Chapter One
1.0 Introduction
1.1 Background To The Study
Audit involves performing procedures to obtain evidence about amounts and disclosures in the financial statements so as to evaluate the appropriateness of accounting estimates made by management (KPMG, 2008). Audit report quality is a basic requirement to enhance the credibility of financial statements within the stakeholders. The Audit quality therefore, is a basic ingredient in enhancing the credibility of financial statements to users of accounting information. Consequently, studies (Fairchild, 2008; Coate, Florence and Kral, 2002) note that audits add credibility to the financial information by providing an independent verification of management-provided financial reports, thus reducing investor’s risk. Financial reporting credibility is reflected in the confidence of users in audited financial reports (Watkins, Hillis on, and Morecroft, 2004). As opined by Levitt (2000), the perception of audit quality plays a critical role in maintaining systematic confidence in the integrity of financial reporting. The higher the perceived audit quality, the more credible the financial statements. This will consequently improve user’s confidence in those financial statements.
Concerns about audit quality have gained increased ascendancy especially as a result of the spectacular financial reporting scandals in major corporations, such as Enron, WorldCom and other companies. The aftermath of these scandals has led to the identification of a perceived “expectation gap” in the audit quality as many users of audited financial statements have different expectations of the audit function from what it actually delivers (Beattie, Brandt and Fearnley, 1999).Therefore, there has been a call for sweeping changes in the auditing profession to ensure improved audit quality (Auditing Profession 2002).
However, the non quantitative nature of “audit quality” as a variable has necessitated the existence of a plethora of proxies and indicators for its measurement (Cameran, Prencipe and Trombette , 2007). De Angelo (1991) defined audit quality as the probability that an auditor will both discover and truthfully report material errors, misrepresentation and omissions detected in a clients accounting system. This probability depends upon the broad concept of an auditor’s professional conduct, which includes factors as objectivity, due professionalism and conflict of interest. Some studies (Francis 2004, and Geiger & Raghunandan, 2002) measure audit quality in terms of audit or reporting failure, based on the idea that audit quality is inversely related to audit or reporting failures. Other studies (Nagy, 2005; Myers, Omer & Myers, 2003) use earnings as a surrogate for audit quality. The implicit assumption is that high audit quality implies high earnings quality (Johnson, Khurana and Reynolds, 2002).
Wallace (1980) notes that a measure of audit quality is the audi t’s ability to reduce noise bias and improve the fineness in accounting information. Researchers have also used estimated discretionary accruals as a surrogate for audit quality (Dechow & Dicheve, 2002; and Krushman, 2003) assuming that higher estimated discretionary accruals reflect lower earnings quality and thus lower audit quality. Knechel and Vanstraelen (2007) note that audit quality is measured by the propensity of the auditor to issue a going concern opinion. Finally, Modrich, Jackson and Roebuck (2007) note that true audit quality is when the audit does not result in a type 1 error: a failing company being given an unqualified report or a type 11 error: a non-failing company being given a qualified report.
Chijoke, Emmanuel and Nosakhare,(2012) opines that all the divergences with regards to the appropriate measure of audit quality may be seen to reflect the need by researchers to monitor and provide indices amenable to control so as to make inferences on the audit quality.
Consequently, studies (Arrunada and Paz-Ares, 1997; Healey and Kim, 2003; Brody and Moscove, 1998) have attempted to identify possible control variables for the state of audit quality. In the light of these studies, auditor tenure has become the focus of much debate. The resulting dilemma is that the firm is faced with the decision of whether to replace its auditors after a period of time or to build and maintain a long-term relationship with the audit firm. The outcome is at polarity with conflicting findings. While some researchers have identified the need and have provided justification for auditor rotation (Healy and Kim, 2003; Ebimobowei and Oyadonghan 2011; Geiger and Raghunandan 2002) others argue on positive effects of tenure on audit quality (Ghosh and Moon, 2005; Adeyemi and Okpala 2011; Defond and Francis, 2005).
In recent years, auditors had been blamed for their role in notable corporate scandals in Nigeria such as Cadbury Nigeria Plc (2006), Intercontinental Bank Plc (2009), African Petroleum Plc (2009), Afribank Plc (2009) etc. The criticism had raised lots of questions regarding audit quality and audit tenure. The question of whether audit quality is affected by the length of time that an auditor serves a client has received extensive attention from researchers. Therefore, ongoing interest in the issue suggests that this question has not been completely answered by extant research. This study is to assess the effect of audit firm tenure on auditor reporting quality in Nigeria audit setting.
1.2 Statement Of The Problem
Several studies (Arrunada and Paz-Ares, 1997; Healey and Kim, 2003; Brody and Moscove, 1998; Dopuch, King and Schwartiz, 2001; Myers et al 2003; Mgbame, Eragbha and Osazuwa, 2012) have attempted to analyze some explanatory variables for the state of audit quality. In view of these studies, auditor tenure has become the focus of much debate. Should a firm replace its auditors on a regular basis, or should the auditor be allowed to build a long-term relationship with the client? Studies on the effect of auditor tenure on audit quality are at divergent.
The spate of audit failure in the world, especially in Nigeria, has brought great disappointment to the users of financial reports. The bane of the problem has been linked to long term of audit firm tenure which has also been linked with creative accounting. In Nigeria audit setting, the challenge of audit tenure and audit quality reporting has not attracted much empirical studies beyond mere anecdotal opinions (Mgbame, Ezagbhe and Osazuwa, 2012). Thus, this study will examine the effect of audit tenure on audit quality report in Nigeria.
1.3 Objective Of The Study
The objectives of the study are specified thus;
- To determine whether the length of auditor tenure enhance audit quality.
- To examine whether audit tenure impairs auditor independence for compromising audit quality.
1.4 Research Questions
- Does the length of auditors’ tenure enhance audit quality in Nigeria?
- To what extent does audit tenure impairs auditor independence for compromising audit quality?
1.5 Hypotheses
H01: There is no significant relationship between the length of audit tenure and audit quality in Nigeria. H02: Audit tenure does not impairs auditor independence for compromising audit quality in Nigeria.
1.6 Justification For The Study
The results from this study are useful for the users of audited financial statement and regulators as a feedback to enhance audit quality in Nigeria. It will broaden extant literature on audit quality in Nigeria and assist policy maker in formulating and administering pragmatic policy to improve audit quality in Nigeria audit setting.
