auditor rotation

SECTION ONE

1.0 Introduction

1.1 Background Of The study

Users of financial statements need relevant and sufficient

information to assist them in evaluating alternative investment

options. Part of the information required is expected to be

provided in the financial statements of corporate bodies.

Statutory auditors are expected to audit the financial statements

prepared by directors of enterprises and express an independent

opinion on them. Auditor’s independence is one of the most

inportant issues in accounting practise today. Independence

increases the effectiveness of the audit by providing assurance

that the auditor will plan and carry out the audit objectively. High

quality audits enhance the reliability of the financial reporting

process and facilitate optimal allocation of capital by investors

and other users. Credibility is given to financial statements

because of the auditor’s independence. The nature of auditor’s

work requires him to be free and independent from the influence

of any party so that he can objectively form his opinion on the

financial records examined. He should not be tossed and blown

by winds from the client. Recent scene in the global environment

especially the bankrupcy of many large corporations with clean

1

auditors reports has called to question the validity of financial

statements of these corporations. The major accountability

breakdowns at Enron and WorldCom, and other failures in recent

years such as Qwest, Tyco, Adelphia, Global Crossing,Waste

Management, Micro Strategy, Superior Federal Savings Bank,

Xerox, Cadbury Plc in Nigeria etc and the collapse of some of

these corporate giants especially Enron, which resulted from

shoddy accounting practices and manipulation of accounting

information has shook investors confidence. The fact that these

financial statements were audited and certified to be true and

fair positions of the companies by qualified audit firms pose

questions about the independence of the auditors and the

quality of audit. This led to several reforms to enhance auditor

independence and audit quality and to restore investor

confidence in the nation’s capital markets.The accountants’ rule

of ethical conduct on integrity, objectivity and independence

requires that member’s objectivity must be beyond question if

he is to report as an auditor. The objectivity can only be assured

if the member is and is seen to be independent. The auditors’

reports tend to give credibility to the financial statements, the

question that emanates from all these issues are: whether such

credibility can be assured when there is a long- term auditor –

2

client relationships, whether there is potential negative effects of

long- term relationships between auditors and their clients and

whether mandatory auditor rotation should be required as a

safeguard to ensure and/or demonstrate that auditor

independence is not compromised.

Some view long- term relationships between the auditors and

their clients as a threat to auditor independence (Ryan et al,

2001). Others assert that rotation of auditors would lead to

higher quality audits since the successor (incoming) auditors

would review the work of the predecessors (outgoing), thereby

checking and motivating the predecessors. Also, others believe

that long-term relationships help the auditors to better

understand the unique business transactions and identify key

audit risks, resulting in higher quality audits (AICPA, 1992;

Johnson et al. 2002). Requiring audit firm rotation by limiting the

number of consecutive years that a particular audit firm can

audit a listed/public company has been discussed as one of the

means of improving auditor independence and reducing the

likelihood of audit failures( AICPA’ s Cohen Report, 1978).

Rotation of audit firm is not a new concept; it has been

introduced and implemented in several countries such as Spain,

Israel, Italy and Brazil (Catanach and Walker, 1999). Several

3

debates have taken place concerning audit firm rotation in the

hearings of Sarbanes- Oxley Act as a way of enhancing

independence of auditor. The America Congress also recognized

that the issue of audit firm rotation needed attention and

requested the Controller General to study the potential effects of

mandatory rotation on the firm. With these awakening of

interests in the concept of audit firm rotation; there is need for

an empirical study to investigate whether periodic rotation of

audit firms affects the perceptions of external auditors’

independence and audit quality.

1.2 Statement of the Research Problem

Over the recent years, accounting practitioners and

academicians have debated the pros and cons of long–term

auditor – client relationships. Questionable accounting practices

and the recent audit failures have had a serious impact on the

public’s perception of auditors. Losses suffered by investors and

damages done to the credibility of the accounting profession

have prompted regulators to adopt additional measures to

restore investors’ confidence in the financial reporting system.

One of such measure suggested was mandatory rotation of audit

firms. This study is aimed at investigating the perception of

Chartered Accountants in Nigeria on the issue of mandatory 4

rotation of audit firms, especially with respect to auditor

independence, audit quality, and likely problems associated with

its introduction.

1.3 Objective of the Study

The general objective of the study is to investigate the Chartered

Accountants perceptions of mandatory audit firm rotation. The

specific objectives include:

1. To ascertain Chartered Accountants’ perceptions of the effect

of mandatory audit firms rotation on auditors’ independence.

2. To ascertain Chartered Accountants’ perceptions of the

implication of mandatory audit firms rotation on audit quality

3. To determine Chartered Accountants’ perceptions of likely

problems of introduction of mandatory audit firms rotation in

Nigeria.

1.4 Research Questions

5

The following questions are formulated to achieve the stated

objectives of the study:

1) How does the Chartered Accountants’ perceive the effect of

mandatory audit firm rotation on auditors’ independence?

2) What is the Chartered Accountants’ perception of the effect of

mandatory audit firm’s rotation on audit quality?

3) What are the likely problems of introduction of mandatory

rotation of auditors from the view point of Chartered

Accountants in Nigeria?

1.5 Research Hypotheses

The hypotheses addressed in this study are formulated as

follows:

Hypothesis 1

H0: The Nigerian Chartered Accountants’ perception of the effect

of mandatory audit firm rotation on auditor independence is not

positive.


of mandatory audit firm rotation on auditor independence is

positive.

6

Hypothesis 2


of mandatory audit rotation on audit quality is not positive.


of mandatory audit rotation on audit quality is positive.

Hypothesis 3

H0: Nigerian Chartered Accountants’ do not strongly believe

there are problems associated with the introduction of

mandatory rotation of auditors in Nigeria

H1: Nigerian Chartered Accountants’ strongly believe there are

problems associated with introduction of mandatory rotation of

auditors in Nigeria.

1.6 Scope of Study

There have been much discussion regarding the contributoty

factors behind the recent global bankrupcy of many large

corporations and the lessons to be learned. These discussions

have focused on a wide range of issues: the quality and the

extent of corporate reporting, the role and responsibilities of

executive and non- executive directors, audit committes,

7

mandatory audit rotation, Corporate Governance and regulatory

bodies. This paper focuses on the perceptions of effect of

mandatory audit firm rotation on auditor independence and audit

quality and likely problems associated with the introduction of

mandatory rotation of auditors in Nigeria.

1.7 Significance of the Study

The findings of this study may be of value to the following group

of people:

1) Board of Directors – In establishing policies about rotating

the external auditors.

2) Audit Committees – To know the cons and prons of the

impact of mandatory audit firm rotation and to recommend as

such to the board of directors.

3) The Accounting Profession and Regulators – As the

delibrate on the benefits of auditor rotation, continue to

deliberate upon the appropriate corporate governance principles

and codes required for companies in Nigeria.

4) Financial Statement Users – To know if mandatory audit

firm requirement have any benefit or not.

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5) Standard Setting Bodies– Such as the SEC (Securities and

Exchange Commission), CBN (Central Bank Of Nigeria) will be

able to discover whether there is benefit or not in making

mandatory audit firm rotation a requirement.

1.8 Definition of Terms

Mandatory Rotation: Mandatory Audit firm rotation is defined

as the imposition of a limit on the period of years in which a

particular public accounting firm may be the auditor of record for

a particular public company (Sarbanes-Oxley Act, 2002). The

concept of mandatory auditor rotation is that a company’s

auditors should provide services for a defined period only, after

which they should be replaced by a different firm of auditors.

Auditors Independence: Independence is an attitude of mind

characterized by integrity, objectivity and professional approach

to work (Okaro & Okafor, 2009). Mautz and Sharaf (1961)

developed a concept of independence with two components:

Practitioner-independence and Profession-independence.

Practioner- independence is a state of mind and equates to the

notion of the integrity and objectivity of the individaul auditor.

Profession–independence is the apparent independence of

auditors, as a professional group to the public. The appearance

9

of independence can be evaluated at two levels; The user’s

perception of the individual auditor’s ability to be independent in

particular unique circumstances and; the general public

accountants as professional group.

Audit Quality : the quality of an audit is related to: whether an

auditor’s will discover an error in the financial statement and;

whether an auditor will report the error in the audit report

DeAngelo (1981).

SECTION TWO

2.0 Review of Related Literature

2.1 External Auditor

10

Where ownership is separated from control, there is often the need

to have an independent body of persons who are to verify the

records of stewardship prepared and rendered by those in

fiduciary capacity to resource owners. Such reports will lack

credibility if not verified by an independent expert. As required by

the Companies and Allied Matters Act 1990, external auditors are

required to examine these financial statements not only to

determine whether they represent a true and fair view of the state

of affairs of the entity and are free of any material misstatements,

but also to ascertain whether they conform to the generally

accepted accounting principles (GAAP), other relevant legislation

and standards, and whether there are errors, misstatements or

fraud in those accounts. This attestation function by external

auditors gives credibility to financial statements prepared by

directors and enhances public confidence in the integrity of

financial statements of publicly traded companies.

The duty to engage an external auditor by any company is

statutory (CAMA, 1990). In the selection of external

auditor, the company is free to select any accounting firm to carry

out the audit as specified in CAMA, 1990. The appointment of

extenal auditors is done by the body of shareholders, usually on

the recommendation of the board of directors who selects extenal

11

auditors and recommends to the shareholders for approval as it

deems fit. Such appointments are usually for the financial year of

the company, but if the audit firm offers itself for reappointment at

the end of the financial year for another year and the shareholders

consider its services satisfactory, they may re-appoint the external

auditors for another year. Section 362-366 of CAMA (1990)

provided that apart from the expiration of the auditors one-year

tenure and not withstanding any terms in any agreement between

the auditors and the client, an auditor can be removed by an

ordinary resolution passed by the shareholders at the general

meeting of the company called for that purpose. Where the

existing auditor appointment is not renew, any proposed incoming

auditor must ensure that the previous auditor has validly vacated

office. The client must state the reason for the change of the

external auditors and must give the existing auditor the permission

to discuss the client’s affairs with the new auditor; The proposed

auditor is required to decline the nomination if the client refuses to

do this in line with provision of the Institute of Chartered

Acoountants of Nigerian Rules of Professional Conduct, section 4,

subsection 10-114). Auditors who remain with clients for significant

periods may develop inappropriate relationship which may

compromise independence. A model of appointment of auditors

12

that has a fixed term referred to as auditors’ rotation has been

proposed.

2.2 Mandatory Audit Firm Rotation

public confidence in the integrity of financial statements of publicly

traded companies is enhanced by the audit process and

independence of the auditor from the audit client. Major failures in

corporate financial reporting in recent years, including

accountability breakdowns and auditor failures at Enron,

WorldCom, waste management and others have prompted

regulators to question whether auditor are independent in

performing audit services (U.S. Conference Board, 2003). How to

rebuild the confidence of the investing public remains the most

critical challenge currently facing the global accounting profession.

One strategy for getting the crucible together by the accountancy

profession is the contentious issue of mandatory auditor rotation

that has been proposed by members and critics of the the

profession who contend that long-term relationship between

auditors and clients lead to cozy relationship that present conflict

of interest.

Mandatory Audit firm rotation is a concept that limit the number of

consecutive years that a particular audit firm can audit a public

13

company. Mandatory Audit firm rotation is defined as the

imposition of a limit on the period of years in which a particular

public accounting firm may be the auditor of record for a particular

public company (Sarbanes-Oxley Act, 2002). The concept of

mandatory auditor rotation is that a company’s auditor should

provide services for a defined period only, after which they should

be replaced by a different firm of auditors.

The ultimate question about mandatory audit firm rotation is

whether such a policy enhances independence and audit quality.

Regulators and the business press have shown interest in

considering whether long-term relationships between companies

and their auditors create a level of closeness that impairs auditor

independence and reduces audit quality. The debate of the

propriety of mandatory rotation of external auditors by companies

assumed greater prominence following the Enron saga of 2001 and

the enactment of Sarbanes- Oxley Act 2002 by the USA Congress.

In Nigeria currently, the National Insurance Commission (NAICOM)

as part of its strategic efforts to rebuild and sustain the waning

confidence of stakeholders in insurance, has required that external

auditors appointments shall be for a maximum period of five years,

this is to preclude a situation where the external auditors become

very familiar with employees of the organization that the resultant

14

attestation exercise is not well done. This mandatory rotation of

external auditors’ rule has been adopted by the Central Bank of

Nigeria for all banks. The apex bank has made mandatory rotation

of auditors every five years a rule for financial institutions in

Nigeria. The view is that if employees of the audit firm get very

acquainted or too familiar with the staff of client companies, many

transactions may be taken for granted and not properly verified

and this would likely impact the quality of audit negatively. The

advocator of mandatory rotation believe that audit firms should be

rotated every three to five years such that employees of both

entities would not get too acquainted, objectivity would be

maintained and the audit exercise would be thorough as to be able

to add credibility to the stewardship report of directors.

On the issue of mandatory rotation of firms, the Sarbanes-Oxley

Act 2002 only provided for the rotation of both the Lead and

Reviewing audit partners, but did not provide for statutory

rotation of audit firms. The Act as part of quality control measures

designed to enhance the objectivity and independence of auditors

provided for change of personnel within audit firms. It specifically

provided that both the Lead and Reviewing audit partners must

be rotated at least every five years. The Institute of Chartered

Acoountants of Nigerian Rules of Professional Conduct for Members

15

also provided for an orderly rotation of senior personnel and audit

engagement partners serving on the audit engagement. The Act

provides that no audit engagement partner should remain in

charge of an audit for a period exceeding seven consecutive years.

In Nigeria, firms of Chartered Accountants adhere to the practice of

rotationg personnel and engagement partners periodically in line

with the ICAN’s position.

2.3 Mandatory Audit Firm Rotation and Auditors

Independence

A breakdown in auditor independence can result in an audit

failure and adversely affect those parties who rely on the fair

presentation of the financial statements. There has been much

discussions and conjecture regarding the potential positive

impact of auditor rotation on objectivity and independence. The

improvement of auditor objectivity and independence has been

argured to be a primary reason for the introduction of mandatory

rotation of auditors. Long-term audit relationships can become

too comfortable, with auditors identifying too closely with

management and losing their professional scepticism . Auditors

might smooth over problems due to the financial rewards of

maintaining a long-term relationship with a client. Regulators

and the business press have shown interest in considering 16

whether long-term relationships between companies and their

auditors create a level of closeness that impairs auditors’

independent. Long-term relationships may result in a

troublesome degree of closeness between management and the

auditor, Enron and Andersen its long-time audit firm, provide a

graphic example. When a contentious issue arises, this close

relationship may create a conflict of interest for the auditor that

can adversely affect the audit process. Mandatory audit firm

rotation would enhance auditors independence, this belief was

put forward by a variety of individuals and committees. How can

an audit firm remain independent when it has established long-

term personal and professional relationships with a company by

auditing that company for many years, some 10, 20 or 30 years?

(Barbara et al, 2005). In 2002 when the Enron collapse was still

fresh , CalPers publicaly asked the US Security and Exchange

Commission to adopt a package of financial market reforms, and

listed a series of proactive efforts of its own, one of which would

be to oppose shareholder approval of any auditor that has been

ratained by a company for more than five years (SEC, 2003). At

this time question were every where about whether Andersen,

the independent public auditor of Enron was indeed

“independent” of its client. CalPers thought that auditor rotation

17

would prevent that sort of problem in the future. In Nigeria,

(Okaro, 2004) pointed out that mandatory rotation of auditors is

one of the recommendations that have been made in various

fora aimed at ensuring that Nigerian auditors are not only

independent in theory but also in practice. The US Commission

on Public Trust and Private Enterprises (2003) recommended

that audit committe should consider rotation of auditors as a

means of enhancing auditor independence and building

shareholder confidence in the integrity of the firm’s finanacial

statements. Ensuriing auditor independence has been a long

term objective of good corporate governance and some have

questioned whether public auditors can truly be independence

from the public companies that pay thier audit fees. GAO (2003),

pointed that the Sarbanes-Oxley Act 2002’ changes that requires

audit partner rotation, but does not require audit firm rotation

have already remediated the closeness problem to a certain

extent. The Sarbanes-Oxley Act 2002’ stance which conform

with section 476 of the ICAN Rule of Professional Conduct for

members represent a very persuasive position on the matter

(Asein, 2007). section 476 of the ICAN Rule of Professional

Conduct for members issued in 1997 states in part “there is a

concern that a long involvement by a single individaul or audit

18

team with an audit client could lead to the formulation of a close

relationship which could be perceived to be a threat to

objectivity and independence”. Section 4.77 of the Rule requires

audit partner rotation but not audit firm rotation by providing

that no audit engaged partner should remain in charge of such

an audit for a period exceeding seven consecutive years’.

2.4 Mandatory Audit Firm Rotation and the Perception of

Auditors Independence

The profession maintains that auditors must be independent in

fact and independent in appearance. Okaro & Okafor (2009) put

it this way an accountant is enjoined in carrying out his

assignment not only to be independent, but must also be seen to

be independent, He should not be involved in any relationship

that may enable members of the public to question his

objective/independence. In light of recent events, the media and

other factors have hightened the awareness of the issue of

independence. These has created a perception problem that

maintaining independence in appearance has become difficult

for some firm. The perception of auditor independence as it

relate to mandatory audit firm rotation is the idea that audit firm

rotation will incrementally strengthen independence in

appearance. It is utmost importance to the profession that the

19

general public maintains confidence in the independence of

auditors. Public confidence would be impaired by evidence that

independence was actually lacking, and might also be impaired

by the existence of circumstances , which reasonable people

might believe to be likely to influence independence.

Researchers have raised questions about how the capital

markets’ and investors’ current perceptions of auditor

independence would be affected by mandatory audit firm

rotation. Some believed that the perception of auditor

independence held by capital markets and institutional investors

would be affected by requiring mandatory audit firm rotation ,

while other believed the perception of auditor independence

would not increase. Even if there are no reviewed evidence to

show that rotation improves independence, the perception of

independence is arguably just as important. The perception of

independence is as important as actual independence. It is not

enough that financial statements be accurate, the public must

also percieve them as being accurate SEC (2000). The public

faith in the reliability of a company’s financial statements

depend on the public perceptions of the outside auditor as an

independent professional. If investor were to view the auditor as

an advocate for corporate client, the value of audit function itself

20

might be lost. The US Senate Subcommittee on Reports,

Accounting and Management has argued that mandatory auditor

rotation adds substance to the public’s perception of

independence( U.S. Senate, 1976). If this holds true, it would

follow that more confidence may be placed in the opinions

expressed by auditors (Petty & Cuganesan, 1996). Most support

for this view comes from articles and Press comment, the

arguments are not based upon detailed empirical study.

Shockley (1981) in his empirical study on the topic, showed no

evidence of a significant relationship between tenure and the

perception of auditor independence.

2.5 Mandatory Rotation Of Auditors and Audit Quality

Operationally, the primary audit quality question is whether such

a policy will lead to more-independent auditors performing better

audits by either detecting or reporting material misstatements in

the financial statements, or whether the constant rotation of

audit firms will result in inferior audit performance. Some

individuals believe that under mandatory audit firm rotation, the

auditor might be less likely to succumb to management pressure

to accept questionable accounting practices because the

incentive to keep the client is gone and another audit firm would

be looking at the firm’s work in the future. Others believed that 21

audit quality may also be increased through a change in auditors

because a new auditor would provide a fresh look at the entity’s

financial reporting practices and accounting policies. Okaro &

Okafor (2009) suggested the introduction of mandatory rotation

of auditors as one of the means of curtailling incidence of audit

failures in Nigeria. Three related conditions affect issues of audit

quality and audit firm rotation: Closeness to client management;

Lack of attention to detail due to staleness and redundancy; and

Eagerness to please the client (Barbara et al, 2005). The major

perceived benefit of mandatory rotation apart from better

perception of auditor independence is an improvement in audit

quality due to the aviodance of over- farmiliarity with the client

and its management and the opportunity for a fresh approach to

the audit. Those who support mandatory audit firm rotation

contend that pressures faced by the incumbent auditor to retain

the audit client coupled with the auditor’s comfort level with

management developed over time can adversely affect the

auditor’s actions to appropriately deal with financial reporting

issues that materially affect the company’s financial statements,

but proponents of mandatory audit firm rotation cite that

pressures to retain the client can adversely affect the auditor’s

decision to deal appropriately with audit issues, when the clients’

22

management is not in support of the auditor’s position on what is

required. Those in support also believe that mandatory audit firm

rotation would serve as an incentive for the auditor to take the

appropriate action since the auditor would know that his tenure

as auditor is for a limited term. Some argured that long term

audit relationships may result in ineffective audits. (Brody &

Moscove, 1998) pointed that the auditors may be come less

rigorous due to learned confidence in the client and over reliance

on prior years work papers which may create a tendency to

anticipate results rather than keeping alert to subtle but

important changes in client circumstrances. Nally (2002)

supports regular partner rotation, but said mandatory rotation of

audit firms will hurt the quality of audits.

2.6 Mandatory Audit Rotation and Perception of Audit

Quality Audit quality comprises actual and perceived quality

(Taylor, 2005). Actual quality is the degree to which the risk of

reporting a material error in the financial accounts is reduced,

while perceived quality is how effective users of financial

statements believe the auditor is at reducing material

misstatements. Higher perceived audit quality may then help

promote investment in audited clients. Even if research has

generally not found significant positive effects of firm rotation on

23

audit quality, could rotation be effective in increasing perceived

audit quality?

2.7 Likely Problems Of Introducttion of Mandatory Rotation Of Auditors In Nigeria

The expected problems of mandatory rotation is on the quality of

audit work, the cost of audits, cost of management time, lack of

specialized knowledge, problem of chioce due to inadequate

audit firms of sufficient size and quality to support a system of

mandatory rotation. Asein (2007) listed the following to be

possible problems of mandatory rotation: Increased cost of audit,

growth of monopoly, impact on provision of non-audit services

and impact on long-term corporate strategy. The AICPA

statement of position regarding mandatory rotation of audit

firms of publicly held companies (1992) concluded that

mandatory rotation should not be introduced based largely on

empirical evidence that demonstrated that there is a higher

instance of audit failures in the early years of an engagement. In

the course of an audit, the audit team accumulates extensive

knowledge of the client’s business, systems and personnel.

Under mandatory rotation system this knowledge may be lost at

each change of audit firm. The new auditor’s lack of knowledge

of the company’s operations, information systems that support

the financial statements, and financial reporting practices and 24

the time needed to acquire that knowledge increase the risk of

an auditor not detecting financial reporting issues that could

materially affect the company’s financial statements in the initial

years of the new auditor’s tenure. If audit firm were to be

continually rotated, the valuable knowledge and insight that

each audit firm gained would simply vanish and the detrimental

effect on audit quality would be repeated on a regular basis,

under such a system, the major victim of forced rotation would

be the company’s shareholders and the investing public ( Nally,

2002). It is common knowledge that a major requirement of

audit exercise is adequate knowledge of the business of the

client, a critical issue in audit effectiveness is the knowledge of

the business (Asein, 2007). GAO ( 2003) concluded that

mandatory auditors rotation may not be the most efficient way

to enhance auditor independence and audit quality, considering

the additional costs and the loss of institutional knowledge of a

public company’s previous auditor.

Those who oppose audit firm rotation contend that mandatory

audit firm rotation will increase costs incurred by both the audit

firms and the companies, and conclude that the increased risk of

an audit failure and the added costs of audit firm rotation

outweigh the value of a periodic fresh look by a new firm. The

25

cost related to regular switching of auditors may be

unacceptably high and outweigh the potential of benefits of

mandatory rotation. On costs, GAO (2003) survey found that

nearly all large public accounting firms estimated that initial year

costs under mandatory audit firm rotation would increase by

more than 20% over subsequent –year costs to acquire the

necessary understanding of the new client and its business. The

key empirical study quantifying the inrcrease in cost was carried

out by Ridyard & de Bolle (1991) in which a survey of European

audit firms revealed that start up cost were estimsted at 15% of

all costs for a new client in which the audit firm had industry

experience and 25 % when the audit firm had no industry

experience. On costs, GAO (2003) survey found that nearly all

large public accounting firms estimated that initial year costs

under mandatory audit firm rotation would increase by more

than 20% over subsequent – year costs to acquire the necessary

understanding of the new client and its business.

Asein (2007) opines that to regularly change external

auditors/audit firms as it is being canvassed will have a

significant implications for the cost of audit. Each time the

external auditor is changed, the cost of acquiring knowledge of

the business sufficient to enable the auditors identify and

26

understand those issues that may have a significant impact on

the financial statements as required by the International

Standards On Auditing (ISA) 310: Knowledge of Business,

will be significant both in terms of time and money he said.

Conversely, those in support believe that the value of the fresh

look to protect shareholders, creditors, and other parties who

rely on the financial statements outweigh the added costs

associated with mandatory audit firm rotation. Okaro & Okafor

(2009) for instance argured that mandatory rotation is

inexpensive to implement compared with other audit quality

control measures. James Copeland the CEO of Deloitte and

Touche representing the AICPA in a speech before the US Senate

Committee on Banking, Housing, and Urban Affairs, indicates

that rotation would increase start-up costs for auditors

(Copeland, 2002). However, The U. S. Conference Board (2003)

believes that the cost of implementing rotation of auditors will be

significantly less than the costs endured by investors in the

capital market resulting in the loss of investor confidence in

reponse to inaccurate financial statements.

Certain researchers have considered the implicit cost of the

client’ management time employed in selecting new auditors

and familiarising them with the company’s business, operations

27

and system. This concern about the over increased cost of

management has been expressed in the AICPA Report of (1992)

and the review of economic consequences of mandatory rotation

by Arrunada and Paz-Ares( 1995). Where there are specialised

industries only few audit firms may have partners and staff with

specialised knowledge of these industries and business due to

mandatory rotation of audit firm businesse may be forced to

rotate an auditor without this specialised knowledge. Petty and

Cuganesan (1996) argured this to be vulnerable to a reduction in

audit quality. Arrunada and Paz-Ares( 1997) further expanded

this argurement by pointing out that audit firm will have little

incentive to invest in specialised industries with few clients as

they will not be able to capture an adequate portion of the

market to recover the investment.

Mandatory rotation will also have implications for the provision of

non-audit services which are often assigned based on core

competence, track record and even brand name of practicing

firms. Are there sufficient firms in Nigeria to sustain the scope

for making choice of firms for non-audit jobs? Given that the big

four handle the bulk of the large puplicly held companies, will

rotation involve only these four firms? Are the non- Big four firms

able or willing to handle large audits? . Previous evidence

28

suggests that the Big four will gain greater market share if

rotation is mandatory which will lead to a less competitive

environment without addressing the related policy issues, and

less competition will probably lead to substaintially higher audit

fees (Barbara et al, 2005).

SECTION THREE

3.0 Methodology

3.1 Research Method

The survey design research method was used in carrying out this

study. Questions were developed to secure specific kinds of data

via structured questionnaires that were capable of providing

explanation to the phenomenon under study to a significant level

of accuracy.

3.2 Sources of Data

This study relied on both primary and secondary sources of data.

The primary data were those got through questionnaire

administration to the participants. The Secondary data were 29

gotten from review of books, journal, internet and reports of

various panels and committees.

3.3 Target Population

A survey of the 27,100 total members of the Institute of

Chartered Accountants of Nigeria was carried out through

fieldwork questionnaire administration and study. The total

number was obtained from the ICAN President’s 2008/2009

stewardship report to members of the institute at the 44th

Annual General Meeting of the institute held on the 1st of June,

2009 at the shell Hall of Muson Centre, Onikan, Lagos.

3.4 Sample Size

In every study, the researcher is expected to draw a sample size

from the population where the population is relatively large. It is

difficult for the researcher to work with a total population of

27,100 Chartered Accountants. In view of this, the researcher

used Yaro Yamane’s formula to determine the sample size for

this study thus: n=N/1+N(e) 2 Where; n = sample size, N =

Population size and e = error-limit (0.05).

n = 27,100/ 1 +27,100(0.05)2

n = 27,100/ 68.75

30

Sample Size (n) = 394 approximately.

3.5 Sampling Techniques

Convenient sampling method was used to draw the sample of

394 Chartered Accountants randomly from the population.This

is because the researcher believed the Chartered Accountants

possessed the same knowledge of the subject area.

3.6 Data Collection

Questionnaire was used as data collection instrument. The

questionnaire contains nine statements. Statements 1–3 relates

to the effects of mandatory audit firm rotation on auditors’

independence, Statements 4–6 relates to the effects of

mandatory audit firm rotation on audit quality, statements 7-9

relates to likely problems of introduction of mandatory auditor’s

rotation in Nigeria. A five-point Likert rating scale was used to

measure each Chartered Accountant’s perception/agreement to

each statement thus: Strongly agreed (5), Agreed (4), Undecided

or Neutral (3) , Disagreed (2) and Strongly Disagreed (1). Also a

question was included to sort for the opinion of the respondents

on whether mandatory audit firm rotation should be introduced

in Nigeria. The only demographic data requested was the post

qualification years of experience, the gender and the industry

where the respondents work. The questionnaire was

31

administered and collected through a research assistant during

ICAN 39th Annual Chartered Accountants’ Conference at Abuja

and personally at the 44th Induction Ceremony of New ICAN

Members in Lagos.

3.7 Validity and Reliability

To ensure the content validity of the instrument for data

collection, the survey questions were developed based on a

careful review of academic and regulatory literature report in

this subject area. The questionnaire was pre-tested with two

chartered accountants who gave feedback and suggestions on

improving the clarity of the questionnaire for the final version.

After comments from the pre-test groups, we made minor

adjustments to the content of the questionnaire and submitted it

to the seminar supervisor for vetting, correction and suggestions

to be sure that the questions were capable of soliciting

responses that proffer answers to the research problems. To

ensure the instrument reliability, Collection of data covered

qualified members of ICAN.

3.8 Method of Data Analysis :

The data collected was analyzed in tables using sum of

frequencies. The mean of the responses were reported as an

acceptable descriptive measure in order to facilitate

32

computations necessary for conclusions to be expressed. The

mean responses for each of the questionnaire items were

computed and compared with the mean of the five points–Likert

scale which is 3 calculated thus; {5+4+3+2+1} ÷ 5. The

results useful for testing the hypotheses were computed with

the use of t-test statistics.

3.9 Description of T-test Statistics

T-test is a parametric statistic that can be adopted to test the

significance

between means differences based on the student t- distribution

(Asike,

1991). For our purpose the following formular was applied: T = x-µ S/√n-1

Where; T = t- value calculated, X = mean score for each

response, µ = the cut-off point for high perception/ strong

believe (i.e. True mean of the population), S = the sample

standard deviation, n = number of respondents, and n-1

represents the degree of freedom.

Determination of the t-Critical Value:

33

At 5% level of significance and (n – 2) degree of freedom, the

one- tailed t-distribution critical value is 1.645.

Decision rule:

the decision rule is to accept the HO and reject the H1 if the

calculated t-test value is less than the the critical or t-test table

value (one tailed); otherwise reject the HO and accept the H1.

SECTION FOUR

4.0 Data Analysis and Test of Hypothesis

34

4.1 Data Analysis

Two hundred and ninety nine (299) complete and valid

responses were received representing 75.89% of the total

questionnaire. The data analysis is divided into section A and

section B. Section A covers the demographic information, while

section B covers responses from the participants.

4.1.1 Section A

This section covers the analysis of the demographic distribution

of the collected responses. Table 4.1.1 provides demographic

information on respondents. As indicated in the table majority

52.17% work in audit/ accounting practicing firms. In addition,

participants working in all the sectors have significant years of

accounting/ auditing related experience, with 73.91% having

over 5 years or more accounting related work experience. The

demographic information indicates that the respondents possess

the characteristics necessary to make informed judgments on

issues address in this study.

Table 4.1.1 Demographic Composition of RespondentsCurrent work position: Number

Audit /Accounting firm 156

35

Financial institution 51Academic institution 23

Public sector 31Other companies 38

Total 299

Accounting Work experience:20 years and above 1810 years to 20 years 435 years to 10 years 160Less than 5 years 78

Total 299

Gender:Male 257

Female 42Total 299

Sources: Field Survey (2009)

4.1.2 Section B

The focus of the data analysis here is establishing whether

Chartered Accountants perception of the effect of mandatory

audit firm rotation on auditor independence and audit quality is

positive and whether the Accountants strongly believe there are

problems associated with the introduction of mandatory audit

firm rotation. Likert- five point rating scale was used to measure

the Chartered Accountants perception and believe to each of the

statements relating to auditors independence, audit quality and

likely problems of mandatory audit firm rotation in Nigeria.

Lower rating by the Chartered Accountants to each of these

statements were considered to be negative perception/weak

36

believe; while high rating were considered to be positive

perception/strong believe. The following tables show the results

of the analysis of the responses and the computed mean and

standard deviation of the responses.

Table 4.1.2.1: Tabulation of Chartered Accountants Perception of the Effect of Mandatory Audit Firm Rotation on Auditor Independence.

Likert rating 5 4 3 2 1 TotalMean

Std. dev

Questionnaire item 1 117 129 7 28 18 299 4.000 1.155

Questionnaire item 2 96 139 12 14 37 299 3.812 1.279

questionnaire Item 3 131 117 7 23 21 299 4.050 1.184

Source: Field Survey (2009).

Table 4.1.2.2: Tabulation of Chartered Accountants Perception of the Effect of Mandatory Audit Firm Rotation on Audit Quality

Likert rating 5 4 3 2 1Total

Mean

Std. dev


questionnaire Item 5 41 49 7131 71 299

2.525 1.371

questionnaire Item 6103 101 13 39 43 299

3.608 1.434


Table 4.1.2.3: Tabulation of Chartered Accountants Believe of Problems Associated with the Introduction of Audit Firm Rotation in Nigeria

Likert rating 5 4 3 2 1Total

Mean

Std. dev




37


Table 4.1.3: Tabulation of Chartered Accountants Opinion on Introduction of Audit Firm Rotation in NigeriaOpinion YES NO Total

Number of Accountants 103 196 299

Percentages 34.45% 65.55% 100%


4.2 DISCUSSION OF FINDINGS

Statements 1-3 relate to the chartered accountants’ perception

of auditor independence as it relates to mandatory audit firm

rotation. The mean response to (statement 1) shows that

majority of the respondents agreed that rotation would

decrease management’s ability to influence the auditors. The

mean response to (statement 2) shows that high proportion of

the respondents also agreed that rotation will increase the

potential of auditors to be more vocal in disagreeing with

management on issues that need to be straightened. The mean

responses to (statement 3) show that majority of the

respondents agreed that mandatory rotation/ audit term limit

would increase auditor’s independence in audit process.

Statements 4-6 sought to determine the chartered accountants’

perceptions of audit quality as it relates to mandatory auditor

rotation. Statement 4 asserted that frequent auditor changes will

38

increase the potential for detection of material

misstatement/manipulation by the auditor. The mean responses

shows that a higher proportion of the respondents agreed with

this statement. The responses to statement 5 (frequent auditor

changes will increase the auditor’s potential to gain adequate

knowledge of the client’s industry and business practices)

indicate that majority of the respondents disagreed with this

statement. On the other hand the mean responses to statement

6 indicated that the chartered accountants believed that

mandatory rotation of audit firm will increase audit quality.

Responses to Statements 7 and 8 shows that majority of the

chartered accountants believed that there would be problems

associated with the introduction of mandatory audit firm rotation

in Nigeria such as Increased audit costs, growth of monopoly,

loss of client firm’s industry/business practices and cost of

management time in identifying a new accounting firm and

familiarizing the firm with the client’s business. Statement 9

sought to determine whether the chartered accountants agreed

that the problems associated with mandatory audit firm rotation

will outweigh the potential benefits. Majority of the participants

disagreed with this statement.

39

A substantial proportion of the respondents (65.55%) agreed

that audit firm rotation should be required in Nigeria, 35.5%

disagreed with the opinion that mandatory audit firm rotation

should be introduced in Nigeria.

4.3 TEST OF HYPOTHESIS

In testing all the hypotheses the T-test for each of the

questionnaire items were calculated and compared with the T-

table value {df =298 (i.e. 299-1), one- tailed test} at 0.005 level

of significance which is 1.645.

4.3.1 Hypothesis 1:


of mandatory audit firm rotation on auditor independence is not

positive.


of mandatory audit firm rotation on auditor independence is

positive.

Recalling that 3 is the cut off for positive perception, the

hypothesis is restated as H0: X < 3: H1: X ≥ 3. The table below

shows the summary of the results of analysis of the mean of the

Chartered Accountants’ perception and t-test calculated.

40

Table 4.3.1 Summary of Perception of the Effect of Mandatory Audit Firm Rotation on Auditor Independence Results (Mean, t-Value calculated and t-table value)

Questionnaire

items

Mean Perception t- value =x-µ

s/√n-

1

t-table @

0.05

(one-tailed)

Item 1 4.000 14.937 1.645

Item 2 3.812 10.968 1.645

Item 3 4.050 15.302 1.645


The mean perception to all the statements concerning the effect

of mandatory audit firm rotation on auditor independence were

more than the cut-off mean. Also the t-value calculated for all

the three satatements are greater than the t-table value, thus

leading to the rejection of the null hypothesis that the Chartered

Accountants perception of the effect of mandatory audit firm

rotation on auditor independence is not positive.

4.3.2 Hypothesis 2


of mandatory audit rotation on audit quality is not positive.


of mandatory audit rotation on audit quality is positive.

Recalling also that 3 is the cut off for positive perception, the

hypothesis is restated as H0: X < 3: H1: X ≥ 3. The table below

41

shows the summary of the results of analysis of the mean of the

Chartered Accountants’ perception and t-test calculated.

Table 4.3.2 Summary of Perception of the Effect of Mandatory Audit Firm Rotation on Audit Quality Results (Mean, t-Value calculated and t-table value)

Questionnaire

items


s/√n-

1

t-table

(one-tailed)

Item 4 3.394 4.459 1.645

Item 5 2.525 -5.977 1.645

Item 6 3.608 7.325 1.645


The mean perception of the Accountants to statements 4 and 6

are greater than the cut-off mean. However, the mean of the

Accountants’ perception to statement 5 is less than the cut- off

mean. Also the t-value calculated for statements 4 and 6 are

greater than the t-table value. This lead to the rejection of the

null hypothesis that the Chartered Accountants perception of the

effect of mandatory audit firm rotation on audit quality is not

positive in these cases. For statement 5, the t- value calculated

is less than the t-table value. The null hypothesis was accepted

in this case.

4.3.3 Hypothesis 3

H0: Nigerian Chartered Accountants’ do not strongly believe

there are problems associated with introduction of mandatory

rotation of auditors in Nigeria.

42

H1: Nigerian Chartered Accountants’ strongly believe there are

problems associated with the introduction of mandatory rotation

of auditors in Nigeria.

Recall also that 3 is the cut off for strong believe, the hypothesis

is restated as H0: X < 3: H1: X ≥ 3. The results of analysis of the

mean of the Chartered Accountants’ believe and t-test calculated

is shown below.

Table 4.3.3 Summary of Chattered Accountants Believe of Problems Associated With Introduction of Mandatory Rotation of Auditors Results (Mean, t-Value calculated and t-table value)

Questionnaire

items


s/√n-

1

t-table

(one-tailed)

item 7 3.709 10.122 1.645

item 8 3.598 7.370 1.645


The mean perception of the Chartered Accountants to

statements 7 and 8 are greater than the cut-off mean. Also the t-

value calculated were greater than the t-table value. The null

hypothesis that Nigerian Chartered Accountants do not strongly

believe there are problems associated with introduction of

mandatory rotation of auditors in Nigeria was therefore rejected.

43

SECTION FIVE

5.0 Summary of Findings, Conclusion and

Recommendations

5.1 Summary of Findings

The statistical results of the study show the following findings:

The chartered accountants perceived that rotation can

enhance auditor independence.

The chartered accountants perceived that rotation would

decrease management’s ability to influence the auditor.

44

Majority of the Chartered accountants believed that

mandatory rotation can leads to higher quality audits.

The chartered accountants perceived that rotation would

increase the auditor’s potential to detect material

misstatement and manipulation.

The Chartered Accountants do not perceive that mandatory

audit firm rotation would increase the auditor’s potential to

gain adequate knowledge of the client’s entity.

The Chartered Accountants believed there are problems that

would be associated with mandatory audit firm rotation

introduction in Nigeria.

The Chartered Accountants disagreed that the problems of

periodic rotation of audit firms would likely exceed the

benefits.

Majority of the chartered accountants agreed that audit firm

rotation should be required in Nigeria.

5.2 Conclusion

Based on the results of this study, the following conclusions

were made:

The Nigerian Chartered Accountants perceived that rotation

will increase auditor independence.This support the thoery

that audit firm rotation enhances perception of auditor 45

independence. Other findings also support mandatory

rotation and suggest that rotation puts auditors in a stronger

position to resist management pressure and be more

objective (Brody and Moscove, 1998). Prior researchers have

noted that independence appears to deteriorate with longer

auditor tenure and support the thoery that audit firm

rotation enhances perception of auditor independence. GAO

(2003) study cited that 65% of fortune 1000 companies

agreed that the perceptions of auditor independence would

increase under mandatory audit firm rotation.

Nigerian Chartered Accountants perceived that rotation will

increase audit quality in terms of providing opportunity for a

fresh look/ fresh approach to the audit and auditors’

potential to detect material misstatement or manipulation.

This were consistent with the position that changing auditors

would actually improve quality by providing a fresh look

(Brody and Moscove, 1998).

Problems such as increased costs, lost of client knowledge

and lack of chioce of audit firms can be associated with the

introduction of mandatory audit firm rotation rule in Nigeria.

The Chartered Accountants surveyed support mandatory

rotation of audit firm introduction in Nigeria.

46

5.3 Recommendations

Auditor rotation appears to enhance perception of

auditor independence, for this reason publicly traded

companies that have used the same auditor for years

should consider adopting a rotation policy.

The study recommends that the effectiveness of alternative

corporate governance provisions such as partners’ rotation,

peer-review mechanism, role of non-executive directors and

audit Committee should be monitored while the regulatory

agencies continue to study the pros and cons of mandatory

audit firm rotation as an option to improve the accuracy

and reliability of the financial reporting system.

The study also recommends that ICAN ( The Institute of

Chartered Accountants of Nigeria) management should

always carry its members along in any policy issue like

mandatory rotation of audit firm. While ICAN as a body is

saying No to mandatory rotation on the excuse that it

does not accord with International best practice, its

members or rank and file are saying Yes to it.

This study covered only perceived auditor independence

and audit quality analyzed through questionnaires, further

empirical research is recommended to investigate the 47

effect of mandatory auditors’ rotation on actual auditor

independence and audit quality through the employment of

analytic modalities such as informative and statistical

documents), perhaps using the Nigerian’ banking sector

where mandatory rotation has been introduced as a case

study.

This study was limited to the perceptions of Chartered

Accountants (ICAN members) the study of the perception of

other groups is recommended.

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