ABSTRACT
This study sought to examine the effect of creative
accounting practices on the audit of financial statements. The conflict of
interests within corporate firms has been largely linked with creative
accounting behavior. Management may engage in fraudulent financial reporting to
boost earnings and to present sound and stable financial performance. The
independent opinion of the external auditors thus provides a reasonable
assurance to the owners that the financial statements are free from material
misstatements. In spite of this, financial reporting scandals and large case
frauds have been reported in big business Corporations around the globe. External
auditors have either failed to detect creative accounting techniques used or
colluded with management to manipulate the financial statements. Book entries
such as provisions and reserves were the common techniques used by the affected
Corporations. Therefore, this study aimed at ascertaining the impact of
creative accounting practice on audit failure; impact of creative accounting on
audit risk; impact of provision for depreciation and deferred tax on firms’
performance. Using the responses from a sample of senior audit managers of the
big four audit firms in Nigeria, the Pearson’s Chi Square method of data
analysis was used to determine whether there is a significant association
between creative accounting practice and audit risk and whether there is a significant
association between creative accounting practice and audit failure. Also,
ex-post factor design was used to extract a time series data for 10- year
period from the Nigerian Stock Exchange Fact Book to compute two (2) sets of
ratios; Returns on equity and Long term debt to equity ratios. The provision
for depreciation and deferred tax were reclassified while computing the ratios.
The results were estimated using the Wicoxon Signed-Ranks methods of data
analysis. The study found that creative accounting practice has a positive and
significant effect on audit failure (X2C = 24.861> X2t
= 9.49; P < 0.05). Creative accounting practice has a positive and
significant impact on audit risk (X2C = 14.139 > X2t
= 9.49; P < 0.05). Provision for depreciation has a positive and significant
impact on corporate performance (ZC = 8.730 > Zt =
1.96; P < 0.05) and provision for deferred tax has a positive and
significant impact on corporate performance (ZC = 8.224 > Zt
= 1.96; P < 0.05). These imply that creative accounting affect the audit of
financial statements. The study therefore recommends that detection of creative
accounting techniques should be given more attention by external auditors.
Appropriate sufficient audit evidence should support audit opinion. Flexibility
permissible by accounting standards should be minimized and those charged with
governance should improve their oversight and monitoring roles.
CHAPTER ONE
INTRODUCTION
1.1 Background
to the Study
According to Sanusi and Izedonmi (2014), the real causes of
creative accounting lie in the conflicts of interest among different interest
groups. Managing shareholders’ interest is to pay less tax and dividends.
Investor-shareholders are interested to get more dividends and capital gains.
Country’s tax authorities would like to collect more and more taxes. Employees
are interested to get better salary and higher profit share. But creative
accounting puts one group or two to advantageous position at the expense of
others. Amat, et al (2003) therefore concluded that within the agency
framework, it is both logical and inescapable that management behavior will be
self-serving. Agency Theory can, therefore, be said to provide a solid
framework for the understanding of creative accounting behavior.
Creative Accounting has been
defined as the transformation of financial accounting figures from what they
actually are to what the management desires by taking advantage of the existing
accounting rules and standards or ignoring some or all of them (Naser, 1993).
Other notable words used to describe creative accounting include manipulative
accounting, fraudulent accounting, income smoothing, earnings management,
earnings smoothing, financial engineering, window dressing and cosmetic
accounting.
In separate studies, Mulford
and Comiskey (2002) and Van der Poll, (2004) discover that management may use
book entries as strategic tools to manipulate the financial statements and
this, in the long run, may mislead the firm’s stakeholders. When premature or
fictitious revenue is recognized, a book entry is used because no real
transaction exists. Aggressive capitalization and extended amortization
policies as well as the revaluation of assets and liabilities, are brought about
by book entries. In like manner, when items in the income statement as well as
the cash flow statement are reclassified, book entries are also used.
Porter et al. (2003) define
audit risk as the risk that the auditor expresses an inappropriate audit
opinion when the financial statements are materially misstated. Audit failure
is said to have occurred when there is a serious distortion of the financial
statements which is not reflected in the audit report, and the auditor has made
a serious error in the conduct of the audit (Arens, et al 2002). Thus, a
properly done audit does not guarantee that serious distortions have not
occurred though it makes such distortions unlikely. Thus, audit failure cannot
occur unless there is serious auditors’ error or misjudgment (Tackett et al.,
2004).
Several research studies have
examined the issue of motivations for creative accounting behaviour. According
to Balaciu and Cosmina (2008), the managers are interested in paying less tax
and dividends, the shareholders in receiving higher dividends, the employees in
obtaining better salary and higher profit share, while the government wants
higher taxes and so on. These conflicting interests are often argued to be the
motivations for creative accounting practices. Amat, et al (2003) also note
that creative accounting may help maintain or boost the share price both by
reducing the apparent levels of borrowing, so making the company appear subject
to less risk, and by creating the appearance of a good profit trend.
Informational perspective is
another key element underpinning the study of the creative accounting
phenomenon. A conflict is said to be created by the information asymmetry
(privilege to certain information) that exists in complex corporate structures
between a privileged management and a more remote body of stakeholders (Okoye
and Alao, 2008). The informational perspective assumes that accounting
disclosures have an information content that possesses value to stakeholders in
providing useful signals. The information perspective provides explanation for
management’s goal of impression management.
According to Clatworthy and
Jones (2011), in corporate reporting, impression management consists of
controlling and manipulating the impression conveyed to users of accounting
information financial reporting communication involves a number of corporate
disclosures, both mandatory and voluntary. Managers that engage in self-serving
disclosure practices may do so at several levels of firm communication through
creative accounting or earnings management as a result of privy information at
their disposal.
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Item Type: Postgraduate Material | Attribute: 106 pages | Chapters: 1-5
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