THE ROLE OF INTERNAL AUDIT ON MANAGEMENT CONTROL SUCCESS
CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
The last decade has witnessed several accounting scandals and corporate failures that were blamed on earnings management practices of firms globally, which audit function was not able to detect. Earnings management involves managers‟ manipulation of the external reporting process and structuring transactions to alter financial reports to either mislead some shareholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers (Healy & Wahlen, 1999). As a result of this practice, which went undetected or unreported by external auditors, the United States alone recorded ten largest bankruptcies in 2002, including the two largest in world history, namely World Comand Enron (Albrecht, Albrecht & Albrecht, 2004). In Nigeria, Cadbury Nig. Plc and African Petroleum are exemplar cases. The increasing incidence of corporate scandals or failures associated with earnings management has led to loss of public confidence in the quality of reported accounting earnings and the audit function generally. Accordingly, earnings management has become a matter of great concern to regulators, practitioners as well as accounting researchers (Okolie, 2014) due to the perverse consequences it has on corporate survival.
Hlioui and Zehri (2012), Cohen and Zarowin (2010), Zang (2007) and Roychowdhury (2006) explain that managers exercise their discretion not only via choice of accounting estimates and methods (accrual-based earnings management) but also through operational decisions (real activities manipulation). Real activities manipulation is an alternative tool of earnings management through changing operating activities and decisions (opportunistic reduction of discretionary expenses, overproduction, and offering price discounts to boost current-period sales). Separately, Graham, Harvey and Rajgopal (2005) suggested that given the stigma associated with accrual management, earnings manipulations are now more likely to be achieved through real economic actions because accrual-based earnings management is more likely to draw auditor or regulatory scrutiny than real decisions such as those related to product pricing, production, and expenditures on research and development or advertising. It is argued that if shareholders have perfect information about managers‟ actions, there would be no information asymmetry between the two parties. Information asymmetry exists when perfect information is absent,which is the assumption.
