AUDIT INDEPENDENCE AND CREDIBILITY OF FINANCIAL REPORTING IN THE NIGERIAN BANKING SECTOR

ABSTRACT

In this study the independence of auditors was critically evaluated and the importance of auditors’ independence in financial statement credibility was analyzed. In order to make informed decision it is important for the financial statement to be credible. The auditors are expected to audit the financial statement of companies in order to present a true and fair view or otherwise of the financial statement. The study adopted a survey research design. The data used for this work were collected from primary sources. The relevant data collected were analyzed using descriptive statistics of mean and standard deviation and inferential statistics of regression and correlation. The results of the analysis show that auditor’s independence affects the understandability, reliability and faithful representation of financial statement in the Nigerian Banking sector. The reason why audit exists is because investors and creditors can make use of financial statement to make their decisions. The study concluded that auditors’ independence and the credibility of financial statement are to be significantly impaired when non-audit services are conducted and that there is a positive relationship between independence of an auditor and the credibility of financial statement, therefore the independence of an auditor is fundamental to the credibility of financial statement. Finally, the study recommends that there should be rotation of auditors to improve the auditors’ independence, implementation of peer assessment in other to ensure that audit are carried out with outmost professionalism and mutual respect and that auditors should not be allowed to provide audit client with any other advisory services.

 

 

CHAPTER ONE

INTRODUCTION

I.1   Background to the Study

In present times, there has been much discussion about the Auditors independence; 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 statements 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 financial statement in order to know the financial position of the organization so that stakeholders can make decisions (Loveday, 2017).

Securities and exchange commission (SEC) require traded companies to make sure their statements are prepared and audited by certified public accounting firm who assume the responsibility for the fairness of the financial statements. This opinion adds to the credibility of the statements which is agreed by the lender and private investors who voluntarily allow company’s statement to be verified by independent body. 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 (Eko, 2015).

The function of auditing is to lend credibility to the financial statement. The financial statements preparation is the responsibility of the management, while auditor responsibility is to lend credibility of the financial statements. The auditor also increases the credibility of other non-audited information which is released by the management. For an audit to be credible and reliable, it must be performed by someone who is independent and cannot be influence by position, power which will affect its own conclusion. The securities exchange commission approved new auditor independence regulation which requires that traded companies should disclose the level of fees that were paid to their external auditor for non-audit services (IAASB, 2015).

The auditor independence has long been recognized as the cornerstone of the public accounting profession and that it is privileged to govern itself. Society grants power and privilege to the Accounting profession. Auditors are obligated to perform their duties for the public benefit in exchange for exclusive professional privilege. Traditional audit independence view regard as a moral perspective (Babatoolu, Osasrere and Emmanuel, 2016). As for a moral perspective, auditors are professionals, with professional obligations to the public. They should not engage in any activity that appears to impair their effectiveness as professionals, regardless of the totality of their incentives (Enofe, Okunega and Ediae, 2013).

Professionals are presumed to do things because of their professional duties, not because of their best interests. In incentives right or wrong is concentrated. Morally, some seem to believe that it is wrong for an auditor if "appear" not to be independent. Intrinsic ethical concentration is an influencing factor to consider on a moral view the nature of the moralistic analysis that support the enhancement of the audit independence and have significant to the auditor's role to play auditors' primary duty to protect the public interest and the necessity to use judgment in fulfilling this duty (Ilaboya and Ohiokha, 2014). The ideal of auditor independence has been clearly stated for a long time. 

The second general standard of generally accepted auditing standards states that “in all matters relating to the assignment, independence in mental attitude is to be maintained by the auditor or auditors.” Essentially, an auditor may function as an employee (internal auditor) or an independent professional (external auditor). Users of these entities' financial information, such as investors, government agencies, and the general public, rely on the external auditor to present an unbiased and independent evaluation on such entities.  In an ideal world this may be the case, but in reality auditors may be less independent than the other auditors (Nemit, 2015).

Safeguarding auditor’s independence is a key priority not only for auditors, but also for management and investors. In the global market of today, the government, creditors, institutional investors, lenders, regulator, stakeholder etc. rely on the information provided by the auditors on the credibility and reliability of the financial statements. From a theoretical perspective, one of the primary purposes of financial reporting is to facilitate capital allocation by increasing contracting efficiency and reducing information asymmetry among capital market participants (Gow, Larcker and Reiss, 2015). Improvements in reporting quality serve to provide investors with more accurate information and thus can reduce information asymmetry and increase contracting efficiency. Thus, improvements in reporting quality can increase a company’s access to external finance and ultimately lead to increases in investment and investment efficiency (Novie, 2013).

Companies establish the credibility of their financial statements by having an independent auditor to verify the accuracy of those disclosures. However, the effect of auditing on financial statement credibility depends on the independence of the auditor and the rigor with which the audit is performed (DeFond and Zhang, 2014). An increase in reporting credibility can increase the degree to which investors rely on financial statement information for both contracting and learning about companies’ operations and performance, which can increase the company’s access to external finance and investment/investment efficiency (Nwanyanwu, 2013).

One of the information used is the financial report is the product of a process of accounting. In this case the financial statements that can be trusted by investors absolutely necessary. In order for those statements to be believed, then the audit of financial statements is necessary especially for a company incorporated in the form of a limited liability company that is open. The management company appointed by the shareholders held accountable in the form of financial statements for the funds that have been submitted to the management of company (Wali, 2015)

I.2   Statement of the Problem

Recent reports of questionable accounting practices adopted by some companies in Nigeria have brought the issue of auditor’s independence to the forefront, and putting the auditing profession credibility in doubt (Otusanya and Lauwo, 2010). Financial reports 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.

Recent misappropriation of financial statement such as by Enron, Worldcom, or Parmalat revealed that information provided by financial statements does not faithfully represent what its purports. Based on recent case of Parmalat, as well as in the cases of Comroad and FlowTex in Germany, management counterfeited documents and receipts for non-existent assets or transactions. These scandals clearly mean that it is not sufficient to rely on management representations to be what they seem at first instance. Rather, the auditor must go beyond the façade and question the truth of any information using professional skepticism. Responding to these developments, standard setters have tightened professional auditing standards. (AU 316, 2005).

Several researches (Adebayo, 2011; Wali, 2015; Loveday, 2017) have been carried out in developed and developing economies on how audit independence affects audit quality. To the best of the authors’ knowledge, none have researched on how audit independence affects financial reporting credibility. Any subsequent failure of firms due to mismanagement, fraudulent practices, etc., are viewed as failures in auditors’ independence in carrying out their duties (Adeniji, 2004). For instance, Enron and WorldCom in USA collapsed shortly after an unqualified (clean report) audit report was endorsed. From the above discussions, there is need to ensure credibility of financial statement of companies in order to increase users’ confidence and thereby affecting investors behavior.

This study seeks to investigate why corporate organizations fail and how it is occasioned by the independence of auditors. Therefore, the study tends to have solve these problems by determining the impact of auditors’ independence on credibility of financial reporting in the Nigerian Banking Sector.

1.3  Objectives of the Study

The main objective of the study is to determine the impact of auditors’ independence on credibility of financial reporting in the Nigerian Banking Sector. There are specific objectives of the study which were to:

  1.       i.         Determine the impact of audit independence on the understandability of financial statement in the Nigerian Banking Sector.
  2.     ii.         Evaluate the effects of audit independence on relevance of financial statement in the Nigerian Banking Sector.
  3.    iii.         Determine the effects of audit independence on the faithful representation of financial statement in the Nigerian Banking Sector.

1.4  Research Questions

From the above objectives, the following questions were derived;

  1.       i.         What impact does audit independence have on understandability of financial statement in the Nigerian Banking Sector?
  2.     ii.         What are the effects of audit independence on relevance of financial statement in the Nigerian Banking Sector?
  3.    iii.         What effects does audit independence have on faithful representation of financial statement in the Nigerian Banking Sector?

 

1.5   Statement of Hypotheses

Hypothesis I

H0: Audit independence does not have significant impact on understandability of financial statement in the Nigerian Banking Sector.

Hypothesis II

H0: There is no significant effect of audit independence on reliability of financial statement in the Nigerian Banking Sector.

Hypothesis III

H0:  There is no significant relationship between audit independence and faithful representation of financial statement in the Nigerian Banking Sector.

1.6    Significance of the Study

The focus of this study is to examine the impact of audit independence on credibility of financial reporting in the Nigerian Banking Sector. This study will be of importance to several stakeholders such as:

Shareholders: The study will assist shareholders to ensure that the financial statement is true and fair and also free from material misstatement in order to place their decisions on the report. The report serves as an assurance that the going concern principle is being followed.

Potential Investors: The outcome of this research will serve as an input to potential investors in decision making concerning investment and financial policies from the financial statement. That is, the research work will serve as a way to put their reliance on the financial statements audited by professional auditors.

Management: The study will help management in knowing matters that can and cannot affect the auditor independence and ensuring the credibility of the financial statement. This will also assist in taking responsibility of preparing and presentation of the financial statement and also ensure the going concern principle is met.

General Public: The research work will educate the general public on how the auditor independence has a positive impact on credibility of financial reporting in the Nigerian Banking Sector. It will also educate them on how auditor independence will help in eliminating creative accounting and window dressing.

Further Researchers: This research will also serve as a resource base to other scholars and researchers interested in carrying out further research in this field subsequently, if applied will go to an extent to provide new explanation to the topic.

1.7   Scope of study

The research work is on the determination of the impact of auditors’ independence on credibility of financial reporting in the Nigerian Banking Sector with the scope explained below;

The scope of the study is delimited to the Nigerian banking sector. There are 21 commercial banks as listed on the website of CBN. These banks will form the universe of the study. The study will be further delimited to selected banks: Guaranty Trust bank, First Bank, Polaris Bank Diamond and Zenith Bank Plc. The employees of these banks will be the focus of the study where data will be gathered. Specifically, the study will be carried out among the branches of these banks that are located in Lagos. 

1.8   Operationalization of Variables

Auditors’ independence is the independent variable which is represented with three proxy variables which are Audit tenure, Audit fees and Independence of audit committee. However, Financial reporting credibility is the dependent variable measured by free from understandability of financial statement, reliability of financial statement and faithful representation of financial statement.

Functional Equations

Y=f(X)

Y= Financial Reporting Credibility (FRC) Dependent Variable

X= Auditor Independence (AUI) Independent Variable

Hence FRC = f (AUI)

Where X = Audit Independence (AUI)

Then x1= Audit Tenure (AUT)

Then x2= Audit Fees (AUF)

Then x3= Independence of audit committee (IAC)

Where Y = Financial Statement Credibility (FRC)

Then y1= Understandability of financial statement (UDE)

Then y2=  relevance  of financial statement (RFS)

Then y3= Faithful representation of financial statement (FRS)

Functional Relationships

UDE = f (AUT, AUF, IAC) ………………………………………... F1

RFS = f (AUT, AUF, IAC) ………………………………………... F2

FRS = f (AUT, AUF, IAC) ………………………………………… F3

Therefore (UDE, RFS, FRS) = f (AUT, AUF, IAC)

F1, F2 and F3 are the working functional relationship in this study used to determine the relationship between the impact of auditor independence on credibility of financial reporting in the Nigerian Banking Sector.

1.9   Definition of Key Terms

Auditors’ Independence: This refers to the freedom of the auditor to act professionally. Independence requires integrity and objective approach to the audit process.

 

Audit Tenure: This refers to the length of the auditor-client relationship. Thus tenure includes the period that the predecessor audit firms (where there has been mergers/de-mergers or other combinations in the audit firm) issued audit reports on the entity.

Audit Fees: This is a fee a company pays an auditor in exchange for performing an audit.

Credibility: This refers to the objective and subjective components of the believability of a source or message. Traditionally, modern, credibility has two key components: trustworthiness and expertise, which both have objective and subjective components.

Financial Reporting: This is the process of producing statements that disclose an organization's financial status to management, investors and the government.

Independence of audit committee: This is a committee of the board of directors responsible for oversight of the financial reporting process, selection of the independent auditor, and receipt of audit results both internal and external.

Faithful Representation: This is the concepts that financial statements be produced that accurately reflect the condition of a business. The faithful representations extend to all parts of the financial statements, including the results of operations, financial position, and cash flows of the reporting entity.

Understandability: This is the concept that financial information should be presented so that a reader can easily comprehend it to adherence to a reasonable level of understandability would prevent an organization from deliberately obfuscating financial information in order to mislead users of its financial statements.

Relevance: This refers to whether financial information can be verified and used consistently by investors and creditors with the same results. Basically, relevance refers to the trustworthiness of the financial statements.

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