CHAPTER ONE

INTRODUCTION

1.1       Background ofthe Study.

 
Over the years and present, the quality of an audit still remain a great value to its stakeholders, simply because it is the product of a competent third party known as the auditor who is believed to have no personal interest in the affairs of the organization, and also being one who is professionally bound to discharge his duty with utmost diligence, objectivity, independence and professional competence. 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).
In the wake of various financial reporting scandals and audit failures associated with some corporations in Nigeria, such as Intercontinental Bank Plc. (2009), African Petroleum Plc. (2009), Afribank Plc. (2009) etc., financial regulators, accounting bodies and policy makers have come to elicit ways to combat these misfortunes and enhance quality audit. Among various issues in concern, the long tenure of an audit engagement is believed to be a compromising factor in guaranteeing the independence of an external auditor as there is increased level of familiarity between the auditor and the client, which as a result puts the auditor’s independence at a high risk of being jeopardized. Independence is fundamental to audit and is the credibility of the audit report; an audit conducted without ‘independence’ is essentially meaningless,(Fogarty & Lansley, 2002).
In order to solve the familiarity threat and improve audit quality, mandatory rotation of external auditors have been suggested as one of the measures to be adopted, meaning that a maximum limit is set for the tenure of an auditor with a firm in order to preserve auditors independence and aid quality audit report (healey & Kim, 2003);(Francis J. R., 2004). Audit quality also appears to improve when the duration of the audit–client relationship is truncated (Chung, 2004). The massive audit cases that occurred in different stock markets in recent years have shown that the reason for audit failure is not merely the technical failure, but a quite important factor is that auditors have lost independence (Li & Wang, 2005). In response to the financial reporting scandals which robed the banking sector of its credibility in Nigeria, the Central Bank of Nigeria (CBN) in 2010 issued a directive in line with the provisions of the CBN Code of Corporate Governance for banks, which stipulates that “the tenure of the auditors in a given bank shall be for a maximum period of ten years after which the audit firm shall not be re-appointed in the bank until after a period of another ten years. For the avoidance of doubt, the maximum period of ten years shall include the period on audit firm which later merged, changed name, and/or first commenced audit assignment in the bank.” (Central Bank of Nigeria, 2010).
However, various issues have been raised about the Mandatory rotation of auditors whereby some proponents do support its implementation with the view that it would secure auditors independence which would eventually aid audit quality and prevent audit failures, other opponents argue that the “mandatory audit firm rotation may not be the most efficient way to enhance auditor independence and audit quality (U.S General Accounting Office, 2003). This study seeks to examine the effect of mandatory audit firm rotation on auditor independence and audit quality in Nigeria.

1.2       Statement ofthe Problem

 
Credible financial information is vital to the growth of any economy; also auditors are expected to be independent and objective in the discharge of their responsibilities (Adelaja, 2009). The most vexing issue hindering credible financial information is the problem of audit failure and it is believed that at the heart of audit failure lies the issue of lack of external auditor’s independence which in turn hinders audit quality. The report of external auditors in corporate financial statements is seen as providing key assurance to the interest of shareholders (Gallegos , 2004). But where the independence of the auditor is in doubt, the stakeholders lose their confidence in the credibility of the financial statement and this result to a great deal of disappointment to various corporate stakeholders/investors in Nigeria. The lack of auditor independence and poor audit are also attributed to various financial reporting scandals (such as Intercontinental Bank Plc (2009), African Petroleum Plc. (2009), Afribank Plc. (2009) etc.,) which have occurred over the years and which have also put some big organizations out of business.
The issue of mandatory audit rotation is one of the measures proposed to counter this problem of audit failure. The study seeks to address the knowledge gap on how the fate of audit quality is determined by auditor’s independence, and how both can be invariably affected by the implementation of mandatory rotation of auditors. As many scholars do support its implementation, many also are against its effects and usefulness in addressing the issue of audit failure of which one of the sensitive issues behind this is the lack of auditor independence. Therefore, on this premise, this research focuses on the effect of mandatory audit firm rotation on auditor’s independence, audit quality and investors’ confidence.
 

1.3       Objectives ofthe Research

 
The objectives of this study are thus stated as follows:

1. To determine the relationship between mandatory audit firm rotation and auditor independence.
2. To ascertain the effects of mandatory audit firm rotation on audit quality.
3. To ascertain the extent to which mandatory audit firm rotation strengthens Nigerian investors’ confidence.

1.4       Research Questions

 
The research questions are given as below:

1. What is the level of impact of mandatory audit firm rotation on auditor independence?

2. To what extent does mandatory audit firm rotation enhance audit quality?

3. To what extent does mandatory audit firm rotation strengthen the Nigerian investors’ confidence?

1.5       Research Hypotheses

 
The hypotheses for this study are thus stated in the null form:

1. There is no significant relationship between Mandatory audit firm rotation and auditor’s independence.
2. Mandatory audit firm rotation has no significant effect on audit quality.
3. Mandatory audit firm rotation has no significant effect on investors’ confidence.

1.6       Scope and Limitations ofthe Study

 
In the spotlight of this research work, the study observed the effect of mandatory rotation of auditors on auditor independence and audit quality in South-east Nigeria. The researcher focused on public and private sectors of the economy, eliciting the perception of Nigerian investors and professional accountants in Anambra State and Enugu State, and covering a period of 2012 to 2015.
The degree of success attributed to this research work mostly depended on the timely response and pleasant cooperative attitude of some sources of information.
 

1.7       Significance ofthe Study

 
This research elaborates on effects of mandatory audit firm rotation on auditor’s independence, audit quality, and investors’ confidence, particularly eliciting the perception of various practitioners and investors in Nigeria. The study is of great importance as it is one which is aimed at evaluating the possible means of strengthening the ethical conducts of an external auditor in maintaining professional skepticism in the course of duty, and also being one which is globally debated based on its implementation, advantages and disadvantages, and its effect on various professional ethics of the discipline. The research and its findings are expected to contribute to the existing body of knowledge, and to various professionals and academics in the discipline.
 

1.8       Operational Definition of Terms

 
AUDIT is an independent examination of, and expression of opinion on the financial statements of a business enterprise by an appointed auditor in accordance with his terms of appointment and in compliance with the relevant statutory and performance requirements.
 
EXTERNAL AUDITOR also known as an independent auditor is an audit professional who performs an audit on the financial statements of a company, government, individual or other legal entity and who is independent of the entity being audited.
AUDITOR INDEPENDENCE is a mental attitude and physical appearance which portrays the auditor as being uninfluenced by others in judgment and decision.
AUDIT TENURE is the number of years an auditor is retained by the firm.
AUDIT QUALITY is the market-assessed joint probability that an auditor will discover a breach in a client’s accounting system although diverse, reflect the same structure.
MANDATORY AUDIT FIRM ROTATION is the imposition of a limit on the period of years in which a particular registered public accounting firm may be the auditor of books of accounts for a particular issuer.
INVESTORS’ CONFIDENCE is the confidence stakeholders place on investments remaining liquid or paying expected income.