*Economics / 7. Accounting and Auditing

Babalola, Yisau Abiodun [PhD Student]

Accounting and Auditing Department

Volodymyr Dahl East Ukrainian National University, Lugansk, Ukraine

CORPORATE AUDIT COMMITTEES AND RISK CONTROLLING IN NIGERIA

Control risks are the risk that the internal control system may not prevent or detect the material misstatements or errors inherent in financial statements and reports (ICAN, 2010). Since the audit committee serves as the template for operationalising the activities of the internal control within the fulcrum of an organization; one such mechanism that has been widely used all over the world in corporate organizations to monitor the financial reporting process and corporate governance is the establishment of an audit committee comprising majorly of independent directors (Abbot and Parker, 2000). Interestingly, the need for internal control in any organization has existed since the beginning of management; the system of control adopted in any economy greatly determines the development and growth of that economy by optimal utilization of men, material, money, machine and time resources. Internal control can neither be neglected nor under-related in any modern and dynamic economy as it was born out of the complexity of the modern business world. The controls are put in place by many organizations including banks to check their resources, minimize wastage and guide plan to their eventual accomplishment.

Originally, the auditor is required to express an opinion of the truth and fairness of the financial statements of a company’s enterprise. In order to be able to express his opinion, the auditors must have examined the records and underlying transactions whether the financial statements are in line with the records. In small business with few transactions, vouching method may be used to examine every transaction and entry in the books. However, in big companies where transactions are numerous, the procedures of vouching all transactions will be very cumbersome and the cost involved will be high (Awe, 2002). It is therefore usual for auditors to determine that there is a system of procedures which if effectively applied all the time will ensure that all records are reliable. This system of procedures design to produce reliable records is usually called “the system of internal control” (Awe, 2002).

Evidences, however, emanating from recent high profile corporate collapses worldwide (e.g., Lehmar Brothers, Enron Corp. and WorldCom in U.S) have really placed skepticism on the efficacy of this system of internal control and as such makes this area of research a special interest to investors, regulators and academics not only in countries that suffered from such corporate collapses, but also in countries that have never experienced such crises. As a result, more attention has been given to regulations and mechanisms to enhance corporate governance worldwide in order to prevent or at least reduce the probability of the occurrence of financial failures and to restore the confidence in companies after they were shocked by the collapse of giant companies. However, the search for mechanisms to enhance corporate governance and increase the quality of financial reports has mostly focused on the structure of audit committees. For example, Levitt (1998), the former US Securities and Exchange Commission chairman (SEC), stated that: “Qualified, independent and tough minded audit committees represent the most reliable guardians of the public interest”.

However, very limited research has been done to evaluate audit committee effectiveness in Nigeria using their own set of principles and recommendations as benchmarks. As a result, very little is known about the efficacy of such principles and recommendations. This study focus on the audit committee's roles in auditor selection and protection of auditor independence by limiting non-audit services purchases because of two reasons. First, a number of researchers, regulators and professional bodies have considered the nomination and selection of external auditors and the protection of their independence to be the primary responsibilities of the audit committee while independent audit committee members have incentives to protect their reputational capital by assuming significant responsibility for the engagement of the audit firm and the protection of its independence (Fama and Jensen 1983). As a result, this study investigates the efficacy of the Nigeria firm’s best practices and recommendations regarding audit committees in the context of auditor selection. In the last few years following the collapse of giant firms worldwide, more attention has been given to enhance audit committee effectiveness as an important means to ensure high quality financial reports.

Lastly, Weber (1968) defined power as the ability to act successfully even against the resistance of others. Although this definition is only one of many found in the literature, it indicates the situations in which one social actor prevails over others. In the context of audit committees, Kalbers and Fogarty (1993) identified six types of power that could affect audit committee effectiveness. Legitimate power results from the fact that an audit committee is established through delegations of responsibility from the corporate board of directors. However, this board of directors is charged with ultimate accountability for corporate management. Despite the fact that the work of the audit committee may be reviewed by the board of directors, the audit committee still holds important decision-making authority. Sanctionary power results from the ability of the audit committee in making decisions that can have impacts on rewards and punishments to other parties such as corporate officers, the internal auditors and external auditors. Because audit committee members are most often outside directors, they are dependent on management, internal auditors, and external auditors for information. As a result, the success of such committee depends on the institutional support that it will get from all the three parties. Decisions made by the audit committee are rationally influenced by the members' ability to obtain information and to use it in a way most likely to accomplish audit committee objectives (information power).

The association between audit fee and non-audit services is important due to its potential to impact on auditor independence. The link between management and auditor has been analytically documented to increase with the provision of non-audit services. The existence of a positive relationship between audit fees and non-audit services purchases increases concerns because where the benefits of cost savings are retained by the auditor; the auditor becomes more dependent on the client, posing a threat to independence (Parkash and Venable 2003). The existence of a positive relationship between non-audit services fees and audit fees has also been documented in the UK. For example, Ezzamel et al. (2006) found that there was a positive association between non-audit services purchases and audit fees. They investigated the market reaction of disclosing non-audit services fees after the introduction of the new US disclosure requirement by the Securities and Exchange Commission that requires all listed companies to disclose both audit and non-audit services fees. The results of this study indicated that there was a significant negative market reaction with respect to firms with the highest unexpected non-audit services fees.

Finally, Abbott et al. (2003) examined the relationship between two audit committee characteristics, namely, independence and activity, and the relative magnitude of non-audit services purchases. They found that firms with independent and active audit committees had a lower ratio of non-audit services fees paid to the incumbent auditors relative to audit fees. However, they compounded only two of the audit committee characteristics (independence and activity) into a single variable called audit committee effectiveness ignoring the influence of the rest of audit committee characteristics on audit committee effectiveness and ultimately on the non-audit services purchases. In addition, they did not investigate which of the two audit committee characteristics contributes more to the control of non-audit services purchases. Moreover, they used 2001 as their test period, which was the first financial year after the Securities and Exchange Commission required all listed companies to disclose their audit and non-audit services fees. This indicates that limiting non-audit services purchases might be a result of management’s desires to send a positive message to the external users of the financial reports that management acts in the best interest of the shareholders and other third parties and not because of the audit committee efforts to control such purchases.

The Companies and Allied Matters Act required that every public limited liability company should have an audit committee. Effective audit committee provides assurance to the shareholders that the auditors, who act on their behalf, are in position to, and do safeguard their interests (ICAN, 2010).

Consequent upon the discussions above, sound corporate governance and the independent of the audit committee are two important factors here. Corporate governance is the key policy goals and deliberate efforts at ensuring that those shouldered with the responsibility of managing the organisation’s resources (i.e. the board of directors) are doing it to the best interest of the owners of the business (i.e. the shareholders). The case where a single individual or a collection of individuals cart away the corporate wealth to enrich themselves and favour cronies and families at the detriment of the corporate existence, expansion and survival is no longer acceptable. On the other hand, the independent audit committee hinged largely on its composition, qualification and experience. In Nigeria, the bases for these requirements are embedded in the various sections of the Company and Allied Matter Act (CAMA) 1990 and it should be strictly adhered to.

References:

Abbott, L. and Parker, S., 2000, Auditor selection and audit committee characteristics, Auditing: A Journal of Practice and Theory, Vol.19, Iss.2,

Awe W., 2002, The Principle of Auditing.

CAMA (1990), “Company Allied Matter Act”, Corporate Affairs Commission, Abuja.

Ezzamel, M., 1994, Organizational change and accounting: Understanding the

budgeting system in its organizational context, Organization Studies,

Vol.15, Iss.1,

Fama, and Jensen, M., 1983, Separation of ownership and control, Journal of Law

and Econornic, Vol.26, pp.301-325.

ICAN (2010), Advanced Auditing and Assurance Professional Examination I

Study Pack, The Institute of Chartered Accountant of Nigeria, Paper 11,

VI Publishers, Lagos.

Parkash, M., and Venable, C., 1993, Auditee incentives for auditor independence:

The case of non audit services, Accounting Review, Vol.68, Iss.1, pp.113-133