view of the corporate scandals and failures that adversely affect corporate entities in recent times in Nigeria. This study examined the impact of audit firms‟ attributes on financial reporting quality of quoted building material firms in Nigeria. The study employed primary source using a sample of one listed building material firms. The study found that audit compensation and audit firm independence have significant positive impact on the financial reporting quality of quoted building material firms in Nigeria at 99% confidence level. The finding suggested that, audit compensation and provision of non-audit services in the quoted building material firms in Nigeria have improved the quality of their financial reporting during the period under review. The study recommends that, policy makers (SEC and FRC) should make policies that would strengthen the auditors‟ independence in the building material firms in Nigeria. It is also recommended that SEC and FRC should make it a policy that public companies, especially building material firms, should consider in employing their auditors an optimal compensation
TABLE OF CONTENTS
Cover
page - - - - - - - - - -i
Declaration - - - - - - - - - ii
Certification - - - - - - - - - iii
Approval
Page - - - - - - - - - iv
Acknowledgement - - - - - - - v
Dedication - - - - - - - - - vi
Table
of Contents - - - - - - - - vii
Abstract - - - - - - - - - viii
CHAPTER ONE
INTRODUCTION
1.1
Background to the Study - - - - - - - -1
1.2
Statement of the Problem - - - - - - - -4
1.3
Objectives of the Study - - - - - - - - -5
1.4
Research Questions - - - - - - - - -6
1.5
Hypotheses of the Study - - - - - - - - -6
1.6
Significance of the Study - - - - - - - -6
1.7
Scope of the Study - - - - - - - - -7
1.8
Limitation of the Study- - - - - - - - -7
1.9
Historical Background of the Area of the Study- - - - - -9
1.10
Definition of Key Terms- - - - - - - -9
CHAPTER TWO
LITERATURE REVIEW
2.1
Introduction - - - - - - - - - -11
2.2
Conceptual Framework - - - - - - - - -11
2.2.1
Proxies of Financial Reporting Quality - - - - - -13
2.2.1.1
Properties of Earnings - - - - - - - -13
2.2.1.2
Investor Responsiveness to Earnings - - - - - -17
2.2.1.3
External Indicators of Earnings Misstatements - - - - -17
2.2.2
Determinants of Financial Reporting Quality - - - - - -17
2.2.3
Audit Firm Characteristics - - - - - - - -20
2.3
Empirical Framework - - - - - - - - -22
2.3.1
Audit Compensation and Financial Reporting Quality - - - -23
2.3.2
Auditor Independence and Financial Reporting Quality - - - -25
2.3.3
Big 4 and Financial Reporting Quality - - - - - -28
2.3.4
Joint Auditors and Financial Reporting Quality - - - - -30
2.4
Theoretical Framework - - - - - - - - -31
2.5
Building Material Firms- - - - - - - - -34
2.5.1
Nigerian Building Material Firms - - - - - -35
2.5.2
Audit Procedures in Building Materials Firms in Nigeria - - - -36
CHAPTER THREE
RESEARCH METHODOLOGY
3.1
Introduction - - - - - - - - - -37
3.2
Research Design - - - - - - - - - -37
3.3
Population of the Study - - - - - - - -37
3.4
Sample Size - - - - - - - - -38
3.5
Sampling Technique - - - - - - - - -38
3.6
Method of Data Collection - - - - - - - -38
3.7
Techniques of Data Analysis - - - - - - - -39
3.8
Variables Measurement and Models Specification
- - - - -39
CHAPTER FOUR
DATA PRESENTATION ANALYSIS AND
INTERPRETATION
4.1
Introduction - - - - - - - - - -40
4.2
Administration and Return of Questionnaires - - - - -40
4.3
Test of Hypothesis - - - - - - - - -49
CHAPTER FIVE
SUMMARY, CONCLUSIONS AND
RECOMMENDATIONS
5.1
Summary - - - - - - - - - -54
5.2
Conclusion - - - - - - - - - -55
5.3
Recommendations - - - - - - - -56
Reference
Appendix
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The main
objective of financial reporting is to provide high quality financial
information about economic entities that is useful for economic decision
making. According to International Accounting Standard Board (IASB), (2008),
high quality financial reporting is critical to investors and other
stakeholders in making investment, credit and similar decision. An important
variable of financial reporting that is usually used as a yardstick of
financial reporting quality is accounting earnings, as it is reported in the
published financial report of firms is expected to provide a timely and
reliable input to potential investors, shareholders, creditors, employees,
management, financial analysts, regulators and other stakeholders for efficient
economic decisions.
The issue
of quality financial reports is of tremendous concerns not only for the final
users, but the entire economy as it affects economic decisions which may have
significant impact. However, managerial opportunistic behaviors as well as
unethical accounting practices are identified as major challenge to the quality
of accounting earnings and financial reporting quality (Shen & Hsiang-Lin, 2007). According to their study of some accounting
scandal and collapse of some corporate entities (Enron, Worldcom, Xerox and
Parmalat), earnings manipulation and artificial transaction are responsible for
the scandal and the collapse of those entities. Moreover, most of the Chief
Executive Officers (CEO) and Managers of the collapsed entities are found
involved in earnings management through structuring and artificial transactions
with related parties which affected earnings and financial reporting adversely
(Shen and Hsiang-lin, 2007). Earnings management as a prime factor that impairs
quality of earnings is regarded as unethical and includes using managerial
judgments and earth in regulation (Bello, 2010). In a study of financial
reporting quality, Shehu (2012) opined that quality financial reporting could
be achieved by full disclosure and higher level of transparency; and regarded
corporate transparency as the widespread availability of relevant and reliable
information about the periodic performance that is free from errors and
misstatements. Therefore, the quality of financial reporting is to promote
transparency and deliver high quality Annual Report through comprehensive
disclosure (Shehu, 2012). As such regulators and financial statements analysts
as well as auditors should ensure that financial statements information is
true, fair and free from opportunistic and unethical judgments, which destroy
the quality of financial reporting.
It is in
view of the importance of quality financial reporting that the International
Federation of Accountants (IFAC) and its audit arm International Auditing and
Assurance Standards Board (IAASB), stated that audit services is an assurances
service that the financial statements prepared by the managers is true and
fair, and free from intentional and unintentional errors and misstatements, and
conform to the relevant rules and regulations guiding the preparation and
presentation of accounting information (IAASB, 2013). According to IAASB,
global financial stability is supported through high quality reporting, which
could be achieve through high quality audits that can help foster trust in the
quality of reporting. It also highlights the importance of audit quality and
its relevance to all stakeholders in the financial reporting supply chain. One
of the critical roles of auditors is that, they assure confidence to financial
statements users about the reported information. Audit services have been
critical to financial reporting quality since industrial revolution (that is,
separation of ownership from management). However, the ability of auditors or
audit firm to provide high audit quality capable of producing high financial
reporting quality is attributed to some certain features of the audit firm,
these features are auditor independence, audit compensation, audit firm type
and size and joint audit services (DeAngelo, 1981 & Krishnan, 2003). For
instance, Brown, Falaschetti and Orlando (2006) state that auditor independence
improve the quality of financial disclosures based on the evidence from the
recent governance scandals around the world. They further lament that a widely
held belief emerged that letting auditors consult for audit-clients compromises
auditors’ independence and thus diminishes the quality of earnings reports.
This is also supported by most of the regulations; for instance it forms part
of the provision of Sarbanes-Oxley (SOX) Act of 2002, which restricted auditors
from providing non-audit services to their clients (Brown et al, 2006). On the
other hand, auditor’s independence with regard non-audit services which lead to
non-audit fees can improve the quality of financial reporting (Arrunada, 1999).
According to him, if informational inputs for producing the audit services
intersect those for producing the non-audit services, then the jointly
producing audit and non-audit services can improve financial reporting quality
by facilitating scope economies. However, managers are using their capacity to
threaten auditors with the loss of non-audit business; in this regard, jointly
producing audit and non-audit services increases the pressures the managers can
place on auditors to endorse compromised financial statements (Arrunada, 1999).
Similarly,
compensation to auditors is found to be related with financial reporting
quality (DeAngelo, 1981); according to this belief, quality may decrease with
fee dependence if marginal forces associated with managerial influence
overwhelm those associated with the scope of activities involved (Frankel,
Marilyn and Karen, 2002; Francis, 2004). On the contrary, audit compensation is
used as a measure of audit quality, based on this view; audit fees reflect
additional audit effort which led to a higher level of audit quality (DeAngelo,
1981; Carcello, Hermanson, Neal & Riley, 2002). In this context, audit fees
and non-audit fees relate to knowledge spillovers that is, transfers of
knowledge from non-audit to audit services. Moreover, increase in audit fees as
a result of nonaudit services may enhance auditor’s incentives to stay
independence.
Another
audit firm characteristic commonly associated with the financial reporting
quality is audit firm size (that is, Big 4).
Audit firm type is conceived as financially independent and highly
experienced, thus less likely to be subjected to any pressure from the clients
“to look the other way” in their role in discovering accounting irregularities
(DeAngelo, 1981). Moreover, Big 4 auditors have more to lose should a scandal
arise, in that their brand names and reputations are more valuable compared
with small non-Big 4 audit firms. For instance, Becker, Defond, Jiambalvo and
Subramanian, (1998), and Francis, Maydew and Sparks (1999) opined that Big 4
audit firms have shown to have higher accrual quality (Financial reporting
quality) as measured by lower absolute values of discretionary accruals, and
their clients are less likely to manage earnings.
Audit firm
characteristics with respect to clients include the joint audit, to ensure
objective financial reporting and financial reporting quality as well. Joint
audits create more differences in auditor choice and potentially in the level
of earning quality than under non-joint audit. Based on joint audit
perspective, DeAngelo (1981) states that audit performed by two audit firm
produce the highest quality financial reporting, while the lowest level of
quality occurs when a single audit firm is responsible for the audit
engagement. Therefore, this study is motivated by the critical role that the
auditors have in corporate financial reporting with regard accounting
irregularities and misstatements including earnings management, which impair,
financial reporting quality and threaten the going concern of corporate entity.
The study however, focuses on the major audit firm attributes (audit
compensation, non-audit services, audit firm type and the provision of joint
audit). These attributes are considered as determinants of audit quality which
has defect linkage with the financial reporting quality.
Nigeria
like other countries of the world witnessed corporate scandals and failures,
such as Oceanic Bank, Societe Generale Bank, Savannah Bank and Cadbury Plc,
which are not pointed by the financial reports in spite of the auditor’s
endorsement. That financial reports are true and fair, and conform to the
relevant rules and regulations; and the actual transactions. Building material
firms are critical to the economic development of any country; this sector is
not being given adequate attention in terms of researches on financial
reporting quality particularly in relation to auditors’ characteristics.
Specially, building material firms are characterized with heavy machineries,
large volume of transactions and large volume of accruals. These features are
potentials for hiding accounting irregularities, misstatements and earnings
management, which affect financial reporting quality adversely. Therefore, the
need for quality financial reports in the recent times and the negative consequences
of poor-quality reporting prompted the study of financial reporting quality of
building material firms in Nigeria.
1.2 Statement of the Problem
Financial
reports are supposed to provide relevant information to the external parties of
an organization. It is thus important that financial reports provide truthful
and accurate financial information to enable shareholders and other interested
parties to make decision wisely. Lack of accuracy in financial reporting will
lead shareholders and prospective investors to make wrong judgment about the
organization. Incidentally, the heavy reliance placed on accounting numbers (as
it measures the direction of business entity as well as decision base by
different users of accounting information, Kothari, et al., 2000; and Bello, 2010) has provided an
incentive for managers to manipulate earnings to their own advantage. This
manipulation that is not supposed to go unchecked by auditors has often led to
the eventual collapse of firms of various sizes and even called to questions
the integrity of auditors and characteristics of audit firms.
The
credibility of financial information is vital to the growth of nay economy.
Auditors on their part are expected to be independent and objective in the
discharge of their responsibilities (Adelaja, 2009), because as the report of
external auditors in corporate financial statement is seen as providing key
assurance and protecting the interest of shareholders (Gallegos, 2004).
However, as O’Connor (2006) noted, one of the most vexing problems in the
financial world today is the emphasis placed on ensuring the independence of
external auditors as a result of recent corporate Scandals. Beatties and
Fearnley (2002) opined that after the collapse of Enron it was generally
believed that rendering of non-audit services compromised the independence of
external auditors. In the real world, when business entities collapse the
consequences are usually enormous. The oversight function of the auditor is
placed under scrutiny when a business whose financial statement once showed no
indication of any failure suddenly becomes bankrupt. As a follow up to the
oversight function, the independence of the auditor in such circumstance would
be in doubt.
Many
studies like DeAngelo, (1986) Jones, (1991) and Dechow, Sloan, & Sweeney,
(1995), Ashbaugh et al.,
(2003) have been conducted on the relationship between audit firm
characteristics and quality of financial reporting. The studies are however
based largely on US and European data, thus reflecting the advanced economies
environment. Few of the studies such as Semiu and Kehinde (2011), Semiu and
Johnson (2012) and Umar (2012) used data from emerging economies such as like
Nigeria. Little is known about the relationship between audit firm
characteristics and firms reporting quality in developing markets such as those
in Nigeria particularly, using data on building materials firms. It is
therefore pertinent to conduct a study that will fill this literature gap.
Moreover, this study used four audit firm chrematistics variables to
investigate their effects on the financial reporting quality of building
materials firms in Nigeria. Hence gap to be filled in the literature because
most of the studies in this area focused on usually one aspect of audit firm
characteristics.
1.3 Objectives of the Study
The aim of this study is to examine
the impact of audit firm’s characteristics on the financial reporting quality of
listed building material firms in Nigeria. The specific objectives of the study
are to:
i.
Determine the impact of audit fee on the financial reporting
quality of quoted building material firms in Nigeria;
ii.
Assess the effect of audit firm independence on the
financial reporting quality of quoted building material firms in Nigeria;
iii.
Assess the impact of auditor type on the financial reporting
quality of quoted building material firms in Nigeria; and
iv.
Examine the impact of joint audit on the financial reporting
quality of quoted building material firms in Nigeria.
1.4 Research Questions
The following research questions are raised to
guide the study:
i.
How does audit fee affect the quality of financial reporting
of quoted building material firms in Nigeria?
ii.
What is the effect of audit firm independence on the quality
of financial reporting of quoted building material firms in Nigeria?
iii.
Does audit firm type have any impact on the quality of
financial reporting of quoted building material firms in Nigeria?
iv.
What is the effect of joint audit on the quality of
financial reporting of quoted building material firms in Nigeria?
1.5 Hypotheses of the Study
In line with the objectives of this
study, the following hypotheses are formulated in null form;
|
Ho:
|
Audit compensation has no significant impact on the
financial reporting quality of
|
|
|
quoted building material firms in Nigeria.
|
|
Hi:
|
Audit firm independence has significant impact on the
financial reporting quality
|
|
|
of quoted building material firms in Nigeria.
|
|
Ho:
|
Auditor type has no significant impact on the financial reporting
quality of quoted
|
|
|
building material firms in Nigeria.
|
|
Hi:
|
Joint audit has no significant
impact on the financial reporting quality of quoted
|
|
|
building material firms in Nigeria.
|
1.6 Significance of the Study
This study is significant in light by the regulators
for measures that could protect and improve the financial reporting quality in
the corporate world. It is also a response to the current call by the IAASB’s
Framework for Audit Quality
which, include raising awareness of the key elements of audit quality;
encouraging key stakeholders to explore ways to improve audit quality; and
facilitating greater dialogue between key stakeholders on the topic (IAASB,
2013). Moreover, the IAASB framework for audit quality attributed the primary
responsibility for performing quality audits to auditors, and emphasized that
audit quality is best achieved in an environment where there is support from
other participants in the financial reporting supply chain. Hence, this study
is an effort towards such direction.
The study
is also significant as it focused on issues related to audit firm
characteristics that are threatening the survival of audit firms of all sizes,
on one hand and the going concern of corporate entities on the other hand.
Therefore, the study is of importance in ensuring the credibility of financial
information not only for the purpose of pointing the tendencies of corporate
scandals, but most importantly the survival of their accounting and audit
profession and the development of healthy financial and capital market. The
study is therefore of immense value to auditors, regulators, managers,
professional accounting bodies, existing and potential shareholders and
researchers.
The findings from this study could
assists auditors in their duties and responsibilities with regards financial
reporting, as to the factors that are of eminent importance in achieving high
audit quality and high financial reporting quality. The study will also offer
important input to serve as a strong base for the regulators and professional
accounting bodies to establish policies relating to type of audit firm
characteristics, audit fees, non-audit services and joint audit. This is
important because most of the issues in this area are based on anecdotal
evidence, particularly in Nigerian context since evidence regarding these
issues has been relatively limited. The study therefore hopes not only to help
enrich the literature, but also provides important quantitative information for
policy formulation.
The findings from the study could
educate both existing and potential shareholders of building material firms in
Nigeria on the audit firm characteristics that improve the quality of financial
reporting (with respect to audit firm characteristics). The study is also of
great importance to researchers, as it provides empirical evidence on the
relationships between audit firm characteristics and the quality of financial
reporting from listed building material firms in Nigeria.
1.7 Scope of the Study
This study
focuses on audit firms’ characteristics and the quality of financial reporting,
within the context of listed building material companies in Nigeria. Financial
reporting quality is represented by earnings quality which is proxied by
absolute discretionary accruals of the quoted building material firms during
the period covered by the study. On the other hand, audit firm characteristics
in this study covers audit compensation/fees, audit firms’ independence,
auditor type and joint auditors.
1.8 Limitations of the Study
In carrying out this research it is evident
that there is limitation that will fall short of what has been an established
interpretation of the findings one of the limitations are unavailability of
text of the subject, also my inability to reach the study subjects, and discuss
personally with them which I feel will bring out the best result. But that
cannot be possible due to lack of adequate mobility and finance. The researcher
intends to use questionnaire to be distributed and people to be able to cover
enough organizations to make my findings reliable. I also intend to limit the
area to be covered in the research to the Audit attributes and financial
reporting quality of listed building material Dangote Cement Depot Dutse.
Dangote Cement Plc engages in the preparation,
manufacture, control, research and distribution of cement and related products.
It has operations in Nigeria, Benin, Ghana, Senegal, South Africa and Zambia.
The company owns cement import terminals in Lagos, Port Harcourt and Ghana
through which it imports and bags bulk cement. Dangote Cement was founded on
November 4, 1992 and is headquartered in Lagos, Nigeria. “
Established
in May 1981 as a trading business with an initial focus on cement, the Group
diversified over time into a conglomerate trading cement, sugar, flour, salt
and fish. By the early 1990s the Group had grown into one of the largest
trading conglomerates operating in the country.
In
1999, following the transition to civilian rule and after an inspirational
visit to Brazil to study the emerging manufacturing sector, the Group made a
strategic decision to transit from a trading-based business into a fully-fledged
manufacturing operation. In a country where imports constitute the vast
majority of consumed goods, a clear gap existed for a manufacturing operation
that could meet the ‘basic needs’ of a vast and fast-growing population.
The
Group embarked on an ambitious construction programme, initially focused on the
construction of flour mills, a sugar refinery and a pasta factory. In 2000 the
Group acquired the Benue Cement Company Plc from the Nigerian government and in
2003 commissioned the Obajana Cement Plant; the largest cement plant in
sub-Saharan Africa.
Dangote
Cement depot is located at No. 452, Kiyawa Road Dutse Jigawa State. It operates
in distributing cement in all over the state, the cement is by no doubt the
most used construction material in the state. As Dangote Cement is an adhesive
substance, in other words, it is binding material or a substance used in the
construction process for binding or holding other materials together.
The
cement is not usually used on its own, but rather used in binding together sand
and gravel. Cement, when mixed with fine aggregates produces mortal, and when
mixed with gravel sand produces concrete.
1.10 Definition of Terms
Attributes: In general, an attribute is a property or
characteristic.
Audit: Audit is the
examination or inspection of various books of accounts by an auditor followed
by physical checking of inventory to make sure that all departments are
following documented system of recording transactions.
Auditing: Auditing typically refers to financial statement audits or an
objective examination and evaluation of a company’s financial statements
usually performed by an external third party.
Building Material: Building material is material used for construction. Many naturally occurring substances, such
as clay, rocks, sand, wood, and even twigs and leaves, have been used to
construct buildings.
Finance:
Finance is a
term for matters regarding the management, creation, and study of money and
investments.
Financial Reporting: Financial reporting is the process of
documenting and communicating financial activities and performance over
specific time periods, typically on a quarterly or yearly basis.
Firms: A firm is a for-profit business organization such as a corporation,
limited liability company (LTD), or partnership that provides professional
services. Most firms have just one location.
Internal
Audit: Internal Audit is a
department or organization within a company tasked with providing unbiased,
independent reviews of systems, business organizations, and processes.
Quality: In business, engineering, and manufacturing, quality or high quality has
a pragmatic interpretation as the non-inferiority or superiority of something (goods or services); it is also defined as being suitable for the intended purpose
(fitness for purpose) while satisfying customer expectations.
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