Full Project – IMPACT OF MANDATORY AUDIT FIRM ROTATION ON AUDITOR INDEPENDENCE, AUDIT QUALITY AND INVESTORS’ CONFIDENCE

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CHAPTER ONE

INTRODUCTION

1.1              Background ofthe Study.

An audit’s value to the company’s stakeholders has remained high because it is the product of a competent third party known as the auditor, whom the company’s stakeholders believe has no personal interest in the company’s affairs and is also bound to discharge his duty with utmost diligence, objectivity, independence and professionalism. An audit is an examination of the financial accounts in order to determine whether or not management’s accounting estimations are accurate (KPMG, 2008).

Financial regulators, accounting groups, and policymakers in Nigeria have come up with strategies to counteract the financial reporting scandals and audit failures linked with several firms in Nigeria, such as Intercontinental Bank Plc. (2009), African Petroleum Plc. (2009), Afribank Plc. etc. The extended duration of an audit engagement is seen to compromise the independence of an external auditor because of the growing level of familiarity between the auditor and the client, which puts the auditor’s independence at danger. The credibility of an audit report depends on its independence, which is vital to the auditing process (Fogarty & Lansley, 2002).

Mandatory rotation of external auditors has been proposed as one of the measures to be adopted in order to solve the familiarity threat and improve audit quality, meaning that a maximum limit is set for the tenure of an auditor with a firm in order to preserve auditors’ independence and aid quality audit reports (Francis J. R., 2004). Additionally, the quality of audits tends to increase when the audit-client connection is shortened (Chung, 2004). In recent years, a large number of audit cases have indicated that auditors have lost their independence, which is a significant element in audit failure. (Li & Wang, 2005). The Central Bank of Nigeria (CBN) in 2010 issued a directive in response to the financial reporting scandals that robbed the banking sector of its credibility in Nigeria, which stipulates that “the tenure of the auditors in a given bank shall be for a maximum period of ten years after which the audit firm shall not be re-appointed in the bank until after a period of another ten years.” It should be noted that the maximum term of 10 years includes the time spent with an audit company that later merged, changed its name and/or began auditing the bank. Central Bank of Nigeria, 2010).

Mandatory rotation of auditors has been the subject of much debate, with some supporters arguing that it would ensure auditor independence, which would ultimately improve audit quality and prevent audit failures, while others argue that the “mandatory audit firm rotation may not be the most efficient way to enhance auditor independence and audit quality” (U.S General Accounting Office, 2003). Auditor independence and auditor quality will be examined in Nigeria as a result of this investigation.

1.2       Statement ofthe Problem

he success of any economy depends on the availability of reliable financial data, and auditors are supposed to be impartial and unbiased in their work (Adelaja, 2009). It is considered that audit failure is caused mostly by a lack of external auditor independence, which in turn reduces the quality of audits and hence undermines the credibility of financial information. An audit report from an outside auditor is considered to be critical to the interests of shareholders (Gallegos , 2004).

A lack of faith in the financial statement’s reliability results in a significant deal of dissatisfaction for Nigerian business stakeholders/investors when the auditor’s independence is questioned. Many financial reporting scandals (such as Intercontinental Bank Plc, African Petroleum Plc, Afribank Plc, etc.) have happened throughout the years, and some large firms have been forced out of business because of inadequate auditing and lack of auditor independence.

Mandatory audit rotation is one of the strategies offered to address this issue of audit failure. The purpose of this research is to fill in the gaps in our understanding of how auditor independence and obligatory rotation of auditors impact audit quality. As many academics favor its adoption, there are just as many who oppose its effects and usefulness in resolving the issue of audit failure, one of the key reasons underlying which is the absence of auditor independence..Therefore, on this premise, this research focuses on the impact of mandatory audit firm rotation on auditor’s independence, audit quality and investors’ confidence.

1.3       Objectives ofthe Research

The objectives of this study are thus stated as follows:

1. To determine the relationship between mandatory audit firm rotation and auditor independence.
2. To ascertain the impacts of mandatory audit firm rotation on audit quality.
3. To ascertain the extent to which mandatory audit firm rotation strengthens Nigerian investors’ confidence.

1.4       Research Questions

The research questions are given as below:

1. What is the level of impact of mandatory audit firm rotation on auditor independence?
2. To what extent does mandatory audit firm rotation enhance audit quality?
3. To what extent does mandatory audit firm rotation strengthen the Nigerian investors’ confidence?

1.5       Research Hypotheses

The hypotheses for this study are thus stated in the null form:

1. There is no significant relationship between Mandatory audit firm rotation and auditor’s independence.
2. Mandatory audit firm rotation has no significant impact on audit quality.
3. Mandatory audit firm rotation has no significant impact on investors’ confidence.

1.6       Scope and Limitations ofthe Study

In the spotlight of this research work, the study observed the impact of mandatory rotation of auditors on auditor independence and audit quality in South-east Nigeria. The researcher focused on public and private sectors of the economy, eliciting the perception of Nigerian investors and professional accountants in Anambra State and Enugu State, and covering a period of 2012 to 2015.

The degree of success attributed to this research work mostly depended on the timely response and pleasant cooperative attitude of some sources of information.

1.7       Significance of the Study

This research elaborates on impacts of mandatory audit firm rotation on auditor’s independence, audit quality, and investors’ confidence, particularly eliciting the perception of various practitioners and investors in Nigeria. The study is of great importance as it is one which is aimed at evaluating the possible means of strengthening the ethical conducts of an external auditor in maintaining professional skepticism in the course of duty, and also being one which is globally debated based on its implementation, advantages and disadvantages, and its impact on various professional ethics of the discipline. The research and its findings are expected to contribute to the existing body of knowledge, and to various professionals and academics in the discipline.

1.8       Operational Definition of Terms

AUDIT is an independent examination of, and expression of opinion on the financial statements of a business enterprise by an appointed auditor in accordance with his terms of appointment and in compliance with the relevant statutory and performance requirements.

EXTERNAL AUDITOR also known as an independent auditor is an audit professional who performs an audit on the financial statements of a company, government, individual or other legal entity and who is independent of the entity being audited.

AUDITOR INDEPENDENCE is a mental attitude and physical appearance which portrays the auditor as being uninfluenced by others in judgment and decision.

AUDIT TENURE is the number of years an auditor is retained by the firm.

AUDIT QUALITY is the market-assessed joint probability that an auditor will discover a breach in a client’s accounting system although diverse, reflect the same structure.

MANDATORY AUDIT FIRM ROTATION is the imposition of a limit on the period of years in which a particular registered public accounting firm may be the auditor of books of accounts for a particular issuer.

INVESTORS’ CONFIDENCE is the confidence stakeholders place on investments remaining liquid or paying expected income.

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