The Role Of Internal Auditing On Management’s Control Success

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The Role Of Internal Auditing On Management’s Control Success


Abstract


This study was to examine and find out the role of auditing on management’s control success with a particular reference to the Department of Audit, Ministry of Finance, Uyo, Akwa Ibom State. To achieve this objective, four research questions and three research hypotheses were formulated to guide the researcher study. The data collected were analyzed using simple percentages and tables to analyze research questions, and Chi-square statistical tool was used for testing the research hypotheses. A structured questionnaire was used as the major instrument for data collection from the staff and management of Department of Audit, Ministry of Finance, Uyo. After careful analysis of the data, the following findings were revealed that; auditing enhances accountability in public sector in Nigeria. The study was concluded with some recommendations that the state government should improve the remuneration and fringe benefits of internal auditors as this would enhance their efficiency and honesty in the discharge of their duties. Undoubtedly, upholding integrity, objectivity and transparency in the conduct of their respective audit functions will make the internal auditors to be more relevant in the public sector and the rate of inadequate qualified manpower in the audit departments in the public sector should be minimized. To make this effective, more auditors with the required professional knowledge and skill should be employed. Government should show more commitment in this area.


Chapter One


Introduction

1.1 Background of the Study

Organization all round the world be it public or private or otherwise needs auditing for proper assessment of their financial statements. Auditing is an independent examination of an expression of opinion on the financial statement of an enterprise or organization by an appointed auditor in pursuance of that appointment and in compliance with any relevant statutory obligation (Chamber, 2008). It aims at providing solution to the inevitable problem of credibility in report and accounts. It prevents and detects errors and frauds and also produces a report of the true and fairness of the financial statement (Coper, 2003). They also obtain full understanding of the operations under review. The role of internal audit has grown tremendously in most organizations in the recent past. This can be attributed partly to the growth of the organizations, which entails widely extended operations and the need to ensure that the organizations policies and basic accounting controls are observed at every facet of the organization. Again, it can be observed as a measure by management to ensure that the government regulations concerning the operations of organizations, both public and private are duly complied with so as to guard against conflicts and inconsistence with the law.

As the organization expands and supervisory responsibility broadens, the head can no longer have personal knowledge of every aspect of the organization. It becomes impossible for him to control or monitor the continuing effectiveness of all controls. This calls for the delegation of this responsibility to a separate department called the internal audit department. Internal Audit Department is a department set up by management, usually manned by a Chartered Accountant, as established in section 358 of the companies Act 1976, to receive the activities of other employees thereby enhancing controls in the organization.

Decisions may be made for various purpose and they vary from one business to another. Internal control provides assurance and dependability of the financial statements used in making decision, hence, there is need for auditing of financial statement, Auditing therefore is made to determine whether persons in positions of fiscal responsibility in government and commerce are acting and reporting in an honest manner.

The ministry of finance plays a vital role in the overall planning, controlling and disbursement of government funds, for the day to day running of the state administration. Basically, these functions are carried out by various departments in the ministry, the departments; personnel, finance and supplies, planning, research and statistics, office of the Accountant general.

The personnel department is headed by a director and its functions include appointment, promotion and discipline of staff and other staff welfare matters. The department of finance and supplies is headed by director, whose functions include provision of finance management information to the ministry of decision making.

Planning, research and statistics department is headed by a deputy director research into various aspects of government finances and economy while executive director is in charge of ministry of finance incorporated.
The office of the Accountant general is headed by Accountant general whose functions include provision of efficient Accounting services to the government and advising on financial matters. At the helm of affairs in the ministry is the Chief Executive called Honourable Commissioner for Finance while the Chief Accounting Officer is the Permanent Secretary. Management’s Control Success. In general, this ministry takes charge to disbursement of funds to ministries, departments, boards and parastatals for payment of staff salaries and wages, pensions and statistics. The main focus of this research state the intention of the researcher to study the impact audit could create on public sector accounting system in AkwaIbom State.

It is argued that if shareholders have perfect informationabout managers‟ actions, there would be no information asymmetry between thetwo parties. Information asymmetry exists when perfect information is absent,which is the assumption of agency theory and since informationasymmetry exists, stockholders have difficulty detecting earnings management (Fama, 1980). Though, it is argued that businesses adopt some level of discretion in their decision because no firm adopts a hundred percent rule based accounting systems when reporting their economic performances and financial position. In fact, Bello (2002) is of the opinion that it is unimaginable to have accounting systems that are totally rule based without room for occasional judgments.

A considerable number of studies that include Okolie (2014), Okolie, Izedonmi and Enofe (2013), Zgarni, Hlioui and Zehri (2012),Chi; Mehmet and Emin (2012), Ahmadzade, Hassanzadeh, Pooryegane and Ebrahimi (2012), Lisic and Pevzner(2011), Francis and Yu (2009), Rusmin (2010),Roger, Frank, Erik and Ann (2003), Zhou and Elder (2003), and Gaver and Paterson(2001)have found that quality of audit is one of the constraining factors that limit managements‟ manipulation of accounting numbers. Watts and Zimmerman (1986) show that auditing is a valuable form of monitoring used by firms to reduce agency costs. The value of auditing arises, because auditing reduces the misreporting of financial information. The value of auditing on constraining managerial discretion, however, is expected to vary with the quality of the auditor. Becker, DeFond Jiambalvo and Subramanyam(1998) and Heninger (2001) report evidence consistent with the external auditor acting as a constraint on earnings management, with the effectiveness of the constraint depending on audit quality.

The demand for auditing arises from the auditor‟s monitoring role in theprincipal-agent relationship (Eilifsen& Messier, 2000). The performance quality of this monitoring function may vary. Audit quality describes how well an audit detects and reports material misstatements of financial statements, reduces the effect of information asymmetry between management and shareholder sand therefore helps protect the interests of stockholders. High audit quality should be associated with high information quality of financial statements because financial statements audited by high quality auditors may be less likely to contain material misstatements. From an agency theory perspective, audit is a monitoring mechanism that provides reasonable assurance that financial statements are free of material misstatements and therefore protects the interests of shareholders. When the interests of management conflict with the interests of shareholders, management may not act in the best interests of shareholders. A high level of audit quality is therefore expected to result in lower levels of earnings management.
Literature has documented a number of attributes that explain audit quality and how the combined effect of the attributes could help checkmate managers‟ excessive earnings management practice. Of the numerous attributes identified in the literature, size of audit firm, independence and specialization of auditors seemed to stand out. Size of an audit firm is considered critical to its ability to assemble well qualified and highly experienced auditors to engage in different aspects of audit functions. Such a firm is more likely to engage in a wide range of audit assignments for different companies in view of its economies scope and scale. In line with these postulations, Francis, Maydew and Spales (1999) have documented evidence showing that the Big-4 audit firms provide a more significant constrain on earnings management than other audit firms. Thus, the size of an audit firm affects the extent to which it constraints earnings management practice.

In theory, a company‟s auditors are appointed independently by its shareholders, to whom they report. In practice however, auditors are chosen by the company‟s bosses, to whom they all too often become beholden (The Economist, 2002). Hence, auditors might be more inclined to allow aggressive and opportunistic reporting of accruals, resulting in lower quality audits and thus increase in earnings management. This places a question mark on the independence of an auditor. In addition to auditor size and auditor independence, auditors‟ industry specialization is considered to be an important attribute of audit quality as it impacts the earnings management of firms. Studies have shown that client firms with industry specialists are associated with highe rquality of financial reporting (Balsam, Krishnan and Yand,2003; Krishnan, 2003).Like large auditors such as the Big 4 invest in brand name capital, industry specialists to make investments in industry specific accounting technology to differentiate themselves from other auditors (Craswell, Franci& Taylor1995)

The high-profile corporate scandals of 2008 through to 2009 in Nigeria has continued to raise a lot of concern about the integrity of financial and auditing reporting systems in the country. Some corporate organizations in the banking and manufacturing sub-sectors that were never suspected to have problem were found to be living in past glory due to excessive earnings management practices. The ugly practices which were later discovered to have been on for sometime went undetected or unreported by auditors. The experience has since left its perils in the mind of shareholders, prospective investors, regulators and financial analysts.

The chemical and paints industry in Nigeria is considered one of the most susceptible sub-sectors of the country to earnings management. This is due to the ongoing effort by both government and industrialists to develop the industry as priority area of industrial investment and a support toward government housing policy for Nigerians.

The sub-sector has undergone various levels of transformation from the manual based processes to more technologically advanced production methods. In view of the renewed interest in the industry owing to its recent impressive performance and high level of activities, it is imperative to examine its earnings management practices and how it is affected by audit quality.


1.2 Statement of Problem

In the wake of corporate accounting scandals and unethical behaviours despite the existence of the code of best practice for corporate governance, earnings management has become a focal point of business strategists and academic research. The interestfeatures numerous corporate governance components like audit committee characteristics, board monitoring, corporate governance characteristics, institutional monitoring) and accounting standards, as well as the role they play in reducing earnings management. This is because unethical behaviour in reporting the earnings of firms negates the rudiments of agency relationship and misrepresents the organizations financial status.

Many studies have been conducted in the area of earnings management and audit quality most of which recognized the audit quality mechanisms as effective factors that restrain excessive opportunistic behavior amongst corporate management. Most of the studies focused on developed countries, and reported mixed findings (Krishnan, 2003; Balsam, Krishnan &Yand, 2003,DeFond, Raghunandan & Subramanyam, 2002; Beasley &Petroni, 2001; Abbott & Parker, 2000; Craswell, 1999).Some of the studies documented that Big 8, Big 6,Big 5 and Big 4 audit firmsprovide higher audit quality thannon-Big 8, Big 6, Big 5 and Big 4 audit firms (Davidson &Neu, 1993; Teoh& Wong, 1993). The studies of Kim, Chung and Firth(2003) and Lam and Chang (1994) indicate that Big 8, Big 6, Big 5 and Big 4audit firms might not always provide higher quality audit service than the others. This gave rise to the issue of inconclusiveness of findings. Given that the developed markets offer different institutional settings and litigation environments from those in the developing markets, the generalization of their findings is limited. Few studies have been conducted in emerging economies like Nigeria. The studies also documented mixed and inconclusiveness findings (Okolie, et. al.2013; Okolie, 2014; Gabriel &Ioraver, 2015).While these studies have covered some important aspects of audit quality, none of them used auditor tenure in measuring the independence of audit firms despite the strong relationship that exist between auditor tenure and quality of audit.

In addition, the studies used ordinary least square procedure with pooled data (which tends to be biased,to generate serial correlation, cross-sectional correlation and differing variances)instead of extracting panel data to test for cross-sectional effect in line with best practice in earnings management and audit quality studies. This study therefore represents a modest effort to fill the gaps identified in the literature. The study extends its analysis to cover variables that are often neglected in audit quality. The study also extends to a sub-sector that has attracted little attention with regard to earnings management despite its strategic importance to the economy of Nigeria.


1.3 Research Questions

This study sets to provide answers to the following questions:

  1. To what extent does audit firm size affect earnings management in Ministry of finance, Akwaibom state?
  2. What is the effect of auditor independence on earnings management in the listed chemical and paints firms in Nigeria?
  3. How does industry specialist auditor affect earnings management in the listed chemical and paints firms in Nigeria?

1.4 Objectives of the Study

The main objective of this study is to examine the impact of audit quality on earnings management of listed chemical and paints firms in Nigeria. The specific objectives of the study are to:

  1. Examine the impact of audit firm size on earnings management in listed chemical and paints firms in Nigeria;
  2. Assess the impact of auditor independence on earnings management in Ministry of finance , Akwa ibom state
  3. Examine the impact of industry specialist auditor on earnings management in Ministry of finance, Akwa Ibom state.

1.5 Hypotheses of the Study

Based on the objectives of the study, the following hypotheses were formulated:

H0: Audit firm size has no significant effect on earnings management

H0: Auditor independence has no significant impact on earnings management.

H0: Industry specialist auditor has no significant impact on earnings management.


1.6 Scope of the Study

The study covers the period of seven (7) years, from 2006 to 2012.The period was considered adequate because prior studies on this subject matter used maximum of five(5) years. Extending the study to cover seven(7) years would enhance the robustness of the analysis. The period also covers 2007 and 2008 when the global economic crisis that exposed many world corporate scandals started. The justification for the choice of the domain is that chemical and paints sector has received little attention from researchers in Nigeria despite the important role it plays in the country and its contribution to the country‟s economy.


1.7 Significance of the Study

Apart from contributing to the existing literature on the subject matter, the findings of this study will be of interest to policy makers, audit firms and professional accounting bodies, as well as existing and potential investors. Policy makers may use the findings of the study regarding the auditor independence to consider the potential benefits of regulating the minimum length of audit firm tenure, in years, that same auditor should audit the financial statements of a company. It has been posited that as the auditor tenure increases, the auditor is better at assessing risk of material misstatements by gaining experience and better insights into the client’s operations and business strategies as well as internal controls over financial reporting (Arens, Elder&Beasley,2003). Therefore, this study will provide a yardstick which professional accounting bodies will use in establishing policies, procedures to guide members on improving the quality of their audit in order to reduce the way and manner earnings are being manipulated by firms.

Financial analysts may also use the findings of this study to understand how the market interprets higher audit quality in constraining earnings management effect on capital market decisions. If the market sees the firms with industry specialization, longer audit tenure and audited by a big-4 auditor as being associated with higher financial reporting quality, the reported financial statements may be viewed as more reliable for investment decision and credit assessment. Also, both existing and potential investors may be educated on earnings management’s indicators, patterns and how well to monitor and make good out of their investments. In addition, the study will contribute to increasing the available studies on audit quality and earnings management, especially in this sector.


1.8 Operational Definition of Terms

Internal Audit

Internal audit is a dynamic profession involved in helping organisations achieve their objectives. It is concerned with evaluating and improving the effectiveness of risk management, control and governance processes in an organization

Management

Management is the administration of an organization, whether it is a business, a not-for-profit organization, or government body

Control

The power to influence or direct people’s behaviour or the course of events. ‘The whole operation is under the control of a production manager’‘ the situation was slipping out of her control’

Success

Success is the achievement of a high position in a particular field, for example in business or politics. Nearly all of the young people interviewed believed that work was the key to success.


1.8 Organization of the Study

This research work is organized in five chapters, for easy understanding, as follows

  • Chapter one is concern with the introduction, which consist of the (overview, of the study), historical background, statement of problem, objectives of the study, research hypotheses, significance of the study, scope and limitation of the study, definition of terms and historical background of the study.
  • Chapter two highlights the theoretical framework on which the study is based, thus the review of related literature.
  • Chapter three deals on the research design and methodology adopted in the study.
  • Chapter four concentrate on the data collection and analysis and presentation of finding.
  • Chapter five gives summary, conclusion, and recommendations made of the study

Chapter Five


Summary, Conclusion and Recommendation

5.1 Introduction

It is important to ascertain that the objective of this study was to ascertain the role of internal auditing on management control success.

In the preceding chapter, the relevant data collected for this study were presented, critically analyzed and appropriate interpretation given. In this chapter, certain recommendations made which in the opinion of the researcher will be of benefits in addressing the challenges of the internal auditing on management control.


5.2 Summary

This study investigated the role of internal audit in effective management control in public sector organization, the findings of the study reveal that effective management can be achieve in local government and IA effectiveness does play a role in ensuring effective management in public sector, while IA effectiveness does not affect management control in public sector. Since effective management control can be achieve, and IA play key role in ensuring effective management in public sector, there is the need for today’s auditors to acquire the requisite technique and skills in computer operations and electronic data processing in order to carry out their work effectively to continually support IA effectiveness. And management should put in place a conducive environment for internal auditor to perform their duty because of the impact, which it has on AI effectiveness. Therefore training personnel as well as other training infrastructure becomes an important ingredient in the successful operation of internal audit effectiveness in public sector organizations. Heads of internal audit unit should be in attendance at top management meetings to be aware of policies affecting organizational objectives.


5.3 Conclusion

The incidence of internal control system weaknesses have always impeded the ability of most water supply companies to effectively supply water to their customers and therefore generate potential revenue. As such her contribution to the improvement of national goals and objectives is not very satisfactory. Towards this end, internal audit is necessary since it is a catalyst for improving an organization’s effectiveness and efficiency by providing insight and recommendations based on analyses and assessments of data and business processes which translated to better financial performance. Thus, with commitment to integrity and accountability, internal auditing provides value to governing bodies and senior management as an objective source of independent advice, a fact that ensures that the proper processes are followed in generating and safeguarding the organizational wealth. The study reveals that internal control system plays a major role in prudently managing the resources and funds entrusted to managers of an organization. EWASCO has an organizational structure denoted by organizational charts, which indicated formal communication patterns within the organization.


5.4 Recommendations

The study recommends that: Internal control system and the investigating units at water service provision companies should be remodeled and strengthened to position them to discharge their duties effectively and efficiently. This should be done by unbundling components of the sector into separate and distinct, independent entities that handle generation, transmission, distribution and marketing. The companies should secure a cultural change within various cadres of staff that focuses on customer satisfaction, quality service and transparency in service delivery and procurement process. The water service companies should establish more customers care centers to mitigate complaints or wrong billing, disconnections wrongly done, improper address and names. The company should consider prepayments of water bills as an alternative to further accumulation of debts. This will go a long way to improving cash flow position for the company.


The Role Of Internal Auditing On Management’s Control Success


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