MSC Project Topics in Accounting and Finance
ABSTRACT
This study examines the relationship between audit quality and earnings management in the
Nigerian chemical and paints sector over a period of seven years (2006-2012).The
management of earnings was measured using Discretionary Accruals (a modified Jones
model). Generalized Least squares technique was used to estimate the regression coefficients
of the data obtained from the eight (8) listed chemical and paints firms using STATA 10. The
results show that, audit firm size has a significant negative impact on the earnings
management of the firms. The study also found that chemical and paints firms that engage the
services of big-4 auditors engage less in earnings management, which implies that the bigger
the audit firms, the lower these chemical and paints firms engage in earnings management.
The results also suggested that audit firm sizehelps in constraining earnings management in
chemical and paints firms, in the sense that it has significant effect on earnings management.
The study recommends among others that, Nigerian chemical and paints sector in conjunction
with audit firms, professional accounting bodies and standard setters should continue to
improve on the quality of their audits, by setting effective quality control, standards and
policies that will help enhance audit quality; reduce the audit firm tenure and engage only the
audit firms that have the appropriate expertise in an industry, as these may have significant
impact on reducing earnings management in the Nigerian chemical and paints sector.
CHAPTER ONE
INTRODUCTION
1.1 Background to the
Study
The
last decade has witnessed several accounting scandals and corporate failures
that were blamed on earnings management practices of firms globally, which
audit function was not able to detect. Earnings management involves managers‟
manipulation of the external reporting process and structuring transactions to
alter financial reports to either mislead some shareholders about the
underlying economic performance of the company or to influence contractual
outcomes that depend on reported accounting numbers (Healy & Wahlen, 1999).
As a result of this practice, which went undetected or unreported by external
auditors, the United States alone recorded ten largest bankruptcies in 2002,
including the two largest in world history, namely World Comand Enron
(Albrecht, Albrecht & Albrecht, 2004). In Nigeria, Cadbury Nig. Plc and
African Petroleum are exemplar cases. The increasing incidence of corporate
scandals or failures associated with earnings management has led to loss of
public confidence in the quality of reported accounting earnings and the audit
function generally. Accordingly, earnings management has become a matter of
great concern to regulators, practitioners as well as accounting researchers
(Okolie, 2014) due to the perverse consequences it has on corporate survival.
Hlioui
and Zehri (2012), Cohen and Zarowin (2010), Zang (2007) and Roychowdhury (2006)
explain that managers exercise their discretion not only via choice of
accounting estimates and methods (accrual-based earnings management) but also
through operational decisions (real activities manipulation). Real activities
manipulation is an alternative tool of earnings management through changing
operating activities and decisions (opportunistic reduction of discretionary
expenses, overproduction, and offering price discounts to boost current-period sales).
Separately, Graham, Harvey and Rajgopal (2005) suggested that given the stigma
associated with accrual management, earnings manipulations are now more likely
to be achieved through real economic actions because accrual-based earnings
management is more likely to draw auditor or regulatory scrutiny than real
decisions such as those related to product pricing, production, and
expenditures on research and development or advertising.
It
is argued that if shareholders have perfect informationabout managers‟ actions,
there would be no information asymmetry between thetwo parties. Information
asymmetry exists when perfect information is absent,which is the assumption of
agency theory and since informationasymmetry exists, stockholders have
difficulty detecting earnings management (Fama, 1980). Though, it is argued
that businesses adopt some level of discretion in their decision because no
firm adopts a hundred percent rule based accounting systems when reporting their
economic performances and financial position. In fact, Bello (2002) is of the
opinion that itisunimaginable to have accounting systems that are totally rule
based without room for occasional judgments.
A
considerable number of studies that include Okolie (2014), Okolie, Izedonmi and
Enofe (2013), Zgarni, Hlioui and Zehri (2012),Chi; Mehmet and Emin
(2012),Ahmadzade, Hassanzadeh, Pooryegane and Ebrahimi (2012), Lisic and
Pevzner(2011), Francis and Yu
(2009),
Rusmin (2010),Roger, Frank, Erik and Ann (2003), Zhou and Elder (2003), and
Gaver and Paterson(2001)have found that quality of audit is one of the
constraining factors that limit managements‟ manipulation of accounting
numbers. Watts and Zimmerman (1986) show that auditing is a valuable form of
monitoring used by firms to reduce agency costs. The value of auditing arises,
because auditing reduces the misreporting of financial information. The value
of auditing on constraining managerial discretion, however, is expected to vary
with the quality of the auditor. Becker, DeFond Jiambalvo and Subramanyam(1998)
and Heninger (2001) report evidence consistent with the external auditor acting
as a constraint on earnings management, with the effectiveness of the
constraint depending on audit quality.
The
demand for auditing arises from the auditor‟s monitoring role in
theprincipal-agent relationship (Eilifsen & Messier, 2000). The performance
quality of this monitoring function may vary. Audit qualitydescribes how well
an audit detects and reports material misstatements of financialstatements,
reduces the effect of information asymmetry between management and
shareholdersand therefore helps protect the interests of stockholders. High
audit quality shouldbe associated with high information quality of financial statements
becausefinancial statements audited by high quality auditors may be less likely
to contain material misstatements. From an agency theory perspective, audit is
a monitoringmechanism that provides reasonable assurance that financial
statements are free ofmaterial misstatements and therefore protects the
interests of shareholders. Whenthe interests of management conflict with the
interests of shareholders,management may not act in the best interests of
shareholders. A high level of audit quality is therefore expected to result in
lower levels of earnings management.
Literature
has documented a number of attributes that explain audit quality and how the
combined effect of the attributes could help checkmate managers‟ excessive
earnings management practice. Of the numerous attributes identified in the
literature, size of audit firm, independence and specialization of auditors
seemed to stand out. Size of an audit firm is considered critical to its
ability to assemble well qualified and highly experienced auditors to engage in
different aspects of audit functions. Such a firm is more likely to engage in a
wide range of audit assignments for different companies in view of its
economies scope and scale. In line with these postulations, Francis, Maydew and
Spales (1999) have documented evidence showing that the Big-4 audit firms
provide a more significant constrain on earnings management than other audit
firms. Thus, the size of an audit firm affects the extent to which it
constraints earnings management practice.
In
theory, a company’s auditors are appointed independently by its shareholders,
to whom they report. In practice however, auditors are chosen by the company’s
bosses, to whom they all too often become beholden (The Economist, 2002).
Hence, auditors might be more inclined to allow aggressive and opportunistic
reporting of accruals, resulting in lower quality audits and thus increase in
earnings management. This places a question mark on the independence of an
auditor. In addition to auditor size and auditor independence, auditors‟
industry specialization is considered to be an important attribute of audit quality
as it impacts the earnings management of firms. Studies have shown that client
firms with industry specialists are associated with higher quality of financial
reporting (Balsam, Krishnan and Yand,2003; Krishnan, 2003).Like large auditors
such as the Big 4 invest in brand name capital, industry specialists to make
investments in industry specific accounting technology to differentiate
themselves from other auditors (Craswell, Franci& Taylor1995)
The
high-profile corporate scandals of 2008 through to 2009 in Nigeria has
continued to raise a lot of concern about the integrity of financial and
auditing reporting systems in the country. Some corporate organizations in the
banking and manufacturing sub-sectors that were never suspected to have problem
were found to be living in past glory due to excessive earnings management
practices. The ugly practices which were later discovered to have been on for sometime
went undetected or unreported by auditors. The experience has since left its
perils in the mind of shareholders, prospective investors, regulators and
financial analysts. The chemical and paints industry in Nigeria is considered
one of the most susceptible sub-sectors of the country to earnings management.
This is due to the ongoing effort by both government and industrialists to
develop the industry as priority area of industrial investment and a support
toward government housing policy for Nigerians. The sub-sector has undergone
various levels of transformation from them anual based processes to more
technologically advanced production methods. In view of the renewed interest in
the industry owing to its recent impressive performance and high level of
activities, it is imperative to examine its earnings management practices and
how it is affected by audit quality.
MSC Project Topics in Accounting and Finance
MSC Project Topics in Accounting and Finance
AUDIT QUALITY AND EARNINGS MANAGEMENT OF LISTED CHEMICAL AND PAINTS FIRMS IN NIGERIA
Department: Accounting and Finance (M.Sc)
Format: MS Word
Chapters: 1 - 5, Preliminary Pages, Abstract, References, Questionnaire.
Delivery: Email
Delivery: Email
No. of Pages: 93
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