EVALUATION OF THE ROLE OF THE AUDIT COMMITTEE IN ENHANCING THE FUNCTIONS OF THE EXTERNAL AUDITOR (A CASE STUDY OF PZ PLC, ABA, ABIA STATE)

CHAPTER ONE

INTRODUCTION

1. BACKGROUND OF THE STUDY

The concept of audit committee was first endorsed in 1939 by the New York Stock Exchange (NYSE). During the 1970s, the audit committee’s role was very welcome due to the great demands for corporate governance and corporate accountability (Spangler and Braiotta, 1990). In 1972, the U.S. Securities and Exchange Commission (SEC) was the first to recommend that public companies should create audit committees comprised of directors from outside the relevant companies’ managements. In 1977, the NYSE required that all audit committee members should be independent directors. In its Statements on Auditing Standards (SAS 61), the American Institute of Certified Public Accountants (AICPA, 1988) issued “Communication with Audit Committees” regarding the relationship between the audit committee, external auditors, and management of public companies. In 2011, The Blue Ribbon Committee (BRC, 2011) recommended major rule changes, related to improving the effectiveness of the corporate audit committee.

And later, after the corporate collapse of Enron, WorldCom, and others, the Sarbanes-Oxley Act was passed by the U.S. Congress in 2010 giving more power to audit committees, especially in regard to whistleblower and disclosure requirements. The Sarbanes-Oxley Act of 2010 increased audit committees’ responsibilities and authority. It raised membership requirements and committee composition to include more independent directors. Companies were required to disclose whether or not a financial expert is on the Committee. In addition, the SEC and the stock exchanges proposed new regulations and rules to further strengthen audit committees.

Audit committees are identified as effective means for corporate governance that reduce the potential for fraudulent financial reporting. Audit committees oversee the organization’s management, internal and external auditors to protect and preserve the shareholders’ equity and interests. To ensure effective corporate governance, the audit committee report should be included annually in the organization’s proxy statement, stating whether the audit committee has reviewed and discussed the financial statements with the management and the internal auditors (Basuony et al., 2014). As a corporate governance monitor, the audit committee should provide the public with correct, accurate, complete, and reliable information, and it should not leave a gap for predictions or uninformed expectations (BRC, 2011). The BRC report provides recommendations and guiding principles for improving the performance of audit committees that should ultimately result in better corporate governance. The importance of the audit function in terms of the audit committee and audit firm is further strengthened by the Sarbanes-Oxley Act of 2010. Corporate governance standards and principles are extracted from local and international laws, regulations, and rules, as well as from the organization’s bylaws, codes of conduct, and resolutions. Corporate governance focuses on the control systems and structures by which managers are held accountable to the organization’s legitimate stakeholders.

Traditional finance literature has indicated several mechanisms that help solve corporate governance problems (Jensen and Meckling, 2014; Fama, 2014; Jensen, 1986; Turnbull, 2015). There is a consensus on the classification of corporate governance mechanisms to two categories: internal and external mechanisms. However, there is a dissension on the contents of each category and the effectiveness of each mechanism. In addition, the topic of corporate governance mechanisms is too vast and rich research area to the extent that no single paper can survey all the corporate governance mechanisms developed in the literature and instead the papers try to focus on some particular governance mechanisms. Shleifer and Vishny (2015) concentrate on: incentive contracts, legal protection for the investors against the managerial self-dealing, and the ownership by large investors; they point out the costs and benefits of each governance mechanism. Denis and McConnell (2010) use a dual classification of corporate governance mechanisms (They use systems as synonym to mechanisms) as follows: (1) internal governance mechanisms including: boards of directors and ownership structure and (2) external governance mechanisms including: the takeover market and the legal regulatory system. Farinha (2010) surveys two categories of governance (or disciplining) mechanisms, the first category is the external disciplining mechanisms including: takeovers threat, product market competition, managerial labor market and mutual monitoring by managers, security analysts, the legal environment, and the role of reputation. The other category is the internal disciplining mechanisms which include: large and institutional shareholders, board of directors, insider ownership, compensation packages, debt policy, and dividend policy.

1.2 STATEMENT OF PROBLEM

Abbott and Parker, (2000); Krishnan, (2011), asserts that audit committees have been in existence for decades. However, there are criticisms of the practices of audit committees and their relevance. This committee according to CAMA, 1990 as amended consists of shareholders and directors who are expected to carry out oversight functions and present their report to shareholders contained in the financial statement. However, these committee members might not be capable to handle the expected responsibilities since the same law is silent as to their professional capacity or qualifications. Furthermore, does the inclusion of the report by this committee in the financial statement have any effect on the decisions users would make? Does it not amount to duplication of efforts or information overload to have both the reports of the audit committee and external auditor in just one financial statement? These and many more have informed our sudden interest in this area. Undertaking this study is justified from the purview of the decision usefulness of financial statements.

It is a known fact the that financial statement is a source of information to aid users in decision making however, provision of this information will require an analysis of the benefit and associated cost of providing it. If the associated cost outweigh the benefit, then provision of such for decision-making is not relevant. Therefore, a question worth answering is if the cost of including the audit committee report in the financial statement outweighs the information benefits it provides. Hence, the importance attached to a study as this that seeks to examine users’ perception of the inclusion of audit committee report in corporate financial statements. This study will indeed contribute to the existing debate on the importance or otherwise of including the audit committee report in the financial statement. Furthermore, the management team of companies stands to benefit, as this work will reveal if the audit committee report in the financial statement add value to decision making or is just an item of more cost.

1.3 AIMS OF THE STUDY

The major purpose of this study is to evaluate the role of the audit committee in enhancing the functions of the external auditor. Other general objectives of the study are:

1. To examine the activities of audit committee and how it contributes to enhance audit quality
2. To examine the roles of audit committee.
3. To examine how the role of audit committee enhance the functions of external auditor.
4. To examine the factors affecting effective audit committee.
5. To examine the relationship between role of audit committee and functions of external auditor.
6. To provide suggestions on how to perform the activities of audit committee.

1.4 RESEARCH QUESTIONS

1. What are the activities of audit committee and how does it contributes to enhance audit quality?
2. What are the roles of audit committee?
3. How does the role of audit committee enhance the functions of external auditor?
4. What are the factors affecting effective audit committee?
5. What is the relationship between role of audit committee and functions of external auditor?
6. What are the suggestions on how to perform the activities of audit committee?

1.5 RESEARCH HYPOTHESES

H₀: The size of audit committee has no significant influence on the functions of external auditor.

H₁: The size of audit committee has a significant influence on the functions of external auditor.

1.6 SIGNIFICANCE OF THE STUDY

This research would be of interest to the management and employees of Pz Plc of Nigeria. This topic is significant for business management, shareholder and the overall financial community because of the best use of assets comes from internal auditing from its responsibilities especially after financial crisis all over the world that makes internal auditing significant in monitoring and evaluation of management performance. This study keeps track of developments and trends in the field of auditing, whether in the field of professional standards or practices and modern methods and tries to apply this Development in Nigeria. The study would serve as reference materials to other researchers who may want to carry out more research on this or related topic. The study would broaden the researcher knowledge on the subject

1.7    SCOPE OF THE STUDY 

The study is based on the evaluation of the role of the audit committee in enhancing the functions of the external auditor, a case study of PZ PLC Aba, Abia State.

1.8 LIMITATION OF STUDY

Financial constraint– Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).

Time constraint– The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.

1.8 DEFINITION OF TERMS

Audit Committee: An audit committee is an operating committee of the board of directors charged with oversight of financial reporting and disclosure. Committee members are drawn from members of the company’s board of directors, with a Chairperson selected from among the committee members.

Auditor: A person who officially examines the business and financial records of a company or organization.

External Auditor: External auditor as a chartered accountant who is a public officer and is professionally qualified. Section 357 of CAMD 1990 talk on our auditor is appointed and he can also be appointed according to section 86 of the 2011 constitution of the federal republic of Nigeria.