CHAPTER ONE
INTRODUCTION
Background of Study
The role of audit committee is of much interest to regulator and the public in corporate governance. Earlier, the function of the audit committee was to oversee corporate financial reporting and disclosure for public companies. However, in recent years, the role of audit committee has become more pronounced by Securities and Exchange Commission (SEC), Public Company Accounting Oversight Board (PCAOB) and Blue Ribbon Commission (BRC) due to the various economic events that have shaken the stability of the financial markets and investor’s confidence. Due to a number of corporate accounting scandals, the Sarbanes-Oxley Account of 2002 (SOX), also know as the public Company Accounting reform and Investor Protection Act of 2002 has stressed the importance of audit committee responsibility by increasing the requirements in terms of audit committee membership and composition.
The separation of management (control) from shareholders (ownership) necessitated the need for the former to account for the resources (capital) entrusted to them by the latter. According to Jensen and Meckling (1976) an agency problem arises whenever one person employs another to perform task on his behalf. Agency problem involves management (agent) attempt to maximize its welfare at the expense of shareholders (principal) and on the other hand, a deliberate attempt by shareholders to maximize their returns by establishing a monitoring system designed to ensure that management do not maximize its welfare at shareholders expenses.
This agency problem precipitated the need for a means by which management could make itself accountable to shareholders. This need is met by the preparation and presentation of accounts (financial statements) shareholders and other users. This arrangement has been made compulsory by law.
In Nigeria, the law governing the preparation of the financial statement of corporate entities is the Company and Allied Matter Act, 1990. Section 334 of CAMA 1990 (as amended) made it mandatory for directors of companies to prepare financial statements at the end of each accounting year. Based on the importance of financial statements, together with the considerable influence it has on the perception and decision of various users, not foregetting the belief or assumption that management may be bias when accounting for their own activities, there was need to wide-out all element of doubt and embrace a high level of assurance that the financial statement prepared and presented by management shows the true financial position of the reporting corporate entity. This assurance can only be attained when such financial statements are subjected to an “Audit”, through the process of “Auditing” by an independent person called “Auditor”.
During an audit, independent and competent accountants throw an investigative searchlight on the financial activities of the company over the period under review and issues a report informing the shareholders as to whether the account presented to them is a reflection of what happened during the period or not. Agency problem gave rise to accountability which is incomplete without an audit. Audit assumes accountability through the detection of existing malpractice, error and fraudulent practice and tendencies.
Since the milestone case of Mckessen and Robin in 1939 in the USA in which auditors were blamed by the regulatory bodies and users for whom the accounts were meant, efforts have been intensified to enhance the quality of audits as well as the independence of auditors in order to make financial statement more reliable and credible worldwide. One of such efforts manifested in the introduction of the Audit committee of the board of Directors. In fact, it was the Security and Exchange Commissions investigation report in the aforesaid case in USA that recommended that public companies must have Audit committees of the Board of Directors to oversee the internal control system and the financial reporting process (Abel, 2001).
The passing of the Sarbanes-Oxley Act in 2002 in the US Congress took the unprecedented step of vesting each public company Audit committee with direct management responsibility (Richard and Gale, 2003) set a new tone of the song of assurance in financial reporting across the globe. Similar steps were taken in UK and China and this expanded the duties responsibilities and power of Audit Committee.
According to Gwilham and Killommins (1998) the presence of Audit Committee has been found to create a perception of enhanced auditors independence and more reliable financial reporting among financial statements users. Jensen and Meckling (1997) suggested that because of the conflicting interest between managers and debt holders, higher leverage increases debt holders need to monitor managers. Managers have incentives to control the agency cost of debt and can do so by providing increased monitoring through audit committees.
In this period of economic crisis, the need for accountability becomes more conspicuous. The question on the effectiveness of audit is therefore worth examining in the Nigeria context. The nature and essence of an audit is such that the person performing it must be independent. By this, it means that the auditor is impartial and free from all direct and indirect influence of those affected by his work.
In Auditing the importance of independence is so overwhelming that various attempts have been made by law makers and accounting bodies to ensure its existence. In this research study an attempt is made to evaluate the relevance of Audit Committees to financial reporting in Nigeria and also to look at the extent to which Audit Committees have contributed to the independence of Auditors.
1.2 Statement of the Research Problem
Audit Committees are by reference to relevant sections of CAMA 1990 expected to bridge the expectation gap in providing a means by which the opinion expressed by auditors on a firm’s financial statement can be seen to be unbiased and independent. It is argued that the presence of Audit Committees is likely to lead to unnecessary rift between shareholders and directors as well as management and auditors. Also, were the managing director is a very influential member in the board and succeeds in hijacking authority from others, the audit committees would have no choice but to dance to this tune, given the composition of the audit committees of equal number of directors and representatives of the shareholders of the company subject to a maximum of six (6) members. This makes the appointment of the committee unnecessary. In view of the above, the study intends to find answers to the following questions:
Does the financial literacy of audit committee members enhance financial reporting in Nigeria?
How does the frequency of meetings and audit committee members enhance financial reporting in Nigeria?
What is the effect of multiple directorships of audit committee on financial reporting in Nigeria?
1.3 Objectives of the Study
The basic objective of this stud among others is to evaluate audit committees and financial reporting in Nigeria.
To examine if the financial literacy of audit committee members enhance financial reporting in Nigeria.
To ascertain if the frequency of meetings of audit committee enhance financial reporting in Nigeria.
To determine the effect of multiple directorships on financial reporting in Nigeria.
1.4 Hypotheses of the Study
The following hypotheses have been formulated to serve as a base for this research:
H1: Financial literacy of audit committee members does not enhance financial reporting in Nigeria.
H2: Frequency of meetings of audit committee members does not enhance financial reporting in Nigeria.
H3: Multiple directorships do not have an effect on financial reporting in Nigeria.
1.5 Scope of Study
This research work is an empirical study on audit committee and financial reporting in Nigeria for the period 2012 cut across fifty quoted firms.
1.6 Significance of the Study
The significance of this study is the benefits that both the corporate entities and the general public (within the Nigerian context) are expected to gain from this research work.
The result of this study will be very useful not only to other researchers in this area of study but also to corporate bodies in Nigeria as it will help them understand the role that audit committees play in improving and ensuring an effective internal control system, corporate governance and ultimately, a sound and reliable financial reporting framework.
1.7 Limitations of the Study
The limitation encountered in the course of the study includes:
Finance is a significant limitation: The available fund is not adequate to carry out the needed research based on high cost of transportation and the increasing rise in the buying of time to access information from the internet.
Time: This research was carried out alongside with my lectures, balancing both is not an easy task.
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