The Impact of Internal Audit on Financial Reporting Quality
Chapter One
Objectives of the study
The main objective of the study is to examine the impact of internal audit on financial reporting quality.
Specifically, the study sought to:
- Examine the impact of Internal Audit Standards on financial reporting quality.
- Examine the impact of Internal Audit Independence on financial reporting quality.
- Examine the impact of Professional Competence on financial reporting quality.
- Examine the impact of Top Management Support on financial reporting quality.
CHAPTER TWO
LITERATURE REVIEW
Conceptual review
Concept of Internal Audit
Institute of Internal Audit (2009) had defined internal audit as an objective, independent, consulting and guaranty function designated with the belief to add-value to organization’s activities. It’s as well helps an organization to attain its objectives of introducing a disciplined, in systematic ways of evaluating sound and effective risk management, control and governance processes.
More so, an evaluation of European internal audit literature by Allegrini, (2006) and a study of the Asia Pacific internal audit literatures by Cooper, Leung and Wong (2006) confirmed paradigmatic shift. McNamee and McNamee (1995) also elucidates the internal audit duty has shifted through three main stages. The first revolution of internal auditing started in the 1940s. In this first phase of the duty of internal audit based precisely on checking transaction and records. In the 1940s, the internal auditor was an associate in achieving business processes as well as creating higher profitability by further working with management to ensure policies and procedures were strictly adhered to. In the 1990s, internal audit became a value adding service to organizations including helping organizations in the minimization of risk by using sophisticated risk modeling, computerize assisted auditing, basing on quality management including audit process and statistical sampling.
According to Jurchescu (2010), see internal audit as an independent and objective functional activities which facilitates management with the aid of ensuring effective management of public sector income and expenditure, ensuring proper activities in public sector organizations, helps the public sector to achieve their objective through systematic and methodical approaches, evaluate and improves the effectiveness of internal control system and risk management. The above definition is concerned with the functions of internal auditors in public sector, mostly on the protection of resources wastages, the prudent utilization of revenue and expenditure on the evaluation of the effectiveness of risk management, internal control system and management processes.
According to Unegbu and kida (2014), an aspect of the internal control system provided by management of an organization to foster adequate acquiescing with the given policies and conduct to achieve the aims. From all the above definitions, internal audit can be seen as independent appraisal established within the organization with the aim of reviewing the effectiveness of the activities of an organization, evaluation of risk management, ensuring compliance with laid down rules and regulations and internal control system of the organization. However, the internal auditor is a worker within internal audit sector who is delegated with the responsibility of carrying out internal audit functions.
Cohen and Sayag, (2017) viewed internal audit as an unavailing control mechanize in both private and public sectarianism. Thus, is the proper period to look at the matter of internal audit (Sumritsakun & Ussahawanitchakit, 2009), particularly at local government level to assist towards their advancement. Therefore, there is need for the internal audit to be effective to ensure improvement in the Ministries, Departments and Agencies (MDAs) (Unegbu& Kida, 2014).
Danbatta (2017) concludes that a well examined internal audit research is known to reveal errors, strengths or shortcomings of internal control system of the organization.
Concept of Financial Reporting Quality
The theory of firm reporting quality was first posed by financial analysts and Stock Exchange market agents. They inferred that the reported profit does not show the firms’ profitability as it is purporting. Consequently, analyzing firms’ financial statements is a difficult task due to the manipulation tendencies associated with accounting information, particularly earnings. Thus accounting earnings as a major factor that conveys signals to the capital market is regarded as high quality if the probability of errors and misstatements is low or absent (Ewert & Wagenhoper, 2010). Based on this assertion, firms’ financial reporting quality is measured in terms of earnings quality which is also synonymous with accruals quality; that is, earnings with less accruals and high cash flow components.
Earnings management involves the repetitive selection of accounting measurement or reporting rules in a particular pattern, the impact of which is to report a stream of income with a smaller variation from trend than would otherwise have appeared (Copeland, 1968). Earnings management is defined by Barnea et al. (1976) as the deliberate dampening of fluctuations about some level of earnings considered being normal for the firm. In views of Schipper (1989) Earnings management can be equated with disclosure management, in the sense of a purposeful intervention in the financial reporting process.
Merchant and Rockness (1994) describe earnings management as any action on the part of management which affects reported income and provides no true economic advantage to the organization and may in fact, in the long-term be detrimental. In the same vein, Healy and Wahlen (1999) opine that earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers. According to them, earnings management might be defined differently, but there seems to be the same underlying concept that earnings management distorts a company’s real performance. More recently, Bello (2010) defined earnings management as any attempt to cook/doctor or tailor financial accounting reports to a given desired level.
CHAPTER THREE
RESEARCH METHODOLOGY
Introduction
In this section, the researcher sought to respond to the various research questions so as to meet the goal and intent of the study. This section deals with research philosophy, research design, sampling, research instruments, data collection and analytical methods. Research methodology is described as a way to comprehensively address the research problem, (Kothari, 2004).
Research Design
Research design is the ordering of conditions for gathering and data evaluation in a way that strives to put together pertinence to the research justification with a cost- cutting measure in procedure (Kothari, 2008). The research used here was a descriptive survey design. Information about a group of people (one or more), who are asked a number of questions with their answers being recorded and inputted into spreadsheet tables. The questions may be about their opinions, attitudes, characteristics or experiences.
Willing participants are asked questions and their replies are put together with percentages, frequency counts or more sophisticated statistical indexes, from the answers received, from which inferences can be drawn about a particular population. Additionally, it discusses in detail the prevailing status of two or more variables at a given position in time. It also checks to see if there is anything linking them and what is most suited in establishing the perceived role, effectiveness and evaluation of internal audit function in companies listed on the Manufacturers Association of Nigeria.
Population
Kombo and Tromp (2006) describe population as a complete category of elements or persons that at the minimum have one thing that they share in common. Mugenda and Mugenda (2003) interpret it as a whole group of individuals, events or objects that have a common noticeable attribute and adjust to a given description. A census of all companies was used since it is accurate and involves the whole population. The study population will be the firms listed on the Manufacturers Association of Nigeria, which are 66 listed companies.
CHAPTER FOUR
DATA ANALYSIS, RESULTS AND DISCUSSION
Introduction
This chapter presents the various statistical approaches used to check the impact of internal audit quality on the financial reporting quality of firms listed on the Manufacturers Association of Nigeria. Data gathered from the field is shown and examined using descriptive and inferential statistics.
CHAPTER FIVE
SUMMARY, CONCLUSIONAND RECOMMENDATIONS
Introduction
In this chapter, a summary and discussions of the findings, conclusions, recommendations and suggestions for further studies are presented.
Summary
The internal audit function is important to the growth of firms as it provides essential services for the management of the firms. It is helpful in bringing a “methodical disciplined way to gauge and refine the control and governance procedures, effectiveness of risk management” Institute of Internal Auditors. It is a vital function and as evidenced by the increasing demand for this service in several organizations.
The Internal Audit department is seen as an important factor when it comes to accounting systems being applied. The financial reports express the work and quality of an internal audit department and it efficiency will help in enhancing the quality of activities of the company.
The significance of internal audit is displayed in the increasing demand for this service in all organizations. Unfortunately, researchers have paid minimal attention to it and its impacts on the financial reporting quality of organizations. The role of this research was to establish if there is a connection between the internal audit and financial reporting quality of firms listed in the Manufacturers Association of Nigeria in Nigeria. From the analysis the study confirmed that the professional competence of internal auditors affects the performance of firms to a great extent.
The study highlighted the internal controls that influence the financial reporting quality of those firms in Nigeria to a great extent. It also revealed that internal audit controls in an organization have features built into them to ensure that fraudulent transactions are exposed. Intentional errors are concentrated in relatively few audits and these are fairly predictable by industry. Others agreed that cash receipts bear fairly strong controls, organizations that reveal an internal control problem encounter a significant increase in market-adjusted cost of capital.
The study also revealed that sticking with professional standards is a vital component of internal audit. Internal auditors also offer activities other than financial reporting as recognized by formal auditing standards. Standards for audits and audit-related activities affect the production of firms listed on the Manufacturers Association of Nigeria. Performing auditing work in compliance with the internal auditing standards positively influences the efficacy of auditing. Furthermore, internal audit practices and contribute to the improvement of risk management, control and governance in firms with efficient and controlled approaches.
The study further revealed that, an internal auditor must be free of both the staff and operational pursuits of an organization. The internal audit department in organizations must be separate from the activities which it regulates and must also be independent from the daily internal control processes. Every firm should have official principles of internal audit validating its position and powers in the framework of the firm. Independence is a vital component of auditing, the truthfulness of the auditor‘s opinions, conclusions and recommendations should be respected as such. Internal auditors must not have a conflict of interests with the firm; and finally, independence in carrying out an internal auditor’s duties is essential for the achievement of the function and objective of internal audit.
Conclusion
The study examined the impacts of internal audit quality on the financial reporting quality of firms listed on the Manufacturers Association of Nigeria. The research concluded that the quality of work of the internal audit sector has conspicuously and positively impacted the financial reporting quality of organizations listed on the Manufacturers Association of Nigeria. The independent variables studied: professional proficiency of auditors, auditor’s independence, quality of work of auditor’s and top management support showed that they all positively and significantly influence financial reporting quality in a significant way.
Roth (2004) observed that financial reporting quality was deemed reliable for management to utilize to make decisions which would accomplish their objectives and goals. This was provided by good internal control. However, if the time used to process transactions go up, productivity reduces and no value is added to activities if internal controls are inappropriate. Internal audit often help reveal efficiency breakthroughs which lead to effective process improvements. Additionally employees having such interactions with internal auditors can obtain new perspectives with regards to their positions and may bring about ideas that improve the performance of the firm.
The employees and management of firms owe a responsibility to the owners and stakeholders of the firms, and internal audit helps enhance that (Eighme & Cashell, 2002). Shareholders are concerned about their investments and interested in the returns. Other stakeholders are interested in reliable financial reports on business practices and performance and growth of the firm, an when these are combined, the internal audit department provides a neutral and objective service to management and other stakeholders.
The internal audit enhances the system of accountability that the executive directors and employees have towards stakeholders (Eighme & Cashell, 2002). The internal audit department accords an independent, dependable, objective, and neutral function to the management, board of directors, and audit committee. Stakeholders on the other hand are concerned about the return on investments, sustainable increase, and reliable reporting on the financial reporting quality of an oaganization (Ljubisavljević & Jovanovi, 2014).
Recommendations
There is the need for firms to adopt effective internal processes and practices that address key internal auditing practices for effectiveness of audit quality cannot be overemphasized. Audit quality is mainly about the quality of people, their training and moral calibre. As such the firms listed on the Manufacturers Association of Nigeria should consider the skills, personal qualities of audit personnel and the tutelage given to audit staff as the important factors that determine auditor quality.
The study also established that in order to implement good internal audit independence, managers need to know that they should be concerned about the interrelationships between internal audit independence and financial reporting quality. Internal auditors need to continuously update themselves with the ever changing times and technologies and also enhance their skills. By applying skills in vital instances, as well as building personal and professional credibility, internal auditors can become indispensable by spreading good governance and enhancing the efficiency of internal audit. The management of firms should organize seminars and worNops for internal auditors to be trained frequently by experts and be updated with the new practice principles.
Limitations of the Study
Due to inadequate funds the researcher conducted this research under serious financial constraints. This made it hard for an in-depth study to be conducted. Some respondents were biased while giving information due to reasons such as victimization as such the research findings were skewed.
Secondly the limitation of time was much evident since the sources of the data operate on working days and the researcher is equivalently equally an employee. Respondents were naturally skeptical and uneasy when asked to contribute to a study in which they were not aware of its ramifications. To make the respondents feel at ease, the researcher made it clear the nature of the study and its proposed function. The researcher further explained that the research was purely an academic undertaking and that data divulged would be kept in secret by the researcher. The research process was an expensive and tiresome exercise since the researcher had to commute frequently to where the respondents were and also had to communicate frequently to follow up with the respondents.
Suggestions for Further Research
It is of great importance to have quality audit work done and greater belief to be placed in financial statements prepared by companies as such further studies to look into areas that concern audit quality such as turnover of auditor’s satisfaction of services to customers and their loyalty.
The study sought to determine the impacts of internal audit quality on financial reporting quality of firms listed on the Manufacturers Association of Nigeria. The research proposes that an in-depth study should be carried out on the impact of internal audit quality on financial reporting quality of state corporations and also on companies not listed on the Manufacturers Association of Nigeria.
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