CHAPTER ONE

INTRODUCTION

1.1 Background to the study

The quality of financial reporting has been receiving greater attention, especially after recent

accounting scandals.

Credibility of Financial Reporting is the extent to which accounting information accurately

reflects the company’s current operating performance. it is useful in predicting future

performance, and helps assess firm value (Deschow&Schrand, 2004 as cited in Hribar,

Kravet & Wilson, 2011).

The objective of financial reporting is to provide high quality financial information about

economic entities that is useful for economic decisions. According to International

Accounting Standard Board (IASB, 2008), high quality financial reporting is critical to

investors and other stakeholders in making investment, credit and similar decision. An

important variable of financial reporting that is usually used as a yardstick of financial

reporting quality is accounting earnings, (Okoh, 2012; Yahaya, Kutigi & Ahmed, 2015) as it

provides a timely and reliable input to potential investors, capital providers, employees,

management, and other stakeholders for efficient economic decisions.

The quality of financial statements is not an indicator that can be easily quantified, as it

cannot be observed directly, being based on the perception of the users of financial

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information. Each category of users has its own expectations and perceptions regarding what

information is useful and of good quality (Achim& Chis, 2014).

Where information in the financial report is established to be materially false and misleading,

a crisis may ensue for the corporation concerned as well as for its auditors and regulator

which may include liquidation and litigation. However, as a myriad of scandals has shown,

the contents of financial reports remain a source of worries for stakeholders.

Eriabie&lzedonmi (2016), reported that high profile scandals like the ones involving

Afribank and Intercontinental Bank PLC in Nigeria involved extensive fraud and falsification

of financial statement contents. To forestall financial statement fraud crisis, organizations

take a wide range of actions which include setting up committees whose roles include

watching closely the contents of the financial report from compilation to publication and

beyond.

One of such committees is the audit committee which according to Eyenubo, Mudzamir, &

Ali (2017) consists of a selection of members of an organization saddled with the duty of

oversight of the company’s accounting and financial reporting as a good corporate

governance tool which enhances the integrity of financial reporting.

Safeguarding auditor’s independence is a key priority not only for auditors, but also for

management and investors. In the global market of today, the government, creditors,

institutional investors, lenders, regulator, stakeholder etc. rely on the information provided by

the auditors on the credibility and reliability of the financial statements. From a theoretical

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perspective, one of the primary purposes of financial reporting is to facilitate capital

allocation by increasing contracting efficiency and reducing information asymmetry among

capital market participants (Gow, Larcker& Reiss, 2015).

The Audit quality can be defined in two dimensions: first, detecting misstatements and errors

in financial statement and second, reporting these material misstatements and errors

(Matoke&Omwenga, 2016). Due to the fact that these characteristics are largely

unobservable, different proxies have been used by researchers like; Bogale (2016); Hassan

(2015); Yi-Fang, Lee-Wen, and Min-Ning (2015) to measure audit quality like: audit size,

audit hours, audit fees, reputation, litigation rate. (Krishnan &Schauer, 2000).

The spate of audit failures in the world has brought a great deal of disappointment to

investors and other corporate financial reporting stakeholders. Longevity of audit firm tenure

has also been linked with fraudulent financial reporting (Adeyemi, Okpala&Dabor, 2012). If

empirical studies are not carried out with respect to specific environmental factors the

problem of poor audit quality may be exacerbated with likely grave consequences for the

selected banks.

According to De Angelo (1981), audit quality is defined as the competency and independence

of auditors in detecting and reporting material misstatement. Zehri and Shabou (2011)

asserted that high quality auditors are more likely to discover questionable accounting

practices by clients and report material irregularities and misstatements compared with low

quality auditors. Due to this, a higher audit quality is able to better constrain earnings

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management, and in turn enhance the quality of financial reports (Ching, Teh, San & Hoe,

2015). The function of auditing is to lend credibility to the financial statement. The

financialstatement preparation is the responsibility of the management, while auditor

responsibility is to lend credibility of the financial statements. The auditor also increases the

credibility of other non-audited information which is released by the management. For an

audit to be credible and reliable it must be performed by someone who is independent and

cannot be influenced by position, this also implies that the auditor must not be an employee

in the company in order to avoid power which will affect his own conclusion. The securities

exchange commission approved new auditor independence regulation which requires that

traded companies should disclose the level of fees that were paid to their external auditor for

non-audit services.

1.2. Statement of the problem

Prior research on this area on audit quality and credibility of financial reporting are quite

numerous and focusing on Nigeria Banking Sector .Previous research in the related literature

has employed various measures as proxies of audit quality. Several studies have indicated

that a higher quality of auditing mitigates accruals based earnings management (Okolie,

2014; Soliman and Ragab, 2014; Gerayli, Yanesari and Ma’atoofi, 2011; Becker, DeFond,

Jiambalvo, &Subramanyam, 1998). This study used audit firm size, audit fees, audit tenure,

and audit independent as audit quality measures.

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After going through extent literature the researcher discovers that there is no concesus yet on

the relationship that exist between Audit quality and credibility of financial statement.

According to Itoro Monday Ikpantan and Emmanuel EmeakponuzuDaferighe they reported a

negative impact of Audit quality measures on the credibility of financial statement

whileKabiru and Abdullahi (2012) reported a positive impact of Audit quality measures on

the credibility of financial Statement.

Okoli 2014 reported a negative impact of Audit quality measures on the credibility of

financial Statement while Abdul Rahman & Lukman (2016) reported a positive impact of

Audit quality measures on the credibility of financial Statement.

Most of the researchers in the previous studies uses Audit firm size, Audit Tenure as

measures but does not take into Cognizant Audit fee as a measure of Audit Quality

This study therefore tends to find out to what extent some Audit quality measures affects

banks’ financial reporting quality.

1.3. Research Questions

Answer to the following questions will be sought as a basis for testing the hypotheses:

i. What is the impact of audit independence on the credibility of financial reporting?

ii. What is the impact of Auditors Tenure on credibility of financial reporting?

iii. What is the impact of Audit Fee on credibility of financial reporting?

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1.4. Objectives of the Study

The study in specific terms intended to:

i. Examine to what extent audit independence affects the credibility of financial reporting

ii. Determine the impacts of Auditors Tenure on credibility of financial reporting

iii. Examine the impact of Audit fee on credibility of financial reporting

1.5. Statement of Hypothesis

Hypothesis 1

HO: Audit quality does not have significant impact on understandability of financial

statement in the Nigerian Banking Sector

Hypothesis II

HO: There is no significant effect relationship between audit qualities on reliability of

financial statement in the Nigerian Banking Sector

Hypothesis III

HO: There is no significant relationship between audit quality and faithful representation of

financial statement in the Nigerian Banking Sector

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1.6. Significance of the study

The focus of this study is to examine the impact of audit quality on credibility of financial

reporting in the Nigerian Banking Sector. This study will be of importance to several

stakeholders such as Shareholders, potential investor’s management and so on.

This study is driven by the quest for quality financial reporting from the banking industry

because of its importance to the development of any country. There are a number of reasons

why this present study is important. Firstly, it aims to study closely certain characteristics of

banks such as their adoption of IFRS, auditor’s independence and performance. These

characteristics being determinants of accounting quality has been established in disclosure

studies through explanations by agency theory.

There is a high rise in the quest for quality financial reporting from the banking industry

because of its importance to the development of any country. It is often held that the need is

driven by the stakeholders’ quest for important guidelines and information in determining

banks’ performance and future prospect. They understand that quality financial reporting can

promote respect for the companies in the marketplace which can result in higher sales,

enhance employee loyalty and attract better personnel to the banks.

The adoption of IFRS in the world over leads to better financial information to shareholders,

better financial information for regulators, enhanced comparability, and improved

transparency of results, increased ability to secure cross border listing, better management of

global operations, and a decreased cost of capital (Gordon 2008). The removal of alternative

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accounting methods that are less reflective of firms’ performance tend to improve accounting

quality and the adoption of IFRS increase in revenue as a result of transparency and integrity

in reporting, and also facilitates easier access to capital.

This Study will therefore give a clearer view of the impacts of Audit quality on the credibility

of financial reports.

1.7. Scope of the study

The research work is on the determination of the impact of audit quality on credibility of

financial reporting in the Deposit money Banks in Nigeria.

The Scope of the study is delimited to the Deposit money Banks. There are 14 commercial

banks as listed on the website of CBN. These banks will be further delimited to selected

Banks. The selected Banks will be the focus of the study where data will be gathered. The

Time frame of annual report to be gathered will be from the period of 2008-2019. The choice

of Time frame is informed by Nigeria’s adoption of international Financial Reporting

Standards (IFRS) in 2011.

This study thus seeks to evaluate audit quality on the credibility of financial reporting in

Nigerian Banking Sector

1.8. Operationalization of Variables

Audit quality is the independent variable which is represented with three proxy variables

which are; Audit tenure, Audit fees, independence of Auditors. However, financial reporting

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credibility is the dependent variable measured by free from understandability of financial

statement, reliability of Financial Statement and Faithful representation of Financial

Statement

1.9. Definition of Terms

Audit Firms: They are firms that provide auditing services. They review activities to identify

inefficiencies in line with standards and organizational objectives.

Auditors’ Independence: This refers to the freedom of the auditor to act professionally.

Independence requires integrity and objective approach to the audit process.

Audit Tenure: This refers to the length of the auditor-client relationship. Thus tenure

includes the period that the predecessor audit firms (where there has been mergers/de-

mergers or other combinations in the audit firm)issued audit reports on the entity.

Financial Reporting: This is a process of producing statements that disclose an

organization’s financial status to Management, Investors, and the Government.

Financial Reporting Credibility: This represents the extent at which financial statements

provide accurate and fair information about the underlying financial position and economic

performance of an entity.

Independence of audit committee: This is a committee of the board of directors responsible

for oversight of the financial reporting process, selection of the independent auditor, and

receipt of audit results both internal and external.

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Understandability: This is the concept that financial information should be presented so that

reader can easily comprehend it to adherence to a reasonable level of understandability would

prevent an organization from deliberately obfuscating financial information in order to

mislead users of its financial statements.

Firms Value: This is the sum of the value of the firm’s equity and the value of debt.

Relevance: This refers to whether financial information can be verified and used consistently

by investors and creditors with the same results. Basically, relevance refers to the

trustworthiness of the financial statements.

Audit fee: This refers to the costs incurred by a firm to pay public accounting firms to audit

the firm’s financial statements.

CHAPTER TWO

LITERATURE REVIEW
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This chapter reviews articles and research papers dealing with impact of Audit quality on

financial reporting quality, with regard to its conceptual, theoretical and empirical findings.

This chapter will discuss: Conceptual Review; Theoretical Review; The Theoretical

Framework; The Empirical Review; Conceptual Framework; and Gaps in Existing Literature.

2.1 Conceptual Review

The purpose of this subsection is to define and provide the basic understanding of concepts

relevant to the study.

2.1.1 Financial Reporting Quality

According to International Accounting Standard Board (IASB), the essential principle of

assessing the financial reporting quality is related to the faithfulness of the objectives and

quality of disclosed information in a company’s financial reports. These qualitative

characteristics enhance the facilitation of assessing the usefulness of financial reports, which

will also lead to a high level of quality. To achieve this level, financial reports must be

faithfully represented, comparable, verifiable, timely, and understandable. Thus, the emphasis

is on having transparent financial reports, and not having misleading financial reports to

users; not to mention the importance of preciseness and predictability as indicators of a high

financial reporting quality (Gajevszky, 2015).

As it is defined in the Conceptual Framework for Financial Reporting of the Financial

Accounting Standard Board (FASB) and the International Accounting Standard Board

(IASB), there are agreed upon elements of high quality financial reporting. The qualitative

characteristics of financial reporting quality include: relevance, faithful representation,

understandability, comparability, verifiability, and timeliness. They are divided into

fundamental qualitative characteristics and enhancing qualitative characteristics. A

theoretical explanation for each of these terms emphasizes their importance as qualitative

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characteristics, and also indicates what qualities are considered fundamental among different

frameworks.

2.1.1. Audit tenure “The audit firm’s (auditors‟) total duration to hold their client or number

of consecutive years that the audit firm (auditor) has audited the client” (Johnson, Khurana

and Reynold, 2002). Auditor tenure has two aspects: the tenure of individuals engaged in the

audit, particularly the engagement partner, and the tenure of the audit firm. Empirical

evidence regarding the effect of auditor tenure on audit quality supports both arguments, with

studies finding that audit quality both increases and decreases as audit firm tenure increases

(Johnson, et al, 2002, Myers, Rigsby and Boone, 2003, Mansi, Maxwell and Miller, 2004,

Ghosh and Moon, 2005). Some studies on audit partner tenure find a positive association

between audit partner tenure and audit quality measured by discretionary accruals (Chi,

Huang, Liao and Xie, 2009, Chen,Huang, Liao, and Xie, 2010). Hence, the imposed

mandatory partner rotation, which limits auditor partner tenure, can result in decreased audit

quality. On the other hand, other studies find a negative association between audit quality and

long audit partner tenure (Carey and Simnett, 2006, Hamilton, Ruddock, Stokes and Taylor,

2005). Hence, the effects of audit partner rotation on audit quality are still inconclusive.

2.1.1.4 Faithful Representation

Faithful representation is the concept of reflecting and representing the real economic

position of the financial information that has been reported. This concept has the value of

explaining how well the obligations and economic resources, including transactions and

events, are fully represented in the financial reporting. Moreover, this quality has neutrality as

a sub notion which is about objectivity and balance. According to Willekens (2008),

researchers concluded that the auditors‘ report adds value to financial reporting information

by providing reasonable assurance about the degree to which the annual report represents

economic phenomena faithfully.‖ Additionally, how business organizations are controlled and

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directed affects the faithful presentation quality; this, in fact, is represented as nt corporate

governance factor when there is extensively disclosed information on corporate governance

issues in the annual report (Beest, Braam, &Boelens, 2009). Besides, the annual report

clarifies assumptions and estimates and explains the usage of the accounting principles in the

company clearly. It also highlights positive and negative changes and events by discussing

them in the annual results. The last important factor that strengthens this quality is having an

unqualified auditor’s report in the annual report.

Reliability as a quality of financial reporting used to be considered as the primary factor of

accounting information. In FASB’s old framework, reliability was the primary quality, and it

was comprised of representational faithfulness, neutrality, and verifiability. However, in the

new framework, faithful representation becomes the primary and the fundamental quality,

instead of reliability. Moreover, faithful representation is comprised of completeness,

neutrality, and accuracy. FASB also believes that reliability is one of the critical qualities to

accounting information (Downen, 2014).

To summarize, according to the FASB Conceptual Framework, FASB has defined the

fundamental qualities as reliability and relevance.

On one hand, the fundamental qualitative characteristics—relevance and faithful

representation—are the most critical and determinative of content in financial reporting. On

the other hand, the enhancing qualitative characteristics—understandability, comparability,

verifiability, and timelines—assist in improving the decision usefulness when the

fundamental qualitative characteristics are recognized. However, according to the

International Accounting Standards Board (IASB), the enhancing qualitative characteristics

cannot, by themselves, determine financial reporting quality.

2.1.1.5Audit Quality and Audit Quality Control

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Since the Audit Quality Forum was established in 2004, one of its key aims has been to

promote confidence in financial reporting. The statutory audit can reinforce confidence

because auditors are expected to provide an external, objective opinion on the preparation and

presentation of financial statements. Auditors need to be independent in the opinions they

express, while the work they have to do to form their opinions is highly dependent on, and

rooted in, the real world and may become particularly challenging in some national

environments.

In recent years audit practitioners, standard setters and regulators have taken significant steps

to enhance confidence in the quality of financial statement audits, particularly in the light of

problems encountered in major capital markets. Recent initiatives have been international in

scope because, to the extent that there have been perceived audit failures, they have involved

businesses with operations and financial statement users in many countries. Initiatives have

therefore sought to promote consistency across countries in terms of what auditors should do

and what financial statement users should expect from audit.

An audit firm should be dedicated to the pursuit of the highest quality in all its operations.

Quality control should not be in respect of each particular engagement only, but must also a

culture in the entire firm.

2.1.1.6 Auditor Independence

Ordinarily, independence means to have freedom from outside control or support; not

requiring or relying on something else. Consultative Council of Accountancy Bodies (CCAB)

views it from philosophical aspect that to be independent is to have the attitude of mind
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which is characterized by integrity as well as objective approach to professional duties. From

ethics point of view Suseno (2013) sees independence as the state of being objective and

unbiased in the cause of performing professional services. It demands that one should be

independent “in fact and in appearance”. Arens, Elder and Beasley (2012) agree that

professionals who are engaged should maintain independence “in fact and in appearance”. It

is to carry out professional duties with a high level of integrity and objectivity.

For the auditor, independence means to be free from undue censorship, control, and

manipulation of executive directors. SEC (2000) asserts that independent auditors are

principally regarded as the gate-keepers of the public securities markets; and whatever passes

through their gates is considered as doubled filtered and pure appearance in”, to perform all

professional duties with integrity and remain objective in all professional obligations.

Logically, auditor’s independence assessed and judged in terms of integrity and objectivity.

Meanwhile, there are environmental threats to auditor’s independence. Zayol, and Adzembe

(2017) observe that the fees received by the auditor for audit and non-audit services pose as

threats to auditor independence. Apart from this, the tenure of the auditor – client relationship

is another potential threats to auditor‟ independence since a lengthy relationship may grow

from formal to informal where auditor will become loyal to the executive directors and the

directors will feel responsible for the auditor‟s wellbeing even during the non-service times.

Enofe, Nbgame, Okunega and Ediae (2013) support this view that the independence of an

auditor becomes vulnerable by the tenure or length of time the auditor is retained in a

particular company. The reason as given by Enofe Nbgame, Okunega and Ediae,(2013) is

that the familiarity developed through long tenure and the wholesome of income the auditor

gathers from a particular company has high tendencies to erode the independence of the

auditor. Based on these threats, Okolie (2014) presumes that once the independence of an

auditor is impaired, it usually results in poor audit quality and brings about greater earnings

management and lower earnings quality.

Profitability is one of the measures of firm performance. Agency theory suggests a possible

relationship between profitability and accounting quality (Agyei-Mensah, 2015). Inchausti,

(1997) (in Agyei-Mensah, 2015) found that managers of very profitable firms will disclose

more quality accounting information in order to support compensation arrangements and the

continuance of their positions. Based on the above explanations, there is expected to exist a

positive relationship between performance and accounting quality. The return on capital

employed is used as a ratio of performance measure in this study. The return on capital

employed is calculated as:

Return on capital employed = Profit before interest and tax x 100

2.1.2.2 Users of Financial Statements

Financial Statements are available sources of information about a company, its current health,

and prospects for the future. A large variety of persons are interested in the acquisition and

utilization of financial information about business firms. The best sources of information are

the financial statements which provide a quantitative history about the firm. Users demand

financial statements because of their value as information sources about a firm’s

performance, financial condition and stewardship of its resources. The users of financial

statements can be internal or external users. Internal users of financial reports include but not

limited to: Analyst, managers and employees, owners while external users include but not

limited to: Suppliers, Customers, investors and Tax authorities.

Obviously, financial statements of enterprise are used by many categories of people who have

contact with the business and who have reasonable right to information concerning the

reporting entity. Additionally, viewed by accounting standards steering committee that most

significant or in the extreme case, the only user group were those comprising the company’s

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shareholders and creditors who need to invest in or lend to those companies which agreed to

provide them with the desire amount of information.

However, the growth and development of company law put in place by the state requires the

preparation and publication of financial accounts (reports of limited company). One factor

which can justify the role of the state in the regulation of the preparation and publication of

accounting information is the existence of other users groups whose interest needed to be

protected by the state. The development has stressed the existence of those other group users

to include employees and the general public and this view was strongly expressed in a

discussion document entitled “corporate Report”. In fact, in 1974, the Accounting Standards

Steering Committee (ASSC), operated jointly by the major accounting bodies, appointed a

subcommittee to prepare a wide-range discussion paper.

The terms of reference of the study were to re-examine the scope and aims of published

financial reports in the light of modern needs and conditions. Secondly, it will be concerned

with the public accountability of economic entities of all kinds, but especially business

enterprises. Furthermore, it will seek to establish a set of working concepts as a basis for

financial reporting. Its aims will be to identify the persons or groups for whom published

financial reports should be prepared, and the information appropriate to their interests.

Types of Financial Statements

According to Grewal (2008), “The term financial statements used in accounting refers, at

least to two statements (i) Statement of Profit or loss and other comprehensive income (ii)

Statement of financial position. To him, these statements are prepared at the end of a given

period of time for a business concern. The Statement of Financial position exhibits the assets,

17
liabilities and capital of the business on a particular date. Statement of profit or loss shows

the result of operations i.e profit or loss during a given period. To Gbede (2000),

Statements include “Statement of Financial Position, Statement of profit or loss and other

comprehensive income, the statement of source and uses of funds, value Added Statements

etc.”

Again, Pandey (1999) believes that financial statements are basically classified into the

income statement and Statement of financial position. He opines that these two are the basic

instruments of an accounting system to communicate financial information to users. Really

for the purpose of this research work, financial statement is basically classified into two:

Income Statement and Statement of financial position

The accountant’s role is to ensure that the information provided is useful for making

decisions. For external users, the accountant achieves this by providing a general – financial

statement that complies with statute and is reliable. For internal users this is done interfacing

with the user and establishing exactly what financial information is relevant to the decision

that is to be made (Bary and Jamie, 2005)

Statements include “Statement of profit or loss account and other comprehensive income,

Statement of Financial position and other comprehensive income, statement of source and

uses of funds, value Added Statements etc.”

Again, Pandey (1999) believes that financial statements are basically classified into the

income statement (Statement of profit or loss and other comprehensive income) and

Statement of financial position. He opines that these two are the basic instruments of an

accounting system to communicate financial information to users. Really for the purpose of

this research work, financial statement is basically classified into two: Income Statement and

the Balance sheet.

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The accountant’s role is to ensure that the information provided is useful for making

decisions. For external users, the accountant achieves this by providing a general – financial

statement that complies with statute and is reliable. For internal users this is done interfacing

with the user and establishing exactly what financial information is relevant to the decision

that is to be made (Bary and Jamie, 2005).

2.13 Audit

An audit is a systematic and independent examination of books, accounts, statutory records,

documents and vouchers of an organization to ascertain how far the financial statements as

well as non-financial disclosures present a true and fair view of the concern. It also attempts

to ensure that the books of accounts are properly maintained by the concern as required by

law.

Auditing has become an ubiquitous phenomenon in the corporate and the public sectors.

Auditors perceive and recognize the propositions before them for examination, obtain

evidence, evaluate the same and formulate an opinion on the basis of their judgment which is

communicated through their audit report.

Any subject matter may be audited. According to Arens, Elder, Beasley, Best, Shailer and

Fielder(2011), auditing is the accumulation and evaluation of evidence concerning the

information needed for determining and Bahram (2007:444) cited in Saputra (2015) contends

that if an audit is to be carried out in a manner that meets the reasonable expectations of the

users of audited financial statements, it is necessary to ensure that it is performed with due

regard for quality. The audit firm must not succumb to the temptation of compromising

quality to achieve financial benefits. In order to ensure high audit quality and restore public

investor confidence in corporate financial reporting, greater regulation of the profession has

been put in place in many countries. Also, the financial failures in many countries have

19
significantly influenced the international regulatory environment in a way that requires a

response.

The setback of the banking sector in Nigeria was partly as a result of financial and accounting

scandals which directly or indirectly involved the auditors. Literature has it that twenty-six

(26) banks were liquidated in 1997 and that there were post- consolidation banking crises in

2009 when ten (10) banks were declared insolvent and eight (8) executive management teams

of the banks were sacked by the Central Bank of Nigeria (CBN). In 2006, Cadbury Nigeria

Plc was involved in a very serious corporate scandal. All of these events and case deeply

influenced and affected the psyche of the shareholders negatively.According to Adeyemi and

Asaolu (2013), the centres of discussion as all of those scandals became manifest were the

reliability of accounting information and the necessity of reviewing the effectiveness of

accounting standards, auditing processes and financial reporting practices.According to

Nashwa(2003),the challenge is that the corporate management is empowered to appoint, hire,

fire, and pay both their internal and external auditors. Consequently,auditors tend to parley

and conive with management in a bid to retain the job of the client.For this reason, auditors

may not be reasonably and practicably independent of the corporate management because

they will have the desire to keep their clients for as long as possible . Adeyemi and Okpala

(2011).report that several audit failures have taken place in Nigeria, some leading to the

restatement of figures in the financial statements.

2.1.4 Audit Fee

Audit fee is the economic remuneration for auditors who provide audit services, which are an

agency fee according to certain standards. The audit fee includes the total cost of audit

through the overall audit work, the risk compensation and the profit demand. During the

20
actual audit work, the audit fee influences not only audit quality, but also the development of

accounting firms and audit industry.

Therefore, audit fee is always the research focus of domestic and foreign scholars. Simunic

first explores the determinants of audit fees using empirical evidence. He finds that the

complexity of the business, asset size, asset-liability ratio, etc. all affects the level of audit

fees. From then on, many scholars continue to study the determinants of the audit fees basing

on Simunic’s audit fee model. Some scholars find that the market can recognize the

characteristics that convey “high quality” signal and are willing to pay audit fee premiums to

them. For example, “Big 4” usually obtain audit fee premiums , because audit clients believe

that “Big 4” have higher audit qualit . Besides, some researches find that there are different

levels of audit fees among “Big 4” and illustrate that the firms with industry specialization

can acquire audit fee premiums

Audit fee is the economic remuneration for auditors who provide audit services, which are an

agency fee according to certain standards. The audit fee includes the total cost of audit

through the overall audit work, the risk compensation and the profit demand. During the

actual audit work, the audit fee influences not only audit quality, but also the development of

accounting firms and audit industry.

Therefore, audit fee is always the research focus of domestic and foreign scholars. Simunic

first explores the determinants of audit fees using empirical evidence. He finds that the

complexity of the business, asset size, asset-liability ratio, etc. all affects the level of audit

fees. From then on, many scholars continue to study the determinants of the audit fees basing

on Simunic’s audit fee model. Some scholars find that the market can recognize the

characteristics that convey “high quality” signal and are willing to pay audit fee premiums to

them. For example, “Big 4” usually obtain audit fee premiums , because audit clients believe

that “Big 4” have higher audit quality . Besides, some researches find that there are different

21
levels of audit fees among “Big 4” , and illustrate that the firms with industry specialization

can acquire audit fee premiums .

2.2 Theoretical Review

Theory is a set of related concepts codified into a law/rule that can describe relationships

among variables (Amos, 2015). Having this in mind, the theories that shall be adopted to

back this study are:

i. Resource Dependence Theory

ii. Value Maximization Theory

iii. Agency Theory

2.2.1 Resource Dependence Theory.

Resource dependence theory (RDT) is the study of how the external resources of

organizations affect the behavior of the organization. The procurement of external resources

is an important tenet of both the strategic and tactical management of any company.

Nevertheless, a theory of the consequences of this importance was not formalized until the

1970s, with the publication of The External Control of Organizations: A Resource

Dependence Perspective (Pfeffer Gerald R. and Salancik 1978). Resource dependence theory

has implications regarding the optimal divisional structure of organizations, recruitment of

board members and employees, production strategies, contract structure, external

organizational links, and many other aspects of organizational strategy.

The theory originated in the 1970s with the publication of The External Control of

Organizations: A Resource Dependence Perspective by Jeffrey Pfeffer and Gerald R.

Salancik.

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RDT is underpinned by the idea that resources are key to organizational success and that

access and control over resources is a basis of power. Resources are often controlled by

organizations not in the control of the organization needing them, meaning that strategies

must be carefully considered in order to maintain open access to resources.

Organizations typically build redundancy into resource acquisition in order to reduce their

reliance on single sources e.g. by liaising with multiple suppliers. 

Resource Dependence Theory (RDT) sees a corporate entity as an open system, which is

dependent on contingencies in the external environment (Pfeffer&Salancik, 1978). The

theory assumes that “to understand the behavior of a corporate entity, one must understand

the context of such behavior. In other words, must understand the organization, system,

circumstance and context. RDT assumes that an organization is largely influenced by external

factors on organizational, and managers can in order to reduce environmental uncertainty and

dependence.

Base on this, it means that Nigerian firms operate under the Resource Dependence Theory

since they depend on laws made by external regulatory bodies on company’s financial

reporting process; and they also depend on independent external auditor whose expertise and

neutrality is needed to provide a reliable and quality report.

2.2.2 Value Maximization Theory

This study opines that exist basically for two main reasons. That is, to maximize profit in the

short run or maximize shareholders’ wealth in the long-term, this implies that management or

23
drivers of organizations business must take decisions that will enhance shareholders’ wealth

in the long-term. It is imperative to note that wealth maximization in this context does not

imply maximizing shareholders’ wealth alone; but extends to maximizing the interest of other

financial claimants especially the debt and warrant holders. The theory explains that all the

activities of organization are profit or wealth driven even when they seem benevolent, as

corporate social responsibility or given to charity. It further explains that the long run wealth

maximization objectives extend to the maximization of other financial claimants like debt and

warrant holders. Following from this, it can be argued that deposit money banks disclosure of

IFRS compliant financial statements will result in maximizing firm’s value.

This is further corroborated by the result derived from the computation of certain ratios

(Profit After Tax & Total Equity) for 3 selected banks between 2011 and 2013. It was

discovered that Zenith Banks PAT and ROE grew from N41.3 billion in 2011 to N83.4billion

in 2013 and N372billion in 2011 to N472bilion 2013 respectively; Access Bank PAT raised

from N5.2 billion in 2011 to N26.2 billion in 2013 and ROE grew from N187billion in 2011

to N245 billion in 2013. In the same vein GTB Plc PAT and equity grew from N51.7 billion

to N85.5 billion and N234 billion to N329.6 billion in 2011 and 2013 respectively. It is

important to note at this juncture that the value relevance is one of the measures used in

determining accounting quality of a firm.

2.2.3 Agency Theory.

Agency theory has been widely used in literature to investigate the information asymmetry

between principals (shareholders) and agent (management). Sarens and Abdolmohhammadi

(2007), states that according to the agency theory, a company consists of a set of linked

contracts between the owners of economic resources (the principals) and managers (the

agents) who are charged with using and controlling these resources. Jensen and Meckling

(1976), states that in agency theory, agents have more information than principals and this

24
information asymmetry adversely affects the principals’ ability to monitor whether or not

their interests are being properly served by the agents.

Sarens and Abdolmohhamadi (2007), opines that an assumption of agency theory is that

principals and agents act rationally and use contracting to maximize their wealth. A

consequence of this is the moral hazard issue. Jensen and Meckling (1976), opine that moral

hazard constitutes a situation where to maximise their own wealth; agents may face the

dilemma of acting against the interests of their principals. Since principals do not have access

to all available information at the time a decision is being made by an agent, they are unable

to determine whether the agent’s actions are in the best interest of the firm.

The literature on agency theory largely focuses on methods and systems, and the

consequences that arise to try to align the interests of the principal and agent (Delves and

Patrick, 2003 ). Delves and Patrick stated that while the agent/principal dilemma in a

corporate context had been pondered as early as the 18th century by Adam Smith3—and

many of its key concepts were developed in literature on the firm, organizations, and on

incentives and information, a separate theory of agency did not emerge until the early 1970s

when Stephen A. Ross and Barry M. Mitnick, working independently, each presented a

theory of agency. Stephen Ross and Barry Mitnick, independently and roughly concurrently,

were the first scholars to propose, explicitly, that a theory of agency be created, and to

actually begin its creation (Mitnick, 2006). He stated that Ross was responsible for the origin

of the economic theory of agency; that he introduced the study of agency in terms of

problems of compensation contracting; in essence, agency was seen as an incentives problem,

and Mitnick was responsible for the institutional theory of agency pointing to the fact that

institutions form around agency and evolve to deal with agency, in response to the essential

imperfection of agency relationships.

25
An agency relationship is defined as one in which one or more persons (the principal(s))

engage another person (the agent) to perform some service on their behalf which involves

delegating some decision-making authority to the agent (Jensen &Meckling, 1976).

According to Investopedia (2016), Agency Theory is the relationship between two parties,

where one is a principal and the other is an agent who represents the principal in transaction

with a third party. It explains the relationship between principals (such as shareholders) and

agents (such as company executives) in business.

2.3 The Theoretical Framework

The study is hinged on agency theory. The theory assumes that an agency relationship occurs

where we have one or more principals who engage another person as their agent to do a

service under their directive. Principally, such arrangement often results in delegating

accountability by the principal, through which the principal (s) place trust on the agent to act

in the best interest of the principal (Jensen and Meckling, 1993).

The theory is particularly related to independence auditor as agent which is hired to disclose

the managers‟ or directors‟ performance to the shareholders through auditing process, as well

as the directors as agents of the shareholders in the effective and efficient management of the

business. Smii (2016) perceived that within the principle of the agency theory, the leader is

supposed to follow an opportunistic behavior to maximize his utility function. And that in

order to cope with such behavior, the shareholders use a third party (external auditor) to

monitor the managers and check the quality of the disclosed information. Scoped around this

theoretical framework the role of the external audit, as a means of controlling and reducing

the agency costs, is twofold: “it helps, on the one hand, reduce the information asymmetry

and, on the other hand, strengthen the mechanisms of corporate governance”.

26
The emphasis of agency theory is on the need for shareholders to monitor the activities of the

board. In this relationship, an independent auditor with core financial training and expertise

will reduce the incidence of management irregularities or fraud, where the underlying

assumption is that independent auditor without stake or a factor to be bias is likely to exhume

inadequacies in the financial dealings of the executive directors/management without fear or

favor. It is therefore on this assumption that evidences become clear that independent auditor

have a symbiotic relationship the credibility of financial report.

With reference to audit independence and its impact on financial report quality, the agency

theory under review, provides a solid foundation explaining the experiences, skills, and

capabilities i.e. qualifications as part of the corporate governance process to oversee

management and protect shareholders‟ interests (Arthurs et al., 2009). This largely support

the earlier study of Barney (1991) ascertain that human capital with firm’s specific skills and

capabilities have potential to turn intangible resources into sources of competitive advantage.

The human capital as applicable to the current study is independent auditor in relations with

robust analysis and quality financial reports in terms of credibility, understandability,

relevance and integrity of financial reports.

Basically, it is the assumption made in agency theory about individualistic utility motivations

resulting in principal-agent interest divergence is the center of focus in this study. In other

words, professionalism in auditing handling and process by independent auditor adds in no

small way to corporate performance, and credible outcome of financial report.

Therefore, focusing on auditor’s independence, the agency theory magnifies the influence of

independence of auditor on the credibility of financial quality, serving as the watchdog on the

management, and revealing financial strengths, deficiency, adherence to standards and

general performance of the company.

27
2.4 Empirical Review

2.4.1 Reviews on Audit Quality and credibility of financial reporting

2.4.2 What is the impact of Auditors independence on the credibility of financial

reportimg?

Sim, Daw and Abu (2016) studied the effect of auditors independence on a firm’s financial

reporting credibility for 56 firms listed on the Malaysian stock market, selected from the

construction sector for the period of 2010 to 2013.

Data were collected from the published annual reports and their notes to the financial

statements of the sampled firms. To assess the level of compliance with the provisions of the

Financial Reporting Standard (FRS) in Malaysia, content analysis was carried out. The firm's

engagement with established audit firms was used as a proxy for audit quality, and return on

assets was used as a measure of firm performance. Panel data analysis was employed in

analyzing the data and testing the stated hypotheses. The use of panel data reveals that

practices of FRS by firms significantly and positively related to their financial performance.

The results also indicate that audit quality has a significant positive impact on business

financial success. The study, therefore, recommends that the management of listed

construction firms improve their practices of FRS and employ the service of established audit

firms in support of financial success in Nigeria from 2007 to 2011. The study is descriptive in

nature and the correlational and ex-post-facto designs were adopted in carrying out this

research. Data were obtained from the published annual reports and accounts, and notes to the

financial statements of the four sampled firms'. The data collected were quantified and

presented in tables. Multiple regression analysis was employed in analyzing the data and

testing the stated hypotheses. The study used auditor independence and audit size as

independent variables, net profit margin as dependent and leverage as control variable.

28
The results of the findings shows that auditor size and auditor independence have significant

impacts on the net profit margin of the sampled firms, however, auditor independence has

more influence than auditor size on the net profit margin. The study recommends that the

management of quoted cement firms in Nigeria should increase the remuneration of auditors

in order to improve their financial performance and the services of audit firms whose

character and integrity are beyond question.

Ilaboya and Ohiokha (2014) examined the impact of audit firms’ characteristics on audit

quality. The study proxies audit quality using the usual dichotomous variable of 1 if big 4

audit firm and 0 if otherwise. A sample of 18 food and beverage companies listed on the

Nigerian Stock Exchange market within 2007-2012 was used for the study. A multivariate

regression technique with emphasis on Logic and Probity method was used to estimate the

model for the study. The findings indicate that there is a positive relationship between firm

size, board independence and audit quality whereas there is a negative relationship

between auditor’s independence, audit firm size, audit tenure and audit quality

Rahmina and Agoes (2014) aimed to determine the effect of auditor independence, audit

tenure, and audit fee both partially and simultaneously on the audit quality. This research uses

primary data collected through the distribution of questionnaires in audit firm listed in Capital

Market Accountant Forum – FAPM in Indonesia. The population of research are senior

auditor, supervisors, managers, and partners positions and worked on the audit firm member

of FAPM. The results of this research show that in general auditor independence, audit

tenure, and audit fee have a positive influence on audit quality. The test Coefficient of

Determination result of 21.4% indicates that the audit quality can be explained by variations

in auditor independence, audit tenure, and audit fee, while the remaining 78,6% is explained

by other variables that are not used in this research, such as auditor’s size, auditor’s industry

specialization, and audit risk.

29
Musa and Shehu (2014) in their research reveal that the financial statement audit is an

important tool for reducing information asymmetries and maintaining an efficient market

environment. The study is descriptive in nature and the co relational and ex-post facto

designs were adopted in carrying out this research. Data were obtained basically from the

published annual reports and accounts, and notes to the financial statements of the four firms

that represent the sample of the study. The data collected were quantified and presented in

tables. Multiple regression analysis using the SPSS Version 15.0 was employed in analyzing

the data and testing the stated hypotheses. The results of the findings shows that auditor

independence and Auditors size have significant impacts on the financial performance of

listed Deposit money banks in Nigeria. However, auditor independence has more influence

than auditor size on financial performance.

Olaoye ,Aguguo, Safiriyu and Abiola(2019) investigated the impact of the independence of

statutory auditor on the reliability of financial statements of the manufacturing companies in

Nigeria. The study adopted a survey research design. It used data collected from structured

online questionnaires which were administered to the shareholders of listed companies in

Nigeria. The population of the study comprised all shareholders in Nigerian listed companies,

150 structured questionnaires were randomly distributed from which 137 were retrieved from

the respondents. The gathered data were analyzed using descriptive and inferential statistics.

For unwavering quality, the Cronbach alpha was used to test the dependability of the

instrument. Findings show that independence of statutory auditors had a positive significant

effect on reliability of financial statements (RFS) (F= 9.018, Adj. R2 = 0.191, p < 0.05). In

addition, it was found that non-financial interest (NFI) had a positive insignificant effect on

RFS, AdjR2 = 0.195; F-Stat. = 9.255; P = 0.000. Audit tenure (AT) also had a positive

significant effect on RFS, AdjR2 = 0.078; F-Stat. = 3.877; P-value = 0.005. While Non- audit

30
services (NAS) exhibited a positive significant effect on RFS, AdjR2 = 0.118; F-Stat. =

5.568; P-value = 0.000. Based on the findings, the study recommended that audit firms

should regulate the number and length of non-audit services rendered to companies they

serve as external auditor and also undergo a frequent review on financial statements where

their clients have interest so as to reduce self-review and self-interest threat.

Hirhyel (2017) studied the effect of audit firm attributes on financial reporting quality of

listed Deposit money banks in Nigeria. The study used 13 firms as sample size. Earnings

quality is the dependent variable; Modified Jones Models was used to measure earnings

management. Industry specialized auditor, audit compensation, audit tenure and audit firm

type are the independent variables. Data for the study were obtained from the audited annual

report of the 13 sampled firms for a period of 8 years covering 2007 to 2014. The study

employed ordinary least square regressions as tool for analysis.

The result shows that industry specialized auditors and audit firms type have a significant

positive influence on financial reporting quality of sampled firms.It was recommended that

they should employ the services of industry specialized auditors and big four audit firm types

who have the capability of influencing the quality of financial reporting.

Dangana, (2014) examined the impact of auditors independence on financial reporting quality

of quoted building material firms in Nigeria. The study employed correlation research design

using a sample of four listed building material firms for the period of ten years (2002-2011).

Ordinary Least Square (OLS) multiple regression technique was employed in the analysis of

the panel data collected for the study. The study found that audit compensation and audit firm

independence have significant positive impact on the financial reporting quality of quoted

building material firms in Nigeria at 99% confidence level. The finding suggested that,

auditors independence and provision of non-audit services in the quoted building material

31
firms in Nigeria have improved the quality of their financial reporting during the period under

review.

Kabiru and Abdullahi (2012), they carried out an empirical investigation into the quality of

audited financial statements of deposit money banks in Nigeria, using both primary and

secondary data and from the population of 21 banks they selected a sample of 5 banks

comprises of First Bank, Zenith Bank, Union Bank, United Bank for Africa and Access Bank,

all publicly quoted companies in Nigeria. They found that Independence of an auditor does

significantly improve the quality of audited financial statements of money deposit banks in

Nigeria. Compliance to auditing guidelines has positive and significant effect on the quality

of audited financial statement of money deposit banks in Nigeria. Material misstatement does

significantly affect the quality of audited financial statements of money deposit banks in

Nigeria.

2.4.3 What is the impact of Auditors Tenure on the credibility of financial reporting

Barbadillo and Aguilar (2008) in a study to of the relationship between the duration of audit

engagement and audit quality specified a model to show the functional relationship between

the dependent variable (value of audit quality) and the main explanatory factor (tenure).

Using a sample of non-financial Spanish companies quoted on Madrid Stock Exchange, the

study reveals an inverse relationship between auditor tenure and audit quality and suggest

that auditors tend to be more dependent in the first years of the auditing engagement. The

study concludes that the shorter the auditor’s tenure, the more they behave in a dependent

fashion.

Geiger and Raghumandan (2002) revealed a negative association between financial reporting

failures and audit tenure by using a US sample of 82 companies using Ordinary Least Square

Model estimation technique for data analyses to test the relationship between financial

reporting failures and audit tenure. Secondary data derived from the published annual reports

of the selected companies for a six year period (2008-2013) was used for the study and the
32
study reveals that Audit Tenure has a negative impact on the credibility of financial

Statement.

Hussey and Lan (2001) undertook a survey of U.K. financial directors on the impact of the

duration of the auditor-client relationship on the audit quality. The findings revealed that

majority of the respondents disagreed on the option of compulsory rotation of audit firms

after a fixed number of years. A multiple regression analysis was further used in order to test

the relationship between rotation and the other variables identified. These were the Finance

Directors’ perception of audit quality, the costs of the audit. The results show that perception

of audit quality would be enhanced if rotation of audit tenure was most unlikely.

Myers, Myers and Omer (2003) using proxy variables such as discretionary accruals and

current accruals, investigate the relationship between audit tenure and audit quality. The

univariate results show that when auditor tenure is longer, the negative value of accrual

measures was observed to be minimal. Furthermore, the study also employed multivariate

analysis in order to examine if the discovered relationship between tenure and accrual is also

influenced by other factors. The relationship between auditor tenure and accrual measures

was also observed to be consistent in multivariate analysis as in the univariate analysis.

On the other hand, the study found that extended auditor tenure had a beneficial effect on the

dispersion of accruals. The implication is that there is the tendency for auditors to place

greater constraints on both income increasing and income decreasing accruals as the audit

client relation lengthens.These results suggest that audit quality does not appear to deteriorate

with tenure.

Nashwa (2004) using a sample of U.S companies, carried out a study to examine the

relationship between long term auditor-client relationship and the probability of audit failure.

A logic regression model was used to predict failure using tenure as the independent variable.

The results indicate that risk increases early in the auditor client relation and then declines

over time suggesting that longer audit tenure overtime will smoothen out any initial

33
challenges that may impair the quality of the auditor’s performance. The results of the study

do not support the hypothesis that short auditor tenure improves audit quality.

2.4.4 What is the impact of Auditors fee on the Credibility of Financial Statement

Okolie (2014) examine the effect of auditors’ independence on financial reporting quality. A

sample of fifty seven (57) listed companies in Nigeria for the period ranging between 2006

to 2011. Findings of the study indicate that audit fee has a negative but significant association

with discretionary accruals. This is affirmed by Abdul-Malik et al (2016) who explored the

impact of audit fees on financial reporting quality in Nigeria. Data was sourced from the

annual reports of Eighty nine (89) listed companies for the period of 2008 to 2013. The result

revealed that audit fees have a negative but significant influence on discretionary accruals.

Choi, Kim, and Zang (2010) employed a multiple regression technique to examine whether

and how audit quality proxied by the magnitude of absolute discretionary accruals is

associated with abnormal audit fees, that is, the difference between actual audit fee and the

expected, normal level of audit fee. The results of various regressions reveal that the

association between the two is asymmetric, depending on the sign of the abnormal audit fee.

For observations with negative abnormal audit fees, there is no significant association

between audit quality and abnormal audit fee. In contrast, abnormal audit fees are negatively

associated with audit quality for observations with positive abnormal audit fees.

Onaolapo, Ajulo and Onifade (2017) examined the effect of audit fees on audit quality in

Nigeria using a sample of listed cement companies on the floor of the Nigerian Stock

Exchange. The explanatory variables were audit fee, audit tenure, client size, leverage ratio

while audit quality as the dependent variable. Ordinary Least Square Model estimation

technique was used for the data analyses. Secondary data derived from the published annual

reports of the selected companies for a six year period (2010-2015) was used for the study.

Findings from the study show that audit fee, audit tenure, client size and leverage ratio

34
exhibit a joint significant relationship with audit quality. Further results show that audit fee in

particular has a significant positive impact on audit quality.

Oladipupo and Monye-Emina (2016) examined the effect of abnormal audit fees on audit

quality in audit market in Nigeria. The study thus employed audit quality as dependent

variables while the explanatory variables were audit tenure, board independence, audit

committee activeness, firm size and leverage. Using a probit binary regression technique on

350 firm observations data obtained from companies quoted on the Nigeria Stock Exchange,

it was observed that both positive and negative abnormal audit fees had insignificant positive

impacts on audit quality. This shows that abnormal audit fee does not matter to audit quality.

Contrary to expectation, board independence and firm size had negative impacts on audit

quality. However, only the impact of board independence was statistically significant. Of the

auditor tenure, audit committee activeness and leverage that have positive impacts on audit

quality, only the leverage had significant impact on audit quality.

Yuniarti(2011) examined the determinant factors of audit quality by proposing the hypothesis

that the audit firm size (size of public accounting firm) and audit fees (audit fees) have an

effect on the audit quality. The unit of analysis was the external auditor who has worked in

(Certified Public Accountant) CPA firm, the author takes the CPA Firm in Bandung, West

Java, Indonesia. This type of research is descriptive verification research, because it describes

the variables and observes the correlation of these variables from the hypothesis that has been

made systematically through statistical testing. The statistical test use path analysis and the

examination of the hypothesis in this research using two ways: simultaneous test and

individual test (partial), using t-test and f-test. Empirical test results that the CPA firm size

does not significantly affect to audit quality in public accounting firm in Bandung, whereas

the amount of audit fee significantly affect to quality of audit and simultaneously CPA firm

size and audit fees do not significantly affect to quality of audit in public accounting firm in

Bandung.

35
2.5. Gaps in the Existing Literature

This research recognized some instances of insufficient information and some gaps in the

existing literature. For example, the size of some study samples is not big enough to draw

reasonable conclusions. By increasing and expanding samples’ sizes, enhances the ability to

compare the level of information as regards financial reporting quality among other industries

(Hashim, 2012).

Another limitation of studies reviewed in this research is the inaccessibility of some data that

is related to the accounting of banks—especially emerging markets. This also restricts the

ability to take into account some other possible indicators that might be essential for

assessing the financial reporting quality, such as earnings forecasts and other useful ratios of

firms. Also, the availability of data throughout the years would support the importance of

being consistent in evaluating the quality of financial reporting in different periods.

Furthermore, in many studies, the lack of control-related and essential variables that are

associated with other factors is clear and noticeable. Therefore, there should be emphasis to

ensure that there are enough controls on all variables that might threaten the results of the

studies. In one study for instance, it is not clear whether outside, not included variables might

have played a role, had they been included along with the variables taken into account in the

study (Hashim, 2012). Moreover, several studies indicate that financial reporting quality is

not determined only by accounting standards (Walker, Zeng, & Lee, 2013).

This research also recognized that there was no concensus yet on the relationship that exists

between Audit quality and credibility of financial statements. Some researchers reported a

positive impact of Audit quality measures on credibility of Financial Statement while some

researchers reported a negative impact of Audit quality measures on the credibility of

financial statements.
36
CHAPTER THREE

METHODOLOGY

37
This chapter guides the researcher into the systematic process of collecting, analyzing, and

interpreting data and observations necessary to achieve the objectives of this study. It

entails the research design, population, sample size and sample technique, sources of data,

research instruments, validation of research instrument, reliability test, model specification

and measurement of variables used for the study.

3.1 Research Design

The longitudinal design was used in this study. It involves taking samples over time, making

observations to track the changes and relating them to variables that might explain why the

changes occur, which in this case measured the effect of independent variables (auditor’s

independence, on a given dependent variable (financial reporting quality) in Nigerian Banks

over a period of twelve (13) years from 2008 to 2019

The choice of the research design adopted was also based on the fact that the longitudinal

design is suitable to establish the time sequence of the variables on the basis of logical

considerations. And considering the scope of this study, it will be appropriate to say that this

will enable the researcher to adequately capture significant changes over time more

efficiently and effectively compared to other methods of design employed by most studies

in this area.

3.2 Population, Sample Size and Sampling Technique

The population of the study comprises of all the fourteen (13) commercial banks currently in

operation in the Nigerian banking industry as at December 31, 2020.

Census sampling method will be used in this study to select the samples. All the 13 banks in

the population frame are identified individually and then those that consistently publish

their annual reports during the time frame of this research were selected.
38
A total number of ten banks were then selected using purposive sampling method in which

the study will be conducted upon. The sample elements selected are First Bank of Nigeria,

Guaranty Trust Bank, Zenith Bank, Wema bank, FCMB, Stanbic, Sterling, UBA, Union Bank

and Access Bank in which the financial report and financial performance of each of the

sample element is then evaluated.

3.3 Sources of Data

Secondary data will be used for this study which will be obtained from the examination of

the annual published financial report and covering variables that could influence the quality

of financial reporting such as the adoption of IFRS, auditor’s independence and performance

of each of the five banks selected for a period of twelve (12) years from 2006 to 2018,

because it is the most recent covering the scope of this study. The analysis of the empirical

data will be done through the use of ratio analysis to determine the financial performance

of the banks and how it has affected their reporting quality.

3.4 Model Specification

This study employs regression analysis (Fogler and Nutt, 1975; Hull and 2 Jones 2008; Vance,

1975; Williams and Mcpherson 2000) as the main statistical method in order to achieve the

objectives of this study, which is to analyze the effect of , auditor’s independence, audit fees

and audit tenure on Financial reporting quality. It is expected that there would be a positive

relationship between financial reporting quality and the aforementioned independent

variables.

The model is therefore specified as follows:

FRQ = f (AI, AUDF AUDT) ……. (3.1)

39
The relation above is expressed in explicit form as

FRQᵢᵼ = α0 + β₁Aiᵢᵼ + β₂AUDFᵢᵼ + β3 AUDTᵢᵼ ἐᵢᵼ………. (3.2)

Where,

FRQ = Financial Reporting Quality

ᵢ = entity of each bank at time (ᵼ)

t = the t-th year (time series annual data)

α0 = Regression Constant

β₁ - β₃ = Regression Coefficients

AI = Auditor’s Independence

AUDF= Audit Fees

AUDT= Audit Tenure

ἐᵢᵼ = Error term

3.5 Measurements of Variable

The variables of this research work are Auditor’s Independence, Audit fee, Auditors tenure

and financial reporting quality. The independent variable is Auditor’s Independence while

the dependent variable is financial Reporting Quality. The dependent variables which is

Financial Reporting Quality, will be assessed in relation to how it is influenced by the

independent variable.

The measure of financial reporting quality used is the modified Jones model (Dechow, Sloan

and Sweeney, 1995) which is one of the models used to determine quality of earnings

40
(earnings management) in accounting and finance literature. Accounting fundamentals are

used to separate accruals into nondiscretionary (normal) and discretionary (abnormal)

components. The absolute value of the abnormal component determines the quality of

earnings. The larger the absolute value of discretionary accrual, the lower the quality of

earnings (Dechow 1995). The discretionary or abnormal accrual is estimated as:

Total Accruals (TA) = Net Profit after Tax (NPAT) – Net Cash Flow from Operations (CFO)

To estimate abnormal accruals (DAC it) for company iin year t, the following cross sectional

regression is performed

TA it/ Ai, t-1 = β1[1/Ait-1] + β2[ΔREV it -ΔAR it/ Ait-1] + β3 [PPE it/ Ai, t-1] + εit…… (3.3)

Where:

TAit = Total Accruals in year t for company i;

Δ REVit = Revenues in year t less Revenues in year t-1 for company i scaled by total assets at

t-1;

Δ RECit = Revenues in year t less Revenues in year t-1 for company i scaled by total assets at

t-1;

PPEit = Gross Property, Plant and Equipment in year t for company i scaled by total assets at

t-1;

Ait-1 = total assets in year t-1 for company i;

εit = the residual of company i for time t;

41
The industry year specific parameter estimates from the above model is used to estimate

company specific normal accruals (NAit) for company in year t as a percent of lagged total

assets; that is,

NA it/ Ait-1= β1 [1/Ai, t-1] + β2 [ΔREV it -ΔAR it] / Ai, t-1] + β3 [PPE it/ Ai, t-1] ……. (3.4)

Where:

AR it = company i Accounts Receivables in year t.

Abnormal/Discretionary Accruals (AA it) for company i in year t = DACit = (TA it/ Ait-1) – (NA

it/ Ai, t-1). The absolute value of abnormal accruals (DACit) is the measure of financial

reporting quality with lower values indicating higher financial reporting quality.

42