The effect of audit quality on the performance of listed manufacturing firms in Nigeria

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The effect of audit quality on the performance of listed manufacturing firms in Nigeria

CHAPTER ONE INTRODUCTION

Background

Audit quality is vital for every organization to achieve efficient and effective management of resources. It leads to the improvement of financial performance as a  key implementation strategy of the  accounting system and helps management check  the work of each department within the firm as a whole. Around the world, audit  quality assures the achievement of quality financial statements or reports for firms  listed on the stock markets of any country.  This is the cornerstone of institutions of   any type that are charged with the responsibility of checking records related  to  business activities. The functions of internal audit reflect the quality of the financial reports or information that the institutions maintain to create confidence among the stakeholders, and also reflect the efficiency and credibility of the institution’s audit department within the organization’s practices as part of the corporate governance structure of the firm’s management and practices.

According to Clarkson (1995), stakeholders have the  organization’s interest at heart  and are impacted by its operations, it could be negative or positive  in  the  way in  which it affects them. Stakeholders normally mentioned are employees, government, customers, competitors and political activist groups and the viability of  any organization is greatly influenced by them. (Dill, 1958; Murray & Vogel, 1997). In stakeholder theory, the firm intends to convert the stakeholders’ interests into goods  and services thereby creating value for them. Profits can no longer be taken solely as success of a firm, but its success is influenced greatly by stakeholder relationships and  is a broad range of issues which need to be addressed.

Agency theory is a contract whereby a person (agent) is appointed  by another person  or a number of people (principal(s)) to perform some service on their behalf. Conflicts may arise when the agent and the principal have interests which are different and  do  not align. An internal audit function can address this when it is independent and  has  the support of top management. Legitimacy theory is established on the belief that companies are always seeking for confirmation that they are doing business within the norms which their society finds acceptable to ensure they continue operating. Legitimacy is very important for businesses and all organizations. Strategy can be changed, when what society thinks is realized, to meet their needs and expectations. Value will be added to the business when financial statements meet the user’s expectations.

Eighme & Cashell (2002) state that the internal audit department is charged with providing information that enhances the system support, the responsibility of the management of the institution and employees as well as the stakeholders of the institution in operation and financial performance of the institution. The internal auditors are neutral information providers to the top management of the institution for smooth management of the entity in lieu of their resources. The internal audit department also provides neutral, reliable and objective  information that helps  with  the management of the organization. The stakeholders are more interested  in  the  return made by the institution, sustainable growth, and reliable information reported about financial performance as a sign of financial health of the organization and its practices (Al-Shammari, 2010).

The Institute of Internal Auditors (2000) propose that, to provide a  systematic  approach that is well able to assess and enhance the strength of risk management, organization and the process of governance is the internal audit function. However, on the role of internal audit, there is a likelihood that this will lead to amplified responsibilities. In addition, internal audit is required to increase responsibilities  that are crucial to the support of the management and the audit committee.

According to DeAngelo (1981), internal audit quality is the combined possibility that  an auditor will become aware of and account for material misstatement.  In this case,  the meaning of audit quality is composed of two mechanisms that are: the capacity to spot misstatements and the readiness to divulge  the misstatements that are discovered  in an audit assignment. Measuring the internal audit quality is divided into two  variables that are aimed to be captured which are the accounting qualifications (AQ)  and the auditing experience (AEXP) of the internal audit staff. The impact of internal audit quality on a company’s financial performance has an impact on  the  firm’s  agency relationship and this has not been studied extensively by most scholars in emerging economies, although auditing services has been well perceived as one of the mechanisms that is used to mitigate the agency problem  that mostly exists  between   the management of the firms and the shareholders. The auditing service is just another element of the corporate governance structure and significant aspect of the regulatory system for protecting the interests of shareholders and to serve the  other stakeholders  in public firms around the world.

Audit quality is defined as the independence, objectivity, consulting activity and assurance designed to provide an accurate picture over a period of time of a firms’ performance (The Institute of Internal Auditors, 2008). It is an exercise of improving risk management, operations and administration of the entity to achieve the intended goals and the protections of the shareholders wealth  and  provides  accurate  information to financial accounting information users. It helps the institution create discipline, improve management process and risk management to achieve the organizational goals. Firm managers are always engaged in returns management to increase their incentive and maximize shareholders wealth. However, if there is an auditor who can assure the quality of returns, the principal will have more confidence  in the return generated by the firm and place greater weight in that measure in  designing the managers’ contract to avoid a conflict of interest (Dunn et al., 2000).

Internal audit performs an essential part in enhancing the achievement of company goals.  Additionally,  it also influences the implementation of strategies that are aimed  at ensuring their success (Ljubisavljević & Jovanovi, 2011). Internal audit is charged with the responsibility for improving management and audit committees (Hutchinson   & Zain, 2009). Therefore, the internal audit report is prepared as a form of communication between internal audit and the management. Additionally, it is established as a crucial guideline to enhance the management of the company and ensure its success (Ljubisavljević & Jovanovi, 2011).

The measurement of the outcome of a company’s operations and policies in financial terms is what defines financial performance (Yan, 1997). It is also the firm’s willingness and ability to meet its agreements as well as long  term  financial  obligations to provide services in the near future (Meckling, 2000).

According to Raw (1986), performance is used in reference to a  business  that  generates significant and positive cash flow which increases at a faster rate in comparison to the overall economy. The firm performance which is a dependent variable is assessed on a few indicators. The return on assets (ROA), return on equity (ROE) and the return on investment (ROI) are mentioned as three indicators of accounting based performance (Schiuma, 2003). These indicators are used widely to check the performance of firms and capture their internal efficiency. A company associated with growth often has a profitable reinvestment opportunity to meet its retained earnings. Businesses that grow are often seen in the technology industries. Firms that have experienced consistent strong performance tend to employ external directors as they have the edge to do so.

According to the agency and resource dependence theories, people play a role  in helping to improve the performance of the firm given that they possess insight in regards to dealing with operation and achieving their responsibilities at  the  highest level of quality. Hutchinson and Zain (2009) have discovered using several regression analyses that between firm’s performance and the internal audit quality there exists a positive correlation.

According to Fadzil et al. (2005), it is clear that internal auditors are more capable of running a company more competently and effectively in  the interest of  shareholders.  A study by KPMG (1999) established that internal audit plays a crucial part in enhancing performance and assisting in profit verification in corporate scandal identification. This is predominantly in relation to financial fraud that relates to weak governance. In this case, internal audit works as a control measure which saves the organization from irregularities and malpractices and enables the organization to accomplish its objectives of enhancing a high level of productivity and profit.

Roth (2004) indicates that for the accomplishment of goals and objectives through reliable financial reports which management uses for decisions, there is the need for adept and effective internal controls. Poor or unnecessary internal controls lower productivity and increase the complexity of processing transactions without adding value to the activities. Humphrey (2006) highlights that employees get a better appreciation of their contribution through audit interviews and review of audit reports with internal auditors. Meletta (2004) equally states that audit committees, leaders and management teams are constantly searching for better approaches for performance management within audit departments. This can be accomplished by outlining quality assurance programs and implementing effective performance  measurement frameworks.

Statement of the Problem

In recent years, corporate accounting scandals coupled by an outcry for transparency and integrity in financial reporting have given rise to two logical outcomes. Internal audit skills are now critical in resolving the complicated accounting manipulations which have muddled financial statements. In addition, public outcry for change and regulatory action has modified the face of corporate governance. As a result, the bar     of ethical and legal scrutiny has been raised for agents of companies working for the principals. These outcomes are jointly responsible for addressing investors’ anxieties about the financial reporting system. However, laxity still exists  in  implementing  these internal audit findings and recommendations. (Kinyua et al., 2015).

Tighter regulations and enhanced standards for accounting and governance of firms   has been the result of the occurrence of financial scandals. The  Corporate  and  Auditing Accountability and Responsibility Act (Sarbanes and Oxley, 2002) was enacted in 2002 in the USA after the World.com and Enron scandals, where investors lost huge amounts of money. These scandals were caused by weak financial controls and ineffective internal audit practices that the Act tries to address.

Audit quality was measured by Geiger and Rghunandan (2002) to check whether a going concern had been issued in the previous year for clients that went  bankrupt.  They discovered that a going concern judgement was likely to be  presented  by  auditors in the later years but less likely in the initial years, which is contradictory to  the concern that audit quality is affected adversely by  a  long  client-auditor relationship.

They highlighted that as auditors;  they should have identified the deficiencies especially in the financial  statements  which were contrary to International Financial  Reporting  Standards  (IFRS)  and should have pointed them out. The International Standards  of  Auditing  (ISA) however, state that the external auditor’s use professional skepticism and report any irregularities or fraud they encounter but their work does not involve unearthing them. Before the external auditor realizes it, the internal audit should already know and through the internal audit reports made, the audit committee should be aware of it.

This study is therefore aimed at answering the question: What is the effect of internal audit quality on firm financial performance in Nigeria?

 

Objectives

  • To scrutinize The effect of audit quality on the performance of listed manufacturing firms in Nigeria.
  • To examine the proficiency of internal auditors on firms listed on the NSE
  • To examine the relationship between financial performance and auditing reporting standard of firms listed on the NSE
  • To understand the level of effectiveness of the Internal Audit Function in manufacturing firms in Nigeria

Research Questions

  • Are there any proficiency of internal auditors on firms listed on the NSE?
  • What are the relationship between financial performance and auditing reporting standard of firms listed on the NSE?
  • What are the level of effectiveness of the Internal Audit Function in manufacturing firms in Nigeria?

Limitations

Due to inadequate funds the researcher conducted this research under serious financial constraints. This made it hard for an in-depth study to be  conducted.  Some  respondents were biased while giving information due to  reasons  such  as  victimization as such the research findings were skewed.

 

 

Secondly the limitation of time was much evident since the sources of  the  data  operate on working days and the researcher is equivalently equally an employee. Respondents were naturally skeptical and uneasy when asked to contribute to a  study  in which they were not aware of its ramifications.  To make the respondents feel at  ease, the researcher made it clear the nature  of the  study and its  proposed function. The researcher further explained that the research  was  purely  an  academic undertaking and that data divulged would be kept in secret by the researcher. The research process was an expensive and tiresome exercise since the researcher had to commute frequently to where the respondents were and also had to communicate frequently to follow up with the respondents.

Significance

This study may benefit the Government of Nigeria by providing an understanding of  how audit quality attributes affect firm operations and the effective management of resources. The study will also recommend how audit practices can be improved. The study will provide useful insight to the NSE on the current status of auditing in the  listed firms. It will also be useful to stakeholders in the Nigerian financial sector as it provides ample evidence in regards to the association between audit quality and their

firm performance.Furthermore, academic scholars will find this study as a useful guide  to  conduct  further research in the field of auditing and as a source for audit quality literature in particular by providing evidence drawn from audit practice in Nigeria and also help  them to appreciate and enhance their knowledge of internal auditing.

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  • This topic contains:
  • Chapter 1-5
  • Abstract
  • References
  • Appendix/If applicable