EFFECT OF AUDIT COMMITTEE
CHARACTERISTICS ON FINANCIAL REPORTING QUALITY OF LISTED DEPOSIT MONEY BANKS IN
NIGERIA
CHAPTER
ONE
INTRODUCTION
1.1
Background to the Study
Corporate
financial report provides fundamental information to a wide range of groups;
its main purpose is to provide information which is supposed to give a true and
fair view of the management’s stewardship, company’s performance and financial
position for the various users of the information to make informed economic
decisions (America Accounting Association, 1961). Financial reporting is the
process by which corporate entities provide interested parties (users) with
information on their transactions during an accounting period (Mbobo & Ekpo,
2016). Among the interested parties are shareholders, creditors, tax
authorities, customers, financial analysts, and lenders. The parties need
quality financial reports for economic decision making. Financial report is one
of the major means that corporate management uses in communicating financial
information for a given period. In this regard, the International Accounting
Standard (IAS 1) states that the purpose of financial reporting is to provide
information about the financial position, financial performance and cash flows
of an entity that is useful to a wide range of users in making economic
decisions. Such information is communicated through financial statements.
Ibadin and Dabor (2015) stated that financial statements show the results of
the management’s stewardship of the resources entrusted to it by revealing
economic information on assets, liabilities, equity, income and expenses,
including gains and losses; contributions by and distributions to owners in
their capacity as owners; and cash flows. Such information, along with other
information in the notes, assists users of financial statements in predicting
the entity’s future cash flows and, in particular, their timing. Moreover,
accounting information contained in the financial statements is one of the very
essential information needed by various stakeholders especially investors for
making informed economic decisions. Investors in search of investment avenues
use the accounting information contained in the financial statements of the
intended investing company in pricing of shares. Market participants seek high-quality
financial reporting or information to mitigate information asymmetry as such
quality information should be a pre-requisite for a well-functioning capital
market. Thus, companies that provide high-quality information have an added
advantage in their rating in the capital market (Ibadin & Dabor, 2015). The
increasing demand for quality financial reporting creates the need for
effective and efficient monitoring mechanisms. This is necessitated by the
conflict of interest between managers, who serve as agents and resource
holders, who serve as principals, wherein, managers carry out activities that
are counter-productive in the realization of the interests of resource holders.
Therefore, board of directors is instituted to monitor the activities of managers.
The board sets several monitoring measures that will ensure the integrity of
management’s decision. One of committees is the audit committee. The quality of
the monitoring process depends on effectiveness of the audit committee. The
effectiveness of audit committee in exercising its monitoring role is defined
as the extent to which they perform their duties which is associated with their
characteristics (Dechow, Sloan & Sweeney, 1996; Beasley, 1996; Carcello
& Neal, 2000; Klein, 2002). An effective audit committee ensures the
provision of credible accounting information to financial statement users by
constraining earnings management by managers (Dandago & Rufai, 2014). It is
in line with increasing loss of credibility of financial reports that the
banking industry, through the Central Bank of Nigeria also developed its code,
the recent of which is the CBN Code of Corporate Governance of 2006 (Ibadin
& Dabor, 2015). Specifically, the code requires that companies should
establish audit committees consisting of directors and shareholders. Under the
code, audit committee is saddled with the responsibility of reviewing the scope
and result of audit, the independence and objectivity of the auditor, among
others. In spite of this, the quality of financial reports of banks has
continued to be an issue of concern. Consequently, the effect of audit
committee characteristics on financial reporting quality has been under
scrutiny. Audit committee independence is one of such characteristics (Klein,
2002). This is measured by presence of non-executive audit committee members who
do not engage in the day to day running of firms. Presence of such members
provides a necessary condition for the audit committee to carry out its
oversight functions objectively. However, a contrary argument to this is that
non-executive audit committee members might not have requisite knowledge of the
internal financial reporting practices of an organization and therefore might
not be able to ascertain possible areas of financial misstatements.
Nonetheless, lack of audit committee independence in Nigerian may have
influence in the increasing spate of financial scandals and bank failures.
Frequency of audit committee meeting is also considered relevant for the
oversight functions of the audit committee (Jenkins, 2000). Menon and Williams
(1994) contend that the more often an audit committee meets the more active it
is being perceived, which leads to fewer financial reporting problems. In
practice, more frequent audit committee meeting gives the committee opportunity
to critically examine financial statements and carry out follow-up actions.
Similarly, Audit committee that meets frequently can reduce the incidence of
financial reporting problems. Therefore, the more frequent the audit committee
members meet, the more thorough they are prone to be in terms of assessing the
quality of financial report. Contrary to this analogy, it can be argued that
frequent audit meetings add cost to the organization. Payment of meeting
allowances constitute cost which often times can be avoided. Managers even use
such avenues to expropriate organizational resources. In the deposit money
banks in Nigeria, the issue of frequency of audit committee meeting is worthy
of emphasis especially in the light of increasing loss of credibility in the
financial reports presented by management of banks whose financial reports are
not well reviewed by the audit committees that meet rarely (Dabor & Dabor,
2015). The existence of female board members could serve as a mitigating factor
against manipulative accounting as there is bound to be less collusion. Relatedly,
audit committee members with requisite financial expertise are prone to be more
active in assessing the quality of financial reports. However, a contrary
argument is that such members might rather aid management in manipulating
accounts especially if their independence is compromised (Illaboya, 2012).
Therefore, the role of the audit committee in monitoring the financial
misstatements to ensure financial reporting quality cannot be overemphasized.
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