CHAPTER ONE

INTRODUCTION

1.1.Background of the Study

External auditors are authorized by law to examine and publicly issue an opinion on the reliability of corporate financial reports. Dennis Applegate describes the history of external audits in an article appearing in the magazine Internal Auditor as follows. ‘The U.S. Congress shaped the external auditing profession and created its primary audit objective with the passage of the Securities Act of 1933 and the Securities Exchange Act of 1934. This combined legislation requires independent financial audits of all firms whose capital stock is bought and sold in open markets. Its purpose, in part, is to ensure that the financial status and operating performance of publicly traded companies are fairly presented and disclosed.” Firms not obliged by law to perform external audits often contract for such accounting services nonetheless. Smaller businesses, for example, that do not have the resources or inclination to maintain internal audit systems will often have external audits done on a regular basis as a sort of safeguard against errors or fraud. The primary goal of external auditing is to determine the extent to which the organization adheres to managerial policies, procedures, and requirements (Lee et al 2012).

Enron was only the first in a string of high-profile bankruptcies. Serious allegations of accounting fraud followed and extended beyond the bankrupt firms to their accounting firms. The legislature acted quickly to fortify financial reporting requirements and stem the decline in confidence that resulted from the wave of bankruptcies. The Sarbanes-Oxley Act is a wide-reaching and complex law that imposes heavy reporting requirements on all publicly traded companies. Meeting the requirements of this law has increased the workload of auditing firms. In particular, Section 404 of the Sarbanes-Oxley Act requires that an entity’s annual report include an official write-up by management about the effectiveness of the entity’s internal controls. The section also requires that outside auditors attest to management’s report on internal controls. An external audit is required in order to attest to the management report (Stoner (2003).

The brain behind of external audit as a governance mechanism is improvement of the performance produced by companies to ensure the reliability and credibility of companies published financial statements. But because of all the financial scandals known around the world such as Enron and WorldCom just to name a few, the credibility of audited financial statements was the subject of several writings since the external auditors caused these scandals. Accurate financial reporting is essential for the proper valuation of securities traded in all and especially infant capital markets like the Douala Stock Exchange. Most independent business people and corporate bodies in Cameroon need accurate accounting information to make informed business decisions regarding investments, reinvestments, strategy formulation, business model, and risk assessment. If the management unit or the board is well informed and served with the right information, it could do well to structure compensation packages and other distributions appropriately and for the ultimate interest of the company. 

 Though it is depicted that 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 (Suraj Ali, 2017).

The independent or external auditor is not an employee of the organization. He or she performs an examination with the with aim of issuing a report containing an opinion on a client’s financial statements. The attest function of external auditing refers to the auditor’s expression of an opinion on an entity’s financial statements (Kinney and Martin, 1994). The typical independent audit leads to an attestation regarding the fairness and dependability of the statements. This is communicated to the officials of the audited entity in the form of a written report certifying the statements (an oral presentation of findings may sometimes be requested as well). During the course of an audit study, the external auditor also becomes well acquainted with the virtues and flaws of the client’s accounting procedures. As a result, the auditor’s final report to management often includes recommendations on methodologies of improving internal controls that are in place. Major types of audits conducted by external auditors include the financial statements audit, the operational audit, and the compliance audit.

To this effect, good quality accounting information would help reduce information asymmetry. Generally, the Enron, Parmalat and Worldcom cases and specific cases in Cameroon have called into question the quality of the accounting information produced by the companies and yet certified by the external auditors. Africa and more specifically, Cameroon, has not remained on the side-lines of these scandals that seem very common. Indeed, various financial scandals and the evolution of accounting standards, with the adoption of the International Financial Reporting Standards (IFRS), have raised the question of the reliability of the financial data on which a large part of the activity of capital markets evolves. The result of these scandals is the development of audit firms and therefore the number of statutory auditors (Mouhamed 2016). Despite the increased growth of the professionals of the figure, the issue of the reliability of accounting information remains at the heart of the debates of several financial experts and economic agents. The Institute of Chartered Accountants of Cameroon (“ONECCA”) has a registered membership of 208 as at 2018. Although this number stands far below similar numbers in countries like Kenya and Nigeria, one may not quickly jump to the conclusion that the small number of accountants in Cameroon may be responsible for the limitation of accurate accounting information and probably not the disrespect of professional ethics.

Amongst other characteristics, the external auditor must exert two important characters: independence and competence, as they seriously affect the audit quality. Indeed, the auditor influences the quality of a financial audit as he has the responsibility to uncover inconsistency in the client’s accounting system and to report it. These amounts to considering the product of two probabilities: discovering the anomaly (competence) and revealing it (independence). Although the number of practitioners cannot be related to ethics, generally speaking, independence and competence as components of audit quality have been challenged by recent research demonstrating their vulnerability to certain common business risks such as adverse selection and dependence on leaders. Kinney and Martin (1994) show from an exploratory study of 1500 audit cases related to errors and irregularities detected and corrected by auditors that the intervention of an independent auditor in the control of the accounts significantly reduces biases in the accounting information disclosed to the shareholders. 

 Independence can be at three levels: independence in scheduling audit work, that is, the auditor must decide alone on the audit program to be implemented, the independence of investigation, which requires a freedom of collection and evaluation of the data judged material by the listener without any interference or manipulations, not of other actors; and lastly independence in reporting, which stipulates a freedom of communication of the results of the auditor’s work and of his opinion. Djoutsa and Foka (2014) came to the conclusion that an independent auditor is the one who has the freedom to schedule the activities of the audit as well as the freedom to communicate the results of the audit, unlike a dependent auditor who receives compensation other than the fees for the audit engagement and provides non-audit services to the same client.

According to the Centre for Audit Quality (2017), audit quality largely depends on the individuals who conduct the audit. The audit committee should assess whether the primary members of the audit engagement team demonstrate the knowledge, skills, and experience necessary to address the company’s risks of material misstatement and have access to appropriate specialists and national office resources during the audit. In the current paper, we have to look at what influences audit quality beyond the above three characteristics, which seem to be in the same cluster – Knowledge. We do not think knowledge without a good reputation could produce reliable figures. 

Indeed, it emerges from Foka et al. (2017) that 45% of auditors who meet the criteria of competence in Cameroon are those whose audit firms belong to the “Big Four” network. We also note from Sangué-Fotso (2015) that the duration of the auditor’s mandate harms the performance although a tenure of six years (renewable once) by OHADA seems to be long enough. It is imperative to reassess the relevance of these indicators in the accounting figures we produce today.

The above leads us to the aim of our study, which is to show how the performance produced by Cameroonian companies and assured by an external audit may be influenced by the specialisation of the auditor, the auditor’s seniority and the auditor’s reputation. To achieve the aim, the following research questions are set:  Due to robust incentives (including taxation, misreporting and other forms of fraud) to misstate accounting information, auditing has become a legal requirement for many entities that have the power to exploit accounting information for personal gain. Traditionally, audits were mainly associated with gaining information about financial systems and the financial records of a company or a business. Due to constraints, an audit seeks to provide only reasonable assurance that the statements are free from material error. Hence, statistical sampling is often adopted in audits. In the case of financial audits, a set of financial statements are said to be true and fair when they are free of material misstatements a concept influenced by both quantitative(numerical) and qualitative factors. But recently, the argument that auditing should go beyond just true and fair is gaining momentum (McKenna, 2011).

A number of benefits stem out of conducting an audit which are key in providing strategic gain to an organization. Riches (2015) lists out the benefits of an audit to an organization including helping to identify weaknesses in the accounting systems and enabling auditors to suggest improvements; assures directors or senior management not involved in the accounting functions on a day-to-day basis that the business is running in accordance with the information they are receiving, and helps reduce the scope for fraud and poor accounting; facilitates the provision of advice that can have real financial benefits for an organization, including how the organization is running, what margins can be expected and how these can be achieved. The advice can cover anything from the tightening of internal controls to reducing the risk of fraud or tax planning; enhancing the credibility and reliability of the figures being submitted to prospective donors or partner organizations; adding credibility to published information for employees, customers, suppliers, investors and tax authorities; provides assurance to donors and directors (if they are not directors closely involved in the business) that the figures in the accounts show a true and fair view.

Despite all these benefits arising out of engaging an auditor to conduct an audit, companies may be required to get their financial statements audited as per the requirements of the law under which it is constituted. The provisions of other relevant and applicable laws may also require an audit or certification of the financial statements. In addition, some donors, who provide Companies with restricted funding, may require special reports from the auditors. For example, a multilateral donor which funds a charity to provide care for patients with special needs may require confirmation from the auditor that the funds contributed by it have been applied by the companies in accordance with the terms of the contract (Ainapure and Ainapure, 2009).

1.2. Statement of the Problem

The collapse of eminent companies such as Enron, Parmalat, Xerox, Cable and Wireless, and WorldCom which were enjoying healthy financial performance throughout the 1990s led to a growing apprehension about the quality of audit work (BPP Learning Media, 2015). In 2001, it was revealed that the management of WorldCom and Enron colluded with their auditors to engage in “creative” financial reporting and in using questionable accounting practices and they manipulated their financial statements to allude to growth and profitability while in reality, they were losing money (Brooks, 2013).

It should be noted that the management of these MFIs are responsible for the preparation of their financial statements according to applicable laws and International Financial Reporting Standard (IFRS). Statutorily, external auditors are required to identify cases of fraud and other financial malpractices and report the same to the Board of Directors and Management, but sometimes they fail to perform this duty as expected. The external auditors’ major concern is risk management since any risk capable of adversely affecting a firm has the potential to impact the results reported in the financial statements, audit planning and conduct (Knechel, Salterio & Ballou, 2007). There is widespread criticism of the work done by external auditors mainly due to the failure to perform the expected responsibilities or to execute them to the anticipated standards. Auditors have been accused of conducting poor quality audits due to a lack of professional competence and independence, failure to dedicate enough time to the audit process and to comply with applicable standards and regulations.

Many reports have emerged on the loss of confidence in the work done by external auditors which results in a decline of society’s confidence in the audit profession in its entirety and by implication the functions of audit (Porter & Gowthorpe, 2004). These negative views have resulted from a discrepancy between the expectations the society have about audit work and what it perceives they deliver otherwise referred to as the “audit expectation-performance gap” (Porter, Baskerville & Hogartaigh, 2012).

Several studies have been undertaken on audit quality, both on internal and external audits. Fossung (2019) conducted a study on the contribution of external audits in the performance produced by Cameroonian companies. Kwabena (2017) undertook a study of the effects of internal audit quality on the financial performance of firms listed in the Nairobi Securities Exchange. Suraj Ali (2017) researched on the effects of internal audits on the financial performance of microfinance institutions in Kenya. Matoke and Omwenga (2016) conducted a study to determine the association between audit quality and the financial performance of listed parastatals in Kenya. These studies among others concluded that audit quality influences firms’ financial performance. However, few of these studies focused on the influence external audit on performance within companies. Consequently, there exist a research gap be covered by the present study.

1.3. Research Questions

1.3.1 Main Research Question

What is the influence of the external audit on the performance of MFIs in Bamenda?

1.3.2 Specific Research Questions

1. To what extent does external auditors’ specialized educational achievement influence the performance of MFIs in Bamenda?
2. What is the impact of the length of time held by the external auditor on the performance of MFIs in Bamenda?

• To what extent does the audit team’s independence affect the performance of MFIs in Bamenda?

1.4. Research Objectives

1.4.1. Main Objective

The main aim of this study is to determine the contribution of external audits to the performance of MFIs in Bamenda.

1.4.2.Specific Research Objectives

The specific research questions include the following:

1. To evaluate the influence of external auditors’ specialized educational achievement on the performance of MFIs in Bamenda
2. To examine the impact of the length of time held by the external auditor of the client on the performance of MFIs in Bamenda.

• To assess the influence of the audit team’s independence on the performance of MFIs in Bamenda.

1.5. Research Hypotheses

H₁: External auditors’ professionalism does not significantly influence the performance of MFIs in Bamenda.

H₂: Duration of the audit tenure does not significantly influence the performance of MFIs in Bamenda.

H₃: External Auditor’s sector of specialisation has no significant influence on the performance of MFIs in Bamenda.