ASSESSMENT OF AUDIT COMMITTEE QUALITY, AUDITOR INDEPENDENCE AND INTERNAL CONTROL WEAKNESS IN NIGERIA (A CASE STUDY OF BENIN ELECTRICITY DISTRIBUTION COMPANY)

CHAPTER ONE

INTRODUCTION

1.1   Background to the Study

For the financial reporting process to be more effective, auditors’ independence must be vigorously monitored, and one potential mechanism that could aid auditors’ independence is for external auditors and audit committees to work more closely together (Levitt, 2000). The Sarbanes Oxley Act (hereafter SOX) of 2002 and the Securities and Exchange Commission (SEC) rules introduced to carry out the directions of the Act indicate that improving corporate internal control is an important policy initiative (U.S. House of Representatives 2002). The SEC now requires Chief Executive Officers (CEOs) and Chief Financial Officers (CFOs) to certify annually and quarterly about the effectiveness of their corporate internal control (SEC, 2002). Further, the SEC has announced rules for the implementation of Section 404 of the Sarbanes-Oxley Act, requiring every registrant to include an internal control report in its annual report, and its independent auditor to issue an “attestation report on management’s assessment of the company’s internal control over financial reporting” (SEC 2003).

According to the IIA, objectivity is an unbiased mental attitude that allows internal auditors to perform engagements in such a manner that they believe in their work product and that no quality compromises are made. Objectivity requires that internal auditors do not subordinate their judgment on audit matters to others. Threats to objectivity must be managed at the individual auditor, engagement, functional, and organizational levels. Thus, due to lack of independence and objectivity, Nigerian Banks have been known with so much corruption that the Chief Internal Auditors doctor the internal audit reports to appease the MD/CEO and deceive the regulatory authorities (e.g., CBN, SEC and NDIC). The recent shame currently going-on in the industry is rooted in the lack of independence and objectivity by both the internal and external auditors.

The emphasis on good internal control of course arises because it is considered to be an important factor in achieving good quality financial reporting. Among the numerous criticisms leveled at Enron Corporation regarding its financial reporting was the charge of a failure in its internal control (Verschoor 2002). It is therefore important to examine monitoring mechanisms corporations can use to ensure the effectiveness of their internal control. Establishing and maintaining proper internal control is the responsibility of management. One monitor of an entity’s internal control is its audit committee. Although not mandated by SEC rules, the accounting profession and policy makers have maintained that a primary function of the audit committee should be the oversight of internal control. Anecdotal evidence (e.g., disclosures in proxy filings) and academic research suggest audit committee do view monitoring internal controls as one of their functions.

Carcello and Neal (2002) report that 91 percent of a random sample of corporate audit committee charters list reviews of internal controls as of the duties of the audit committee. Recently, the SEC (2003) has mandated that all material written communications between a company’s accountant and management be provided to the entity’s audit committee, and this includes “reports on observations and recommendations on internal controls.” The
implication is that an entity’s internal controls should be under the purview of its committee. Because the audit committee is expected to monitor the entity’s internal control, we posit a positive association between audit committee and internal control quality. What constitutes a good audit committee however is not clear. In 1999, the major exchanges introduced new requirements for the size, independence and expertise of corporate audit committees with a view to improving financial reporting. In its endorsement of the exchanges, proposals to revise audit committee requirements, the SEC quoted the Blue Ribbon Committee (BRC) on Improving the Effectiveness of Corporate Audit Committees (BRC) to argue that, under the new requirements, audit committee directors would be “more likely to objectively evaluate the property of management’s accounting, internal control, and financial reporting practices” (SEC 1999) (emphasis added). However, given the skepticism about the effectiveness of audit committee independence following recent disclosures about the composition of Enron’s audit committee (which was independent as defined by the SEC), and concerns about the adequacy of the audit committee expertise requirement (Whitehead, 2002), it is an open question whether the audit committee independence and expertise requirements can favourably effect the monitoring of internal control.

Gee and McVay (2005), Ashbaugh-Skaife, Collins and Kinney (2006), show that audit committee quality, characterized on having more financial expertise, or more specifically having more accounting financial expertise and non-accounting financial expertise, is an important determinant of internal control weaknesses. In addition, we find that auditor independence calculated as the ratio of audit fee to total fee, is also a determinant of internal control weaknesses.

1. 1. Statement of Problem

There are current debate on management manipulation of earnings resulting in corporate fraud, corporate failure in the globe at large and in Nigeria in particular, examples are Cadbury (Nig) Plc, African Petroleum (Nig) plc etc WorldCom. The researcher is to carry out an investigation in order to find out the possible causes of this corporate fraudulent act exhibit by management which have resultant into corporate failure and proffered possible way-out.

1.3   Research Questions

The following are the questions required in order to achieve the objectives of the study.

i.      Is there any relationship between audit committee roles and the quality of financial reporting in Nigeria?

ii.     Is the quality of audit committee associated with the quality of internal control in Nigeria business environment?

iii.    Is there any relationship between effectiveness of audit committee and their ability to help auditors in the quest to maintain true independence in Nigeria?

iv.    Is there any significant relationship between audit committee quality, auditor independence and disclosure of internal control in Nigeria?      

1.4   Objective of the Study

The aim of this research work is to determine audit committee quality, audit independence and internal control weakness in the Nigeria context. This
can be achieved by the following objectives below:

1.     to investigate the relationship between audit committee roles and the quality of financial reporting in Nigeria.

2.     to ascertain whether the quality of the audit committee is associated with the quality of internal control in Nigeria business environment.

3.     to verify the relationship between the effectiveness of audit committee and their ability to help auditors in their quest to maintain true independence in Nigeria economic climate.

4.     to determine the relationship between audit committee quality, auditor independence and disclosure of internal control in Nigeria.

1.5   Statement of Hypotheses

The following hypotheses listed below will be used to test the acceptance or rejection of our data. They are stated in null (HO) and in alternate form (HI):

Hypothesis One

HO:   There is no relationship between audit committee roles and the quality of financial report in Nigeria.

HI: There is a relationship between audit committee roles and the quality of financial report in Nigeria.

Hypothesis Two

HO: The quality of audit committee is not positively associated with the quality of internal control in Nigeria business environment.

HI: The quality of audit committee is positively associated with the quality of internal control in Nigeria business environment

Hypothesis Three

HO:   The relationship between the effectiveness of audit committee and their ability does not assist auditors in their quest to maintain true independence in Nigeria economic climate.

HI:    The relationship between the effectiveness of audit committee and their ability do assist auditors in their quest to maintain true independence in Nigeria economic climate.

Hypothesis Four

HO:   There is no positive relationship between audit committee quality, auditors’ independence and disclosure of internal control weakness in Nigeria.

HI:    There is positive relationship between audit committee quality, auditors’ independence and disclosure of internal control weakness in Nigeria.

1.6   Significance of the Study

The information that will be provided after this study will be of relevance to government/regulators, shareholders, investors and the public in general in the Nigeria business environment as it attempts to provide an insight whether the quality of the audit committee is associated with the quality of internal control.

Professional accountants in the country will also benefit from the findings of the study because it will reveal the state and quality of the accounting and audit services they render to audit firms in Nigeria.

The study is of significance to the Nigerian government and institutionalized financial regulators in the country because it will show where legislations needs to be made or modified to provide for more effective regulation of the business activities in the country.

1.7   Scope of the Study

This study examines the audit committee, auditor independence and internal control weakness in Nigeria with Benin Electricity Distribution Company (BEDC), more emphasis on good audit committee and reduction in internal control weakness because it is considered an important factor in achieving good quality financial reporting. The study will illustrate audit committee quality in Benin Electricity Distribution Company (BEDC) between 2008 and 2013. The research work was mainly carried out in Benin City using a sample size of 50 for effective result.   

1. 1. Limitations of the Study

The study is faced with some constraints which may likely affect the generalization of findings; the constraints include the following below:

• Geographical Coverage: Factor that may likely affect the work is the issue of investigating all accounting firms in the country. Due to the spread of accounting firms all over major cities in the country, the researcher could not be able to cover the whole areas.
• Problem of sourcing for material: The research was faced with problems of getting current materials, textbooks, journals, seminar papers in relation with this research topic. In the final analysis most interviewed and investigated could not give some vital information that would have acted as ingredients in the work.
• The problem of retrieving the questionnaire: Some questionnaires issued to respondents were lost during the attitudes of the respondents to disclose their personal information.

1.9   Definition of Terms

1.     Audit Committee: It has been defined as a committee of directors of a company whose specific responsibility is to review the annual financial statement before submission to the board of directors (CICA, 1996). It can be regarded as a standing committee of the board and shareholders with equal representation of three (3) members each vested with the oversight function of accounting related activities and working with external and internal auditors to ensure effectiveness of internal control system and minimizing internal control weaknesses.

2.     Audit Committee Quality: It is defined as at least one member of the audit committee having accounting or financial expertise. BRC’s (1999).

3.     Auditor: An auditor is an independent person appointed to investigate the organization, its records, and the financial statement prepared by them, thus form an opinion on the accuracy and correctness of the financial statements.

4.     Auditors Independence: This means that auditors should be free to reveal any fact discovered in the examination of the books, he should be free in the expression of recommendation. It is measured in this study as the percentage of revenue from each client to the auditor’s total revenue.

5.     Internal Control: Is defined as a process effected by an entity’s board of directors, management and other personnel designed to provide reasonable assurance regarding the achievement of objectives according to the “COSO framework”.

6.     Internal Control Weakness: It’s defined as a significant deficiency or combination of significant deficiencies, that results in more than a remote likelihood that a material misstatement of the annual or interim financial statement will not be prevented or detected. Auditing Standard (hereafter AS) No. 2.