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1.1      Background to the study

Financial report is shown by an information management to assess the quality of a firm's performance and demonstrate its responsibility to investors, employees, customers, society and government. Financial report serves to present information to help investors, creditors, and other potential users in a similar decision rationally. The statements are very important because of the demonstration of quality of management performance in a period of time. One importance of financial statements is its use to measure management performance. Therefore, management will try to make a financial report in such a way that the performance of the company looks good in the financial statements. Due to the important role of financial statements in demonstrating the performance of a company, the management will try to mislead investors or the owner of the company to avoid the confidentiality of the actual condition of the financial statement. One way that is often applied to mislead the owner of the company or investors is conducting earnings management, because the manipulation of earnings management is the safest and legal, and does not infringe generally accepted accounting principles (Haryudanto & Yuyetta, 2011).

Following the above circumstances, earnings management also called creative accounting, aggressive accounting, involves managers’ manipulation of the external reporting process and structuring transactions to alter financial reports to either mislead some shareholders about the underlying economic performance of the company or to influence contractual outcome that depend on reported accounting numbers (Healy & Wahlen, 1999).This (earnings management) is becoming an area of interest to many researchers, after the case of Enron, WorldCom in the united states and similarly Cadbury Nig. Plc, African Petroleum, Oceanic bank and Intercontinental Bank in Nigeria.

Of recent, the House of Representatives Committee on Finance accused commercial banks in Nigeria of sundry sharp practices, including tax evasion, non-remittance of government revenue and outright falsification of their accounts. However, the committee said it had uncovered a lot of discrepancies in the data submitted to it by the banks including the outright refusal to present documentary evidence of revenue remittances, blank violations of existing laws, self-exemption from existing rules, false declaration and manipulation of financial information (Ijeoma, 2014).

Preliminary discoveries show that the published audited accounts of some banks were at variance with the figures the banks submitted to the committee during investigation. It was then revealed that many banks blatantly engage in the creative accounting technique of inflating their operating costs to reduce exposure to taxes. However, over the years’ Nigerian government lost billions of naira in fraudulent and under hand dealings corruptly designed by some banks to evade taxes. The continues occurrence of corporate scandals or failures associated with earnings management has led to public loss of confidence in the quality of reported accounting earnings and audit function in general especially in the banking sectors. Therefore, earnings management has become a matter of great concern to regulators, practitioners as well as accounting researchers.

Chang, Shen, and Fang,( 2008) explains that managers engage in earnings management for many reasons and probably exercise their accounting discretion to influence reported earnings which is manipulate earnings because of capital market incentives, implement earnings management because of contracts motivation, they conduct earnings management due to regulation motivation etc. Regardless of whichever causes managers to manipulate earnings, the behavior of earnings management implies conflict of interest between managers, owners, and minority shareholders.

However, Audit quality describe how well an audit detects and reports material misstatements (includes intentional and unintentional errors) of financial statements, reduces information asymmetry between management and shareholders and helps protect the interest of shareholder (Chen, Elder & Liu, 2005). As posited by Tobi, Osasrere and Emmanuel, (2016), auditing and the audit process provide an evaluation of the probability of material misstatement and reduce the possibility of undetected misstatement to a reasonable or appropriate assurance level.

In response to the to the global accounting and audit scandals by accounting regulatory bodies around the world headed by the International Federation of Accounting (IFAC), stringent regulations are established and enforced, and the existing ones are reviewed. This include International Auditing and Assurance Standards Board (IAASB), International Standards on Auditing (IAS), International Ethics Standards Board for Accounting (IESBA), International Standards on Quality Control (ISQC), International Auditing Practice Notes (IAPN), and Consultation Papers (IAASB, 2013).

According to IFAC (2013), through its auditing operational arm (IAASB), global financial stability is supported through high quality reporting, which could be achieve through high quality audits that can help foster trust in the quality of reporting. It also highlights the importance of audit quality and its relevance to all stakeholders in financial reporting supply chain. With this, the IAAS developed the Framework for Audit Quality that describes in a holistic manner, the different elements that create the environment for audit quality at the engagement, firm, and national levels, as well as relevant interactions and contextual factors.

Thus not only accounting regulator and professional bodies responded to the gross loss of confidence in accounting and auditing profession associated with poor quality audit, researchers also joined the struggle to investigate the factors associated with audit that leads to earnings management. Literature has documents some attributes that explain audit quality and how the joint effect of the attributes could help checkmate managers’ excessive earnings management practice. Of the numerous attributes identified in the literature, auditor Independence, audit Rotation, auditor Tenure and audit Fee seemed to stand out.

However, a company’s auditors are appointed independently by its shareholders, to whom they report to. However, in practice auditors are also chosen by the company’s bosses to whom they all too often become obliged (Economist, 2002).  Hence, auditor might be more inclined to allow aggressive and opportunistic reports which may result to low quality audits and thus increase in earnings management. This creates doubt on independence of an auditor.

Another doubt is whether the potential benefits of changing auditors periodically (audit Rotation) are outweighed by the drawback of losing the specific knowledge obtained by the auditing firm during the relationship with the client, which might lead to reducing the independence and objectivity of the auditing process. More so, pro-long relationship of auditor and firm may compromise auditor Independence, the auditor should be able to conduct effective monitoring which results in less opportunistic management behavior (Jayeola, Taofeek, & Toluwalase 2017).

However, there is a certain amount of controversy over to what extent the independence of auditing firms is really impaired by a long-term relationship (Audit Tenure) with the client and the desire to maintain that relationship. Furthermore, the economic view of audit quality, suggests that auditor independence and audit quality could impaired in the early years of auditor tenure because auditors could be more accommodating to the client to extract future quasi-rents to recover losses incurred due to low-balling. Thus restricting auditor tenure could impair auditor independence rather than enhancing it.

Another factor affecting the quality of audit is audit fees (audit remuneration) in relation to auditors’ independence. It is argued that audit remuneration can strengthen the auditors’ economic bond with the client, thereby increasing the auditors’ incentives to comply to clients’ pressure, including pressure to allow earnings management which reduces the quality of financial reporting (Simunic 1984, & Becker, Jiambalvo & Subramanyam 1998). On the other hand, audit remuneration can also increase the auditors’ investment in reputation capital which the auditor is not likely to jeopardize or satisfy the demand of any one client, and thus increases quality of audit as such reduces earnings management (Eilifsen & Messier, 2000).

The study is motivated by the crucial role auditors play in corporate accounting financial reporting with regards to accounting irregularities and misstatement which includes earnings management, which impaired financial reporting quality, looms corporate entities and also the recent adoption of International Financial Reporting Standard (IFRS). This made Nigeria to be a member of the International Federation of Accountants (IFAC), where all the international accounting and auditing regulation are applicable to Nigerian Accountants and Auditors. The code of corporate governance and other studies carried out on audit quality reveals that audit quality is the function of auditor independence, auditor rotation, auditor tenure and auditor fees. These attributes are design to bridge the shortcoming of the inherent in audit quality.

Therefore, the study focus on the Nigerian banking sectors. Banks are economic institutions that facilitate economic growth and development by mobilizing savings from the surplus unit and channeling them to deficit unit for productive investments. They also provide the payment and settlement system and implement monetary policy of government; it is on this strength that Ghazali, Shafie, and Sanusi, (2015) considers banks in the financial system as the central nervous system of the economy. In order to ensure efficiency and to safeguard the economy from crises, banking sector operates on stringent regulations and supervisions. The bank managers, like managers in other industries, have incentives to “adjust” earnings and maximize bank and or manager’s wealth. The only difference is the method used to engage in earnings management. Unlike managers in other industries, bank managers usually utilize loan loss provisions to influence earnings reported. Loan loss provision is the sum of the ending balance of allowance for bad and doubtful debts and loan charge offs, then deducting the beginning balance of allowance for bad debts (Chang et al., 2008).

Loan loss provision is an expense on the income statement which signifies managers’ assessment of expected future losses  (Ahmed, Mohammed, & Adisa, 2014). This means that an increase in loan loss provision reduces net income, while a fall in loan losses increases net income.  They expect low levels of nondiscretionary current earnings will encourage managers to realize investment security gains as well as decrease loan loss provisions and conclude a positive relation between earnings and loan loss provisions.

Shrieves and Dahl, (2003) also indicate bank managers intend to realize short-term security gains or losses and utilize loan loss provisions to smooth earnings. Moyer, (1990); Eriabie and Dabor,( 2017) documents that banks intend to execute transactions and manage accruals to achieve primary capital, tax, and earnings goals. In prior related studies, they employed discretionary loan loss provisions to examine earnings-smoothing motivation. Kanagaretnam, Lobo, and Mathieu,(2003); Kanagaretnam, Lobo and Yang, (2004); signal effect; (Eng & Nabar, 2007),  the motivation of capital management (Beatty, Berger, & Magliolo, 1995);. It is argued that if shareholders have perfect information about manager’s actions, there would be no information asymmetry between the two parties. Information asymmetry exists when perfect information is absent; which is the assumption of agency theory and since information asymmetry exists, stockholders have difficulty in detecting earnings management (Fama, 1980). As pointed out by Watts, Zimmerman, and Cliffs, (1986)  audit minimizes information asymmetry and protect the interest of the principals, investors, creditors, suppliers, employees and the general public, by providing reasonable assurance that financial statements prepared

 by management are free from material misstatements. To achieve this goal audit quality realization became apparent especially in the banking sector.

The prominent corporate scandals witnessed around the world and also in Nigeria, especially in the Nigerian banking sectors has raised a great concern on the integrity of financial and auditing reporting systems in the country. The banking and other corporate organizations that were never suspected to have been involve in earnings manipulations were found to be living in the past glory due to excessive earnings management practices. The unpleasant practices which were later discovered to have been on for some time went undetected or unreported by the auditors. The experience has since left its jeopardies in the mind of shareholders, prospective investors, regulators and financial analysts as well as accounting researchers. The banking sector in Nigeria is considered one of the prone sectors to earnings management. Therefore, audit quality remains important to the regulators, accounting researchers and also policy-makers, for monitoring the role of the managers and its committees, as agents of the firms, as it affects the market’s perception of reported earnings. The accounting frauds and corporate failure have brought into question the value and dependability of corporate information and realization to prevent or at a very least, deter future financial scandals, there is a need to conduct more research on the relationship between companies and their auditors with legislation and regulation being one of the avenues that has been suggested as means of restoring confidence in financial information presented to the different stakeholders.

1.2      Statement of Problem

The continues occurrence of corporate accounting scandals has cast doubt on the quality of reported earnings and the ability of audit process to effectively constrain earnings management of companies across the world and Nigeria in particular (Okolie, 2014).  Differences in quality of the audit process and auditors reports result in variations in the credibility of auditors and

the reliability of the earnings reports of companies. These recent corporate financial failures pose a great challenge to the reliability, integrity, effectiveness and significance of the audit function.

In Nigeria, corporate scandals include the cases of Cadbury Nigeria Plc and African Petroleum (AP) (Okolie & Agboma 2008); Savannah Bank and African International Bank (Odia, 2007); Wema Bank, Nampak, Finbank and Spring Bank (Adeyemi & Fagbemi, 2010); and Intercontinental Bank Plc., Bank PHB; Oceanic Bank Plc. and AfriBank Plc (Badawi, 2008). And most recently, the house of Representatives Committee on Finance accused commercial banks in Nigeria of sundry sharp practices; which includes tax evasion, non-remittance of government revenue and outright falsification of their accounts. The above are clearly reported cases that resulted in misleading financial reports. Therefore, there is a dread about the quality of accounting income and its relationship with the quality of the auditing process which has been observed to increase over time following the periodical clusters of business failures, frauds, and litigations.

The issue is whether these corporate collapses are not the outcome of poor audit quality resulting from elongated auditor tenure, short period of audit rotation, high audit remuneration, lack of auditor independence and the inability of the audit function to halt earnings management.

Many accounting scandals of the past decade have involved outright manipulation of accounting data through discretionary accruals, discretionary loan loss provision including recording fictitious inventory and hiding liabilities even in the face of audited financial reports. Knechel (2009) posits that the companies that have involved in real accounting scandals along with a number of lesser known companies greatly involved in transactions where the accounting was technically correct but which served primarily to perplex the financial wellbeing of the organizations and the results of their operations. Hence widespread manipulation of accounting information and income misstatements through earnings management may be as a result to the pressure on corporate accountants, auditors and organizational managers to show profits. A common trend and threat among the companies that are involved in accounting and financial scandals are gross lack of integrity, character and transactions involving related parties (Geriesh, 2006, Enofe, 2010; Carey & Simnett 2006). This is because unethical behavior in reporting earnings of firms negates the principles of agency relationship and misrepresents the organizations financial status. However, Nyor, (2010) founds that some firms in Nigeria (which includes banks) were smoothing their earnings, a fact that was confirmed by Nigeria’s Central Banks’ Governor (Sanusi, 2010).

Many studies have been conducted in the area of earnings management and audit quality most which recognized the audit quality mechanism as effective factors that restrain excessive opportunistic behavior amongst corporate management.

However, few studies have been conducted in emerging economies like Nigeria; that is studies of   (Hassan, 2012), (Okolie, Izedonmi & Enofe., 2013),  (Okolie, 2014), (Jayeola, O, et al., 2017).  Despite the fact that these studies have covered some important aspects of audit quality, few of them used audit rotation and audit fee in measuring independence of audit firm despite the strong relationship that exist between audit rotation, audit fee and quality audit. Further these studies were conducted on quoted firm in Nigeria Stock Exchange like in the study of (Okolie, 2014), who’s conducted a study on auditor tenure , auditor independence and accruals based earnings management of quoted companies in Nigeria which appear to be general not specific.

However, studies such as Yahaya, Kutigi, and Mohammed, (2015) conducted a study on International Reporting Standards and Earnings Management ‘Behavior of listed deposit money banks in Nigeria which uses the Beaver and Engel, (1996) model. Also, Ahmed, Mohammed and Adisa, (2014) assessed the effect of discretionary loan loss provision in Nigerian deposit money banks using the same model, but did not use the most appropriate model for the financial sector. Furthermore, Ali, (2015) assessed “Do Banks in Nigeria Manage Earnings through Loan Loss Provisions”? who used model developed by Beatty, Hong, and Adam, which had been heavily criticized ignoring the appropriate model. It is to this end, that the study adopts the ( Kanagaretnam, Lobo, & Yang, 2005)  model as a test.

Furthermore, the period of the study also matters, as most studies did not cover recent period as such. The study of Hassan (2012) covers the period from 2007–2011, Okolie (2014) cover the period from 2006-2011, Okolie et al., (2013) cover the period from 2006-2011, Zachariah et al  (2015) cover the period from 2006-2013, and Jayeola, O, et al.,(2017) cover the period from 2005-2014. However, this study tends to fill the period gap from prior literatures from 2008-2017.

However, the study tends to use General least square (GLS) and employed Skewness, Kortosis and Shapiro-wilk test for normality. And also robustness test shall be conducted for multicolinearity, heteroscedasticity. Hausman specification estimate is also conducted in order to improve the validity and reliability of the model. Given the above scenario, the study tends to determine whether auditor independence, auditor rotation, auditor tenure and audit fee can significantly constrain or minimize the negative consequences of earnings management of listed deposit money banks in Nigeria.

1.3     Objectives of the Study

The main Objective of this study is to examine the impact of audit quality on earnings management of listed deposit money bank in Nigeria. The specific objectives of the study are:

i.      To examine the impact of auditor’s independence on earnings management of listed deposit money banks in Nigeria;

ii.      To investigate the impact of auditor’s rotation on earnings management of listed deposit money banks in Nigeria;

iii.      To determine the impact of auditor’s tenure on earnings management of listed deposit money banks in Nigeria;

iv.      To assess the impact of auditor’s fee on earnings management of listed deposit money banks in Nigeria.

1.4     Hypotheses of the Study

In line with the objectives of the study, the following hypotheses are formulated in null form:

H01: Auditor Independence has no significant impact on earnings management of listed deposit money banks in Nigeria.

H02: Auditor Rotation has no significant impact on earnings management of listed deposit money bank Nigeria.

H03: Auditor Tenure has no significant impact on earnings management of listed deposit money bank Nigeria.

H04: Auditor Fee has no significant impact on earnings management of listed deposit money bank Nigeria.

1.5      Scope of the Study

This study examined the impact of audit quality on earnings management and it is restricted to deposit money banks listed on the floor of the Nigerian stock exchange (NSE) as at the end of 2017 accounting period. The study covers the period of ten (10) years, from 2008 to 2017. The period is chosen because it covers the global economic crisis which exposes many world corporate scandals including Nigeria. The justification of domain is that mostly financial institute such as banking sectors are prone to earnings management.

1.6                         Significance of the Study

Apart from contributing to the existing literature on the subject matter, the findings of this study will increase to policy makers, audit firms and professional accounting bodies, as well as existing and potential investors. Policy makers may use the findings of the study regarding the auditor independence to consider the potential benefits of regulating the minimum length of audit firm tenure in years that same auditor should audit the financial statements of a company.

It has been posited that as the auditor tenure increases, the auditor is better at assessing risk of material misstatements by gaining experience and better insights into the clients’ operations and business strategies as well as internal controls over financial reporting (Arens, Elder & Beasley, 2003).

Therefore, this study will provide a benchmark which professional accounting bodies will use to in establishing policies procedures to guide members on improving the quality of their audit in order to reduce the way and manner earnings are being manipulated by firms.

The study will also offer important input to serve as a strong base for the audit profession to establish policies relating to type audit firm, audit rotation, audit tenure and audit fees. This is because most issues in this area are based on subjective evidence, particularly in Nigerian context since evidence in regarding these issues has been relatively limited. The study therefore hopes not only to help enrich the literature, but also provides important quantitative information.

Financial analysts may also use the findings of this study to understand how the market interprets higher audit quality in constraining earnings management effect, on capital market decisions.

The study will also add to literature by providing insight into how auditors’ fee metric indicating client importance affecting earnings management in a legal institutional environment of small economy and where the audit market is saturated with little room for growth.

Therefore, the assessments of audit quality and earnings management remain crucial because it reflects the investors‟ confidence in the financial reporting and it affects the allocation of resource.

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