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JOURNAL OF RESEARCH IN NATIONAL DEVELOPMENT VOLUME 6 NO 2, DECEMBER, 2008

RELIANCE ON AUDIT REPORTS: THE EXPECTATIONS AND THE REALITIES 

F. Olurankinse and L. A. Ibadin
Department of Accounting, Adekunle Ajasin University , Akungba-Akoko, Nigeria

 

Abstract
 The objectives of this paper are to draw attention to the dilemma of investors who relied on audited rosy performances of companies to buy shares  in them to discover that they had been swindled and that all they really owned were worthless pieces of paper and to recommend  the way forward. This happened in the cases of Enron in 2001. World Com in 2003 all in the United States of America and the Nigerian cases of African Petroleum PLC (AP) in 2000 and Cadbury Nigerian Plc in 2006. The question that therefore arises is should an investor rely on audited reports to commit his recourses? For this study, the methodology adopted involved the survey technique through which questionnaires were served and the practicing firm of Balogun, Badejo & Co, Chartered Accountants in Lagos was chosen as case study. Twenty respondents were randomly selected from the staff of the company. Data collected were analyzed and the research hypothesis was subjected to test using the student ‘t’ distribution statistics. While it was agreed that it is the responsibility of the Directors of a company to prepare the accounts and for the auditors to express their opinion as to whether the accounts give a true and fair view of the financial position of the company, it was also acknowledged that the Auditor does his work on a sample basis which often add up to less than ten percent of the total transactions conducted in the whole year. Nevertheless it was found out that all the incidents of company collapses of failure have arisen from Auditors compromises and/or Directors concealment of fraudulent transactions/ records or other unrecorded illegalities. The study concludes that Audited Accounts remain veritable instruments for financial management and should continue to be used.

 Keywords:  Audit reports, reliance; expectations; realities


 Introduction and Statement of the Problem
The basic objectives of an audit of financial statements is to enable auditor to express an opinion whether the financial statements are prepared in all material respects in accordance with all identified financial reporting frameworks. In other words, the auditor is required to examine the financial books of the company and establish that they conform to the generally accepted Accounting principles, present a true and fair view of the firm’s position and ensure that the financial statements are not only free of material mismanagements, but also conform to statutory regulations. Such attestation helps to give credibility to the financial statements prepared by Directors and presented to Shareholders as evidence of their stewardship.

The auditor performs his duties on a sample basis. Since all financial transactions are not examined, there is remote possibility that Auditors may inadvertently issues unqualified report when infact the financial statement are materially misleading i.e do not give a true and fair view. In other words, the auditor may give inappropriate audit opinion when financial statements are materially misstated. This is the crux of audit risk which could result in financial losses.

In this last two decades, there had been dramatic rise in the numbers of corporate failures, these failures have understandably elicited reactions from the public for three reasons: (i) They caused several pervasive economic crises (ii) compensations by insurance programmes have not adequately cushioned the effects of the losses and (iii). The corporate insolvencies occurred soon after unqualified reports were issued to the affected companies by external auditors.

In the case of Enron in 2001, the auditor compromised and connived with the directors to issue bogus healthy reports whereas the company was dying (Puscas, 2002). In African Petroleum Plc, the Directors concealed debts totaling over 27billion naira which led to the overvaluation of the company during privatization (Niyi –Makinde, 2003). Now the Company is in financial crises. Recently, in 2006, the Director of Cadbury Nigeria Plc were found to have inflated their stock values such that the profits were overstated by over 5 Billion Naira. This practice continued for over five

years before detection. Before the bubble burst, the company received clean bills of health from their external auditors (Manuaka, 2006). The most pertinent question that arises at this juncture is: Should auditor’s Reports be relied upon?
            The objectives of this research are:

  • To draw attention  to the factors which could mislead the auditor to give a wrong opinion
  • To identify the problems arising therefrom
  • To provide solutions to those problems

Methodology of the Study
The methodology for this study was the survey Research in which questionnaires were served to staff of Balogun  Badejo & Co, the selected case study. Data resulting there from were analyzed using simple statistical tools like means, averages and percentages. The Hypothesis was tested using the student T Distribution Test of proportion. Hence, the statistic T is given as:


   T =                        P – P
hgh          Pq
         


N
Where:
T =       Student T statistic
P =       Number of respondents answering in the affirmative divided by the sample size.
g =       1 – p (i.e – the respondents that will not believe in the given hypothesis)
N =      Sample size

The analysis assumes that 50% of the population will believe the given hypothesis either way i.e. population P = 0.50. a significance level of 5% was adopted.
Decision rule

If the value of “T” calculated is greater than the Table value of T, the Null hypothesis should be rejected and the alternative hypothesis  accepted. Otherwise, accept the alternative hypothesis.

 

Position of Accounting Bodies
According to the International Federation of Accountants (IFAC), a body to which the Institute of Chartered Accountants of  Nigeria (ICAN) belongs: “the basic objective of an audit of financial statement is to enable the auditor express an opinion as to whether the financial statements are prepared,  in all material aspects, in accordance with an identified financial reporting framework”. In other words, the auditor is required to examine the financial statements of the company and establish that they have been prepared in conformity with Generally Accepted Accounting Practice (GAAP), that they present a true and fair view of the firm’s performance and position and ensure that the financial statements are not only free of material misstatements, but also conform to statutory regulations. Such attestations help to give credibility to the financial statements prepared by the directors and presented to the shareholders as evidence of their stewardship.

While the auditor is responsible for forming and expressing an opinion on the financial statements, the responsibility for preparing and presenting the financial statements is that of the management of the entity. It is important here to emphasize that the trust of statutory audit is to place value judgments or access the competence and fidelity of management or assess the propriety of business decision taken by directors in their commercial wisdom.

Under the Anglo-Saxon dispensation where ownership is often separated from control in the quest of leverages in resources management, professionals who are hired by resources owners are obliged to present their report of stewardship in the form of financial statements to their principals (shareholders) at specific periods usually annually.

 Duties and Rights of Auditors
Section 359 of CAMA (1990) states that the primary duty of the auditor of a company is to make a report to its members on the accounts examined by them and on every balance sheet and profit and loss account and all group financial statements, copies of which are to be laid before the company in a general meeting during the  auditor’s tenure of office.
SCHEDULE 6 CAMA (1990) also set out maters that should be contained in the auditor’s report:

  • Whether the auditor have obtained all information and explanations, which to the best of their knowledge, are necessary for the purpose of the audit.
  • Whether, in their opinion, proper books of accounts have been kept by the company and proper returns, adequate for the purpose of their audit, have been received from branches not visited by them.
  • Whether  the company’s balance sheet and profit and loss account are in agreement with the books’] of accounts and returns.
  • Whether the books of accounts show a true and fair view
  • Whether, in their opinion, the books of accounts give the information required by the Act, in the required manner of presentation.

 
In addition to the duty of reporting to members the auditor also has a duty to report to the Audit committee.
 Section 360 further provides that the auditors should carry out such investigation as may enable them form an opinion as to whether the requirement of part V and IV of schedules 3 and part I-III of schedule 4 to the decree are complied with. Under Section, 360, in order to assist the auditor in the exercise of his independence, the statute provides some rights for him in order to enable him achieve the objectives of statutory appointment. The results are detailed as follows:

  • Right of access at all times to the company’s books of accounts
  • Right to require from the company’s offices
  • such  information and explanations as he thinks necessary for the performance of the auditors’ duties
  • In relation to the company’s general meetings held during his tenure of office he has right:
  • To attend such meetings
  •  To receive all such notice of and other communication relating to any such meetings which a member of the company is entitled to receive
  •  To be heard at any such meeting, which concerns them as the auditor

It is worth nothing, however, that nowhere under the relevant provision of the CAMA (1990) where it is expressly stated that the auditor is to detect or uncover fraud.

It is emphasized that the question whether or not an auditor has been guilty of negligence in a particular case can only be answered by reference to the circumstances of that case and the evidence before the court as to what the auditor could and should have done in there circumstances so long as he has acted in a reasonable and prudent manner and in accordance with accepted standards, he will be considered to have discharged his duty to his clients, and will not be liable for them.


Data Presentation and Analysis

Table 1: Sex Of Respondents


FACTOR

FREQUENCY

PERCENTAGE (%)

Male

 18

90

Female

2

10

Total

20

100

Source: Questionnaires served.

Ninety percent of respondents are male while the remaining ten percent are female.

Table 2: Age of Respondents


FACTOR

FREQUENCY

PERCENTAGE (%)

Under 20 years

Nil

-

20-40 years

15

75

 Over 40 years

5

25

Total

20

100

Source: Questionnaires served
 
Three quarters of the respondents are between 20 years and 40 years old while remaining one quarter of them are over 40 years.

Table 3: Work Experience of Respondents


FACTOR

FREQUENCY

PERCENTAGE (%)

 

 

 

 

 

 

 Under 10 years

8

40

10 yrs 20years

11

55

Over 20 years

1

5

Total

20

100

Source: Questionnaires served

Fifty-five percent of respondents have had more than ten years experience on the job and in a position to give reliable answer to question asked.

Table 4: Work Status of Respondents


FACTOR

FREQUENCY

PERCENTAGE (%)

Junior staff

Nil

Nil

 Supervisory staff

15

75

 Management staff

5

25

Total

20

100

Source: Questionnaires served


All respondents occupy top positions in his organization  and know what they are talking about. The responses would be correct.

Data Analysis
 Of all the questions in the questionnaires served to staff of Balogun, Badejo & Co, the most relevant critical question for the research was:
Should an audited account be relied upon by a prospective investor to commit his resources?


Table 5: Worker Responses to Audited Accounts (Investments)


FACTOR

FREQUENCY

PERCENTAGE (%)

Yes

17

85

 No

3

15

Not sure

0

0

 Total

20

100

Source: Questionnaires served


Seventeen respondents, constituting 85% of them, were of the view that audited accounts could be relied upon to make investments whereas the ones representing 15% disagreed. No one was unsure of how to respond to the question asked.

To be able to test the hypothesis formulated for this study the Hypothesis is re-stated as follows:

 Ho:  Audited accounts should not be relied upon as a basis for the commitment of resources by intending investors.

H1: Audited Accounts should be relied upon as a basis fro the commitment of resources by intending investors.

  The null hypothesis is tested at 5% level of significance using the student ”t” distribution statistic.


             
 Therefore, applying the formula:
jkljhjjhjjhghgt           =          P – P
                                     Pq
                                     N
gfgfhWhere P =       Yes     =          17  = 0.85
                                     N                 20

gfgfh Then               0.85 – 0.50                                          0.35
                        t =        0.5 x 0.35                                =          0.175

 

Journal of Research in National Development 6(2) December, 2008

 

                                         N                                              20

= 0.35

 

  0.0935                                   = 3.74


The table value of “t’ at 5% level of significance and  20 ( the number variables) = 2.09.

Since the calculated value of  “t” exceeds the table value of “t”, the Null hypothesis (Ho) is rejected and the alternative hypothesis (H1) is accepted. It is therefore concluded that Audited Accounts can be relied upon as a basis for the commitment of resources by intending investors.

 Discussion and Findings
 It is common knowledge that the financial statements upon which an auditor statutorily expresses an opinion are used for different purposes, e.g. share valuation and acquisition, mergers, dividend policy, diversification of portfolio, assessment of the worth of a firm and credit worthiness.

 From the explanation of the thrust of an audit, the audit report is not a financial analysis upon which investment decision ought to be predicated. External; auditors are not rating agencies which provide the facts behind the figures and can therefore not predict or  guarantee the future of a firm merely by auditing its books,. Obviously more detailed financial analysis is definitely required. The thrust of expectation gap, therefore centres on the use of audit report for purposes unintended by statutes and the inability of such reports to meet the varying needs.

As a professional, the auditor is trained to discharge his duties to clients and the society with ulmost sense of responsibility, objectivity, technical competences and due care. These are hallmarks that have helped the profession not only to sustain its leading edge in corporate governance but also have helped to endear it to all stakeholders in the business world. It is this versatility of the professional auditor that explains why many directors and management of companies undertake other types of audit (.e.g. stock audit, cash management audit, payroll audit, manpower audit) in order to enhance their operations and prosperity.

There is a marked ignorance of the statutory responsibilities of the auditor. This accounts for the widening expectation gap and the frequent calls for he expansion of his statutory duties to include fraud detection.

The responsibility for the prevention and detection of fraud and error rests with the management of the company through the implementation and continued operation of adequate accounting and internal control systems. Such systems reduce but do not eliminate the possibility of fraud and error. The auditor is not and cannot be held responsible fro the prevention of fraud and error.

 It is important to put on record that all cases of negligence, corporate malfeasance or compromise by auditors have always been detected by another set of auditors. So, there is faith in the Auditing system and it holds but high hopes for the general public and prospective investors.

Conclusions and Recommendations
In spite of the seeming shortcoming of auditing in the face of societal expectations, audited accounts remain the face of societal expectations, audited accounts remain veritable tools for financial management and decision-making in the organization. What needs to be done therefore is to introduce legal reforms to protect the diligent auditor and take steps which ensure proactive actions by the supervisory and regulatory authorities like the Securities and Exchange Commission (SCE), the Institute of chartered Accountants of Nigeria (ICAN) the Central Bank of Nigeria (CBN) and all the others. Happily, most companies today preach the gospel of Good Corporate Governance. The Adherence to these principles of best business practices worldwide would definitely enhance the audit function. Finally, sound training. Retraining of auditors would improve the quality of audit reports.

References
Niyi- Makinde T. (2003) “A controversial debt. “Oil and Gas in Tell Magazine January 13 pp 44-45.

Puscas, D. (2002) “A Guide to the Enron Collapse: A

 

St. Pierre, K & Anderson J. A (1984) “ The analysis of the Factors associated with law suits against public accountants” Accounting Review April.

                               Few Points for a Clear Understanding.


                              www.  Polarisinstitude.Org. July.

Swinson, C. (2000) “The fundamental things apply” Accountancy Journal of ICAEW June.

 

Tinker A, (1998) “The old millennium Bomb-Education Malaise to Technological change” Accounting and Business Journal July/ August.