CHAPTER ONE

1.1 Background of the study

High quality reporting is fundamental and necessary for the efficient functioning of capital markets and the effective allocation of resources having financial statements which are reliable provides stakeholders including investors, creditors with information which is necessary to make informed decisions about the business organization in terms of resource allocation, investment strategies company performance etc. The need for high financial reporting has increased in the early 21^st century as a result of increasing accounting scandals such as the ENRON, WOLDCOM, PARMALAT, just to name a few. This has led to the rising demand for disclosure and formulation of accounting standards which uncovered the low quality of financial reporting. According to the growth and employment strategy paper for DSCE (2009), the bankruptcy rate for Cameroon companies is 32%. This problem is however as a result of the difference of reporting need between shareholders and managers. According to the Agency Theory, the delimitations of power and management decisions leads to Agency problems and information asymmetry which arise between managers and shareholders (Jensen & Meckilng, 1976).

Effective management of business therefore requires that this issue of divergence of interest especially on the part of managers be handled correctly by shareholders. As a result, industry has to adopt one of the strategies as highlighted by Arrow (1985). This involves using an auditor to give his opinion on the sincerity and clarity of the accounting figures which has been produced by management. This leads us to the study by (O’Sullivans ans Deacon, 2002), stating that external audit is a corporate governance mechanism with the primary aim to ensure that the accounting data published are reliable.

Audit practices have their roots in ancient times dating back to 3000 BCE in ancient Egypt and Babylon and since then it has been evolving to meet the demand of changing economic landscape and regulatory environment. Today, it plays a crucial role in assuring stakeholders, ensuring compliance and enhancing credibility of financial information. According to Center for Audit Quality (2017), the quality of audits depends largely on the person who conducts the audit. As stated by De Angelo (1981), a good quality audit is the probability that an auditor is able to detect an anormaly in the financial statements of a company and disclose this anormaly. Alvarez (1997) in his work on the relationship between audit and performance in south America as stated by  (Fossung &Verges, 2022)  concluded  that auditing is a solution that can help reduce the disadvantages of managerial behavior. This however will only be effective if it is of high quality.

Focusing on limited companies in Cameroon ( PLCs and LTDs) , internal control measures are always put in place to ensure the reduction of risk. These companies also practice internal audit carried out by professionals or employees of the company. Such audits include compliance, operational, information, performance and environmental audits, with the purpose of improving the effectiveness of risk management, control system and governance process. Despite doing this with objectivity and independence, it is not worthy enough to ensure the quality of financial reporting in these companies, there for a need for external audits. In Cameroon, the quality of external audits plays a crucial role in ensuring the reliability and accuracy of financial reporting within limited companies. External auditing is an audit conducted by an independent professional related to the company by contract, in order to obtain sufficient appropriate audit evidence to give their professional judgment about the true and fair state of the company

Although external audit has as a role to test for misstatement and render assurance report accordingly, the role of the audit committee to shape the accuracy of financial statements by setting audit parameters for quality, transparency and controls cannot be overlooked. In companies that there exists no audit committee as a tool for effective corporate governance, leading to unguided external audit one may not expect accuracy and exhaustiveness. The risk of lack of accuracy and completeness, which may lead to a gap, maybe less in banks and other financial institutions in Cameroon, which have been imposed the position of audit committee by the Central African Banking Commission(“COBAC”). Therefore, industries with no audit committee may run a risk of higher audit expectation gap than the highly regulated financial industry.

The problem of non-reliability of financial reports in recent times has raised serious questions about the effectiveness of audit quality in monitoring and controlling managerial opportunistic behavior (Foka et al., 2018) and cited by Nkengatheh & Dongmo (2022).  studies conducted by Krishnan (2002), Anderson et al. (2004), Charreaux and Philippe (1997), Moore and Ronen (1990) in the European and American contexts have shown that a quality audit mission favours the performance of the company. This may not be the case with sub-Saharan Africa, in general, and Cameroon in particular, where the business environment is marked by increased corruption, misappropriation of public funds, and inequitable distribution of wealth (Belkaoui, 1994; Zafar, 2002).

The various financial scandals of the western world such as the fall of ENRON, the industrial conglomerate of Tyco, WorldCom which was a case of failed business projections, were as a result of poor audit and hence poor reporting quality.

WorldCom was a major accounting scandal that occurred in 2002. The company’s auditor, KPMG, was found to have failed to properly audit WorldCom’s financial statements, which led to the company’s collapse. the relationship between auditor auditee relationship taking into consideration culture was a German payment processing company that collapsed in 2020. The company’s auditor, EY, was found to have failed to properly audit Wirecard’s financial statements, which led to the company’s collapse. Wirecard was founded in 1999 and quickly became one of the world’s largest payment processors. The company processed payments for millions of businesses and consumers around the world. In 2019, Wirecard’s financial statements were audited by EY. EY issued an unqualified audit opinion, which means that it found no material misstatements in Wirecard’s financial statements. However, in 2020, it was revealed that Wirecard’s financial statements had been inflated by billions of euros. EY was heavily criticized for failing to detect the fraud.

Africa and most espercially Cameroon has not been left out concerning the issue of these financial scandals. A recent case involving XYZ Limited, a prominent limited company in Cameroon, highlighted the detrimental effects of poor audit quality. The company’s financial statements were found to contain material misstatements due to auditors’ reliance on management representations without conducting sufficient substantive testing. This case denotes the importance of understanding and addressing challenges in the auditor-auditee relationship to prevent financial misstatements and fraud (XYZ Limited Case Report, 2021). The National Institute of Certified Public Accountants of Cameroon has expressed concerns about the quality of audits in limited companies and the potential impact of conflicts of interest on audit independence. Regulatory bodies have called for further research to identify strategies which can enhance the effectiveness external audit and improve audit quality (National Institute of Certified Public Accountants of Cameroon, 2021).

Other cases  such as SODECOTON, SONARA, FIFA, COFINEST and, more recently, the BICEC case, which is as a result of poor quality of financial reports. The relationship between audit quality and financial reporting quality are intertwined (Gaynor et al., 2016). Based on the analysis above, it is necessary to understand the role that external audit quality plays on the quality of reporting within limited companies in Cameroon.

1.2 Statement of the problem.

The need for high quality financial reporting has increased in the early 21^st century due to increasing financial scandals. Good quality financial and accounting information helps to reduce the risk of information asymmetry. Tondeur and Coulombe (2001), explained that a contract which is based on reliable valid information is considered a definite asset to minimize the cost inherent in conflicts between different stakeholders in a company. This highlights the importance of good quality reporting. However, looking at the financial scandals such as the case of ENRON, WorldCom, Parmalat and cases in Cameroon such as SODECOTTON, SONARA, CONFINEST and most recently BICEC has called into question the quality of financial information produced by companies and yet certified by external auditors. Understanding the relationship that exist between external audit quality and quality of reporting is therefore necessary to improve the quality of reporting within limited companies in Cameroon.

Previous researchers have carried out studies on the relationship between quality of audit and quality of financial reporting ad stated their opinion as well as given recommendations for further research in order to fully understand the concept.

Fossung and Saurelle, (2019) in their study aimed at determining how external audit contributes in the quality of accounting and financial information produced by Cameroon companies used auditors field of specialization, auditors mandate duration and auditors reputation to capture audit quality.

Also, studies carried out by Salma on the relationship between audit quality and financial reporting quality in Egypt used audit firm size, audit fee, and audit tenure as proxies for audit quality while earnings management and conservatism for financial reporting quality.

Salma (2022), in his studies recommends that standard setters should focus more on reports performed by non-big 4 firms and also to control audit tenure (such that it doesn’t exceed 3 years) so as to maintain high reporting quality.

Following the analysis of the literature above, it is therefore necessary to conduct a study on the relationship between external audit quality and quality of reporting within limited companies in Cameroon using audit fee, audit firm size and audit tenure as proxies for externa; audit quality considering that previous work was done but in the Egyptian context. Also based on the fact that Fossung and Saurelle carried out similar studies but using auditor’s specialization, duration of mandate and audit reputation.

1.3 Research Questions

1.3.1. Main Research Question

What is the effect of external audit quality on the quality of reporting within Limited companies in North West Region Cameroon?

1.3.2. Specific Research Questions.

• What is the relationship between audit firm size and quality of reporting within Limited companies in the North West Region of Cameroon?
• What is the effect of audit fee on quality of reporting within limited companies in the North West Region of Cameroon?
• What is the relationship between audit firm tenure and quality of reporting within Limited companies in the North West Region of Cameroon?

1.4. Research Objectives

1.4.1. Main Research Objective

To examine the effect of external audit quality on the quality of reporting within Limited companies in Cameroon

1.4.2. Specific Research Objectives

• To assess the relationship between audit firm size and quality of reporting within Limited companies in North West Region Cameroon.
• To examine the effect of audit fee on the quality of reporting within Limited companies in North West Region Cameroon.
• To assess the relationship between audit firm tenure and quality of reporting within Limited companies in North West Region Cameroon.