CHAPTER ONE

INTRODUCTION

1.1       BACKGROUND TO THE STUDY

In recent times, the business organization faces many financial scandals and crises. All this scandals focuses in the role played by risk based internal audit to protect investor and fulfill their goals. Many laws and rules were established. One of the mechanisms that keeps the interest of many authors is risk based internal audit and more specifically the quality of financial reports in business organizations.Recent studies have examined the impact of internal audit on the transparency and quality of financial reporting. However, few studies have investigated the relationship between risk based internal audit and financial reporting quality (Al-Shetwi et al, 2011).

Abdel-Khalik et al. (1983) found in their study that the risk based internal audit function supports the financial statement audit performed by external audit. This implies improving audit quality and therefore the quality of financial reporting. Schneider and Wilner (1990) estimate that the risk based internal audit functions detect irregularities. Thus, the study of Gordon and Smith (1992) concluded that the risk based internal audit function plays a key role in improving the control environment. It avoids irregularities in the financial statements, which involves improving the quality of financial reporting.

Moreover, increased concerns regarding corporate accountability in various organizations have been associated with the need for appropriate Risk Based Internal Audit which involves risk management and internal control systems (Beekes and Brown, 2006). This has been reflected through recent voluntary corporate governance guidelines. The subjectivity of this area has given rise to different levels of emphasis on risk management and internal control and is, correspondingly, reflected in the governance guidelines of business organization (Basel Committee on Banking Supervision, 2006). While these voluntary guidelines that have originated in each organization may provide different levels of focus on Risk based Internal Audit and governance, it is uncertain as to what extent these different levels of focus exert an influence, either direct or indirect, on an organization's risk management and internal control practices (Sarens and De Beelde, 2006).

Risk-based internal auditing is a new approach to the practice whose aim is to improve the quality andeffectiveness of audits, since determining the appropriate nature, timing, and extent of substantive testing allowsfor higher quality audits at shorter time. Substantive testing is limited where there is internal control reliance andextensive where there is no internal control reliance (Forsati, 2002).Risk-based internal auditing is the process of identifying and reporting the risk of significant distortions in financialstatements. This approach not only increases the value of the product (financial statements), but also makesauditing more profitable. In other words, risk-based internal auditing satisfies both the managers and the auditors (Smith,2006; Harrington, 2004). In this approach, the auditor first examines the accounting and internal control systems(through written narratives, questionnaires, and flowcharts, and by performing a walk-through test), and thenestimates inherent and control risks. Initial estimates of inherent and control risks help the auditor in determiningthe reliability of the internal control system. If the internal control system is effective, the auditor performs the testsof control. The results can adjust and finalize the initial estimates of inherent and control risks(Moradi&Pourhosseini, 2009).

Risk based internal audit allows auditors to control risk at an acceptable level, thus achieving a high level ofreliability while reducing time and cost of auditing.

For organizations to gain competitive advantage firms in developing countries like Nigeria require to improve risk based internal audit to promote governance and accountability for the purposes of attracting capital gain, sustainability and curb vice such as corruption. Arisk based internal audit function could be viewed as a “first line defense” against inadequate corporate governance and financial reporting.

With respect to deposit money banks, the quality of financial reporting is to promote transparency anddeliver high quality annual report through comprehensive disclosure (Hassan, 2013). Financialinformation influences investors’ behaviour with respect to portfolio selection which in turnaffects security prices, and therefore, the terms on which a firm obtains additional financing.

1.2       STATEMENT OF THE PROBLEM

Recent rates of organizational collapses and financial scandals have provoked worldwide concern with risk based internal audit highlighted apparent failures of accountability and subsequent new laws, regulations in response to them to provide compelling evidence that risk based internal audit will enhance the quality of financial report.Risk Based Internal Auditing could improve the precision of financial statement information by issuing qualified opinions to firms with unreliable financial statements; auditors enable investors to screen out such firms. Uncertainty regarding the association between the focus of voluntary corporate governance guidelines and risk management and internal control activities in practice has created a research gap in this area.

The financial crisis experienced today in Nigeria to a large extent attributable to excessive risk-taking by deposit money banks. Given that risk based internal audit is essentially a mechanism for addressing agency problems and controlling risk within the firm, it is not surprising that the recent steps by banking supervisors, central banks, and other authorities have emphasized the importance of effective risk based internal auditing practices in the banking sector. Thus, it is now widely acknowledged that shortcomings in the bank risk based internal audit may have had a central role in the development of low quality financial report. This study is however aimed at examining the impact of risk based internal audit on the quality of financial report in deposit money banks in Nigeria.

1.3       OBJECTIVES OF THE STUDY

The general objective of this study is to analyze the impact of risk based internal audit on the quality of financial report in deposit money banks in Nigeria while the following are the specific objectives:

1. To examine the impact of risk based internal audit on the quality of financial report in deposit money banks in Nigeria.
2. To identify the risk based internal audit system adopted by deposit money banks in Nigeria.
3. To examine the impact of risk based internal audit on the quality of financial performance in deposit money banks in Nigeria

1.4       RESEARCH QUESTIONS

1. What is the impact of risk based internal audit on the quality of financial report in deposit money banks in Nigeria?
2. What are the risks based internal audit system adopted by deposit money banks in Nigeria?
3. What is the impact of risk based internal audit on the quality of financial performance in deposit money banks in Nigeria?

1. HYPOTHESIS

HO1: there is no significant relationship between risks based internal audit and the quality of financial report in deposit money banks in Nigeria.

HO2: There is no significant differences between the risks based internal audit system adopted by deposit money banks in Nigeria.

HO3: There is no significant relationship between risk based internal audit and the quality of financial performance in deposit money banks in Nigeria

1.6       SIGNIFICANCE OF THE STUDY

This study is significant in that it will enable management of banks in Nigeria appreciate the importance of risk based internal audit practices and assist them in rating their level of compliance against those of their competitors or the entire market, and in determining whether risk based audit practices improve banks financial report .

The study will help shareholders know the various mechanisms through which they can exercise their control. Potential investors will also benefit as they will be able to determine banks that are properly governed in making their investment decisions to improve deposit money banks.

It will also guide the government in the developing policy papers, policy making regarding risk based internal audit and its effects on financial report of deposit money banks. The policy maker will know how well to incorporate the sector effectively to ensure its full participation.

The academicians who will be furnished with relevant information regarding the relationship between risk based internal audit and financial reporting in the deposit money banks. The study will contribute to the general body of knowledge and form a basis for further research.

1.7       SCOPE/LIMITATIONS OF THE STUDY

This study will cover the relationship between risks based internal audit and the quality of financial report in 10 deposit money banks in Nigeria over a period of 10 years.

REFERENCES

Abdel-Khalik, A.R., Snowball, D. etWragge, J.H. (1983), "The Effects of Certain Internal Audit Variables on the Planning of External Audit Programs", The Accounting Review, Vol. 58, No. 2 (Apr., 1983), pp. 215-227

Al-Shetwi M., Ramadili S.M., TaufiqChowdury H.S. and SoriZ.M."Impact of internal audit function (IAF) on financial reporting quality (FRQ): Evidence from Saudi Arabia", (2011) African Journal of Business Management Vol.5 (27), pp. 11189-11198

Basel Committee on Banking Supervision (2006), Core Principles for Effective Hank Supervision, Bank for International Settlements. Basel.

Beekes, W., and Brown, P. (2006). Do better governed Australian firms make more informative disclosures, Journal of Business Finance & Account ing.Vol.33 No.3-4, pp.422-50.

Fogarty, T, Zucca, L, Meonske, N. and Kirch, D (1997), "Proactive practice review: a criticalcase study of accounting regulation that never was", Critical Perspectives on Accounting, Vol. 8 pp. 167-87.

Forsati V. 2002.The Shortcomings of System-Based Auditing and Its Replacement with Risk-Based Auditing in Iran.Ma thesis, TarbiatModarres University, Tehran.

Gordon LA, Smith KJ (1992). Postauditing capital expenditures and firm performance. Account Org Society., November, pp. 741-757.

Moradi M, Pourhosseini M. 2009. The Relationship between Certain Financial and Non-Financial Factors and Audit Operations in the FirmsListed in Tehran Stock Exchange. Iranian Journal of Accounting Research. 1: 168-185.

Sarens, G. and de Beelde, I. (2006), Internal auditors' perception about their role in Corporate Governance: a comparison between US and Belgian companies. Managerial Auditing Journal, Vol. 21 No.I, pp.63-8.

Schneider A and Wilner N (1990). A test of audit deterrent to financial reporting irregularities using the randomized response technique.Account. Rev., 65(3): 668-681.