MANDATORY AUDIT FIRM ROTATION ON AUDITOR INDEPENDENCE

EFFECT OF MANDATORY AUDIT FIRM ROTATION ON AUDITOR INDEPENDENCE, AUDIT QUALITY AND INVESTORS’ CONFIDENCE (A SURVEY OF SELECTED STATES IN SOUTH-EAST, NIGERIA)

CHAPTER ONE

INTRODUCTION

1.1 Background of the 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.

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