AUDIT ATTRIBUTES AND FINANCIAL REPORTING QUALITY OF LISTED BUILDING MATERIAL FIRMS IN NIGERIA

MSC Project Topics in Accounting and Finance

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 correlation research design using a sample of four listed building material firms for the period of ten years (2002- 2011). Ordinary Least Square (OLS) multiple regression technique was employed in the analysis of the panel data collected for the study. 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.

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 dearth 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 non-audit 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.

MSC Project Topics in Accounting and Finance