CHAPTER
ONE
INTRODUCTION
1.1.
BACKGROUND TO
THE STUDY
The auditing profession performs a
role in giving reasonable assurance to the public and users’ of financial
statements, specifically investors and creditors, of the reliability and
credibility of a firms’ financial statements. To fulfill this role, there are
several principles that auditors should espouse. One of the most important
principles is independence. By demonstrating their independence, auditors’
opinions on financial statements will be valued by the users. In essence,
auditor independence refers to an absence of interest by the auditor in the
auditing assignment, thereby avoiding material bias that could affect the
reliability and credibility of the financial statements. The auditing
profession promotes the principle of independence to define, defend, and extend
the profession.
Auditor independence
also refers
to the independence of the internal auditor or of the external auditor from
parties that may have a financial interest in the business being audited.
Independence
requires integrity and objective approach to the audit
process. The concept requires the auditor to carry out his or her work freely
and in an objective manner.
Financial statements apart from
stating the financial position of an organization, provides other information
such as the value added, changes in equity if any and cash flows of the
enterprise within a defined period of time to which it relates (Iyoha and Faboyede,
2011). This information is useful to a wide range of users making informed
economic decisions. The quality of financial reporting is indispensable to the
need of users who requires them for investment and other decision making
purposes. Financial reports can only be regarded as useful if it represents the
“economic substance” of an organization in terms of relevance, reliability,
comparability and aids interpretation simplicity (Penman, 1984). Ahmed (2003)
stated that useful accounting information derived from qualitative financial
reports help in efficient allocation of resources by reducing dissemination of
information asymmetry and improving pricing of securities. 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.
The basic purpose of financial
statements in the view of Meigs and Meigs (1981) is to assist decision makers
in evaluating the financial strength, profitability and the future prospects of
a business entity. The basic objective for preparing financial statement is to
provide information useful for making economic decisions. The objective of an
audit of financial statements is to enable the auditor express an opinion
whether the financial statements are prepared in all material respects and also
in accordance with auditing standard.
In recent times, auditors have been
put under pressure to ensure that their reports constitute assurance to
investors that their funds are put into good use and properly accounted
for. In Nigeria, every incorporated
company is required to appoint an external auditor, who is required to render
an independent opinion on the financial statements; whether or not they show a
true and fair view. The Companies and Allied Matters Act (1990) states that
every auditor of a company shall have a right of access, at all times, to the
books, accounts and vouchers of the company and to such information and
explanations as may be necessary in the course of an audit. The auditor shall make a report to the
members of the company on the accounts examined by them. The auditor in performing his duties is
expected to exercise all care, diligence and skills as is reasonably necessary
in each particular circumstance.
Furthermore, there has been much
discussion about the independence of Auditors; 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) has all attempted to clarify and strengthen
auditor independence. Also in the
medieval era, financial reporting was not necessary and hence financial
statements were not prepared neither used to make decisions; but with the
recent development every firm is expected to prepare and report their financial
statement in order to know the financial position of the organisation so that stakeholders
can make decisions.
Audit report is the medium through
which the auditor expresses his opinion on the financial statement examined by
him. Due to familiarity, threat of
replacement of an auditor, provision of book-keeping services by the auditor
and many other factors, the auditor may want to issue an unqualified audit
report even when the situation on ground proved otherwise. This situation raises doubt about the
independence of an auditor. Independence is the cornerstone of accountability. The challenge is that corporate management
hires, fires, and pays both their internal and external auditors. Auditors, therefore, develop good
relationships with management to keep the job of the client. They may not, therefore, be independent of
the corporate management.
Most studies on Auditor independence
have concentrated on it as a financial reporting issue. But financial reporting
is one aspect of the total impact of auditor independence. Much more
significant is the impact of a set of standards on a company’s organisation,
philosophy, business structure compliance to the standards, performance
management, and internal control and so on.
1.2. STATEMENT OF
PROBLEM
In Nigeria, there have been a number
of audit failures, some leading to the restatement of figures in the financial
statements. For example, Lever Brothers,
African Petroleum and Cadbury, just to mention a few important ones. Although,
it has not been proved by any detailed investigation that these audit failures
were due to impairment of auditor’s independence it could reasonably be
suspected to be a contributing factor (Adelaja, 2009).
Financial reports as stated in Igben
(1999) 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.
But in recent times, the financial manipulations, weak internal control
systems, ignorance on the part of the board of directors and audit committee,
manipulation on the part of the reporting auditor and other fraudulent
activities that occur within companies, creating a negative goodwill to the
general public. A typical example of a financial statement malfunction is the
popular case of Enron.
Secondly, concerns have been expressed
about the conflict of interest between the statutory role of the auditor and
the other services it may undertake for a client (UK House of Common Treasury
Committee, 2008). Also, a number of
worrisome audit failures have been recorded across the world: Enron, in the US,
Northern Rock in the United Kingdom, Metagelshaft in Germany, Parmalat in
Italy; Lever Brothers and Cadbury in Nigeria.
Audit firm tenure has also been linked with fraudulent financial
reporting. If empirical studies are not
carried out with respect to specific environmental factors and necessary
policies are not implemented to address shortcomings, the problem of auditor
independence may be exacerbated with likely grave consequences for the nascent
Nigerian Capital Market.
Finally, it is widely accepted that
independence is the most priceless asset in the auditing profession and the
basic principle that underpins the reputation of the auditing profession in the
public eye. By conducting an auditing work independently, auditors protect the
public’s confidence in such services. Despite this, several firms’ scandals,
directly or indirectly involving auditors, have damaged public confidence in
auditor independence. These scandals have taken place not just in one country
but across the world, these scandals have caused the public suffering huge
losses and have also damaged the reputation of the auditors and the auditing
profession. Although these scandals cannot solely be attributed to the failures
of the auditors, the public perceived that a large part of the responsibility
lay with them. This is because the public expects the auditing profession to
perform not just as watchdogs that give them reasonable assurance but also as
bloodhounds that track out everything even when there is nothing to provoke
auditors’ suspicion. Moreover, it is also widely believed that these scandals
took place because of the auditors’ lack of independence, as a result of
accommodating their clients’ interests during audits.