SIGNIFICANCE OF EXTERNAL AUDITOR’S ON THE EXAMINATION OF FINANCIAL STATEMENT (A STUDY OF FIRST BANK OF NIGERIA PLC)

CHAPTER ONE: INTRODUCTION

1.1 Background of the Study

External auditing is a cornerstone of modern corporate governance and financial reporting. An external auditor is an independent professional who examines the financial statements of an organization to express an opinion on whether they present a true and fair view of the organization’s financial position and performance, in accordance with applicable financial reporting standards (such as IFRS) and statutory requirements. The external audit provides assurance to stakeholders—including shareholders, investors, creditors, regulators, and the general public—that the financial statements are free from material misstatement, whether caused by fraud or error. This assurance enhances the credibility and reliability of financial information, which is essential for informed decision-making in capital markets (Hayes, Dassen, Schilder, & Wallage, 2019; Kieso, Weygandt, & Warfield, 2019).

The significance of external auditors in the examination of financial statements cannot be overstated. In the absence of external audit, financial statements would be prepared solely by management, who have an inherent conflict of interest. Management may have incentives to present financial results in a more favorable light to achieve performance targets, secure bonuses, attract investment, or conceal poor performance or fraud. External auditors act as an independent check on management’s assertions, providing an objective, third-party verification of financial information. This independent verification is the foundation of trust in financial markets. Without it, investors would demand higher returns to compensate for the risk of unreliable information, increasing the cost of capital for all firms (DeAngelo, 1981; Watts & Zimmerman, 1986).

The role of external auditors extends beyond mere verification of numbers. In conducting an audit, external auditors evaluate the design and effectiveness of internal controls over financial reporting. They assess the risk of material misstatement, test transactions and balances, verify existence and valuation of assets and liabilities, confirm balances with third parties (e.g., banks, customers, suppliers), and evaluate management’s judgments and estimates (e.g., allowances for bad debts, useful lives of assets, valuation of inventory). Through this detailed examination, external auditors identify weaknesses in internal controls, instances of non-compliance, and potential fraud. While the primary responsibility for preventing and detecting fraud rests with management, external auditors play a critical role in identifying red flags and recommending improvements (Arens, Elder, & Beasley, 2017; Louwers, Ramsay, Sinason, & Strawser, 2018).

First Bank of Nigeria Plc is a historic and iconic financial institution in Nigeria. Established in 1894 as the Bank of British West Africa, First Bank is the oldest bank in Nigeria and one of the oldest in West Africa. The bank has played a pivotal role in the economic development of Nigeria for over 125 years. Today, First Bank of Nigeria Plc is a diversified financial services group, offering commercial banking, investment banking, asset management, insurance, and other financial services. The bank is publicly traded on the Nigerian Exchange Limited (NGX) and is a constituent of the NGX 30 Index. As a systemically important bank, First Bank is subject to rigorous regulatory oversight by the Central Bank of Nigeria (CBN) and the Nigeria Deposit Insurance Corporation (NDIC) (First Bank of Nigeria Plc, 2023; Adebayo & Oyedokun, 2020).

The external audit of First Bank of Nigeria Plc is of particular significance due to the bank’s size, complexity, and systemic importance. The bank has thousands of transactions daily, a complex organizational structure (with subsidiaries in multiple countries), diverse financial instruments (loans, derivatives, investments), and significant branches across Nigeria and internationally. Auditing such a large, complex financial institution requires specialized skills in banking, including expertise in loan loss provisioning, fair value measurement of financial instruments, consolidation of subsidiaries, and regulatory compliance (e.g., CBN prudential guidelines, Basel capital adequacy requirements). The external auditor’s opinion on First Bank’s financial statements provides assurance to depositors, investors, creditors, and regulators that the bank is financially sound and that its reported financial position is reliable (CBN, 2019; Okafor & Udeh, 2021).

The statutory framework for external audit in Nigeria is derived from several sources. The Companies and Allied Matters Act (CAMA) 2020 requires every company (including banks) to appoint external auditors and to have its financial statements audited annually. The Banks and Other Financial Institutions Act (BOFIA) imposes additional audit requirements on banks, including mandatory audit committee formation and specific audit procedures. The Financial Reporting Council of Nigeria (FRCN) Act establishes standards for auditing (the Nigerian Standards on Auditing, which are based on International Standards on Auditing, ISA). The Central Bank of Nigeria also issues guidelines on the appointment, tenure, and rotation of external auditors for banks, including mandatory audit firm rotation after a specified period. These laws and regulations ensure that external auditors meet minimum quality and independence standards (FRCN, 2014; CAMA, 2020).

The external audit process for First Bank of Nigeria Plc typically follows a structured annual cycle. Planning: the auditor understands the bank’s business, assesses risks (including fraud risk), and develops an audit plan and materiality levels. Internal control evaluation: the auditor tests the design and operating effectiveness of key internal controls over financial reporting (e.g., loan origination, deposit processing, information systems). Substantive procedures: the auditor performs detailed testing of account balances and transactions, including confirmations of loans and deposits, testing of loan loss provisions, valuation of investments, and verification of interest income and expense. Regulatory compliance: the auditor tests compliance with CBN regulations, including capital adequacy, liquidity ratios, and prudential guidelines. Reporting: the auditor issues an audit opinion (unqualified, qualified, adverse, or disclaimer) and reports to the audit committee and board of directors on findings, including internal control weaknesses (Arens et al., 2017; Hayes et al., 2019).

The significance of the external auditor’s role is particularly evident in the examination of areas that involve significant management judgment and estimation uncertainty. In banking, the most critical such area is the allowance for loan losses (provision for credit losses). Banks must estimate the portion of their loan portfolio that will not be repaid, based on historical loss experience, current economic conditions, and forward-looking information. This estimate significantly affects reported earnings and capital adequacy. External auditors scrutinize management’s loan loss provision methodology, test the accuracy of loan classification, evaluate the adequacy of collateral, and challenge management’s assumptions. Without rigorous audit scrutiny, banks could under-provision (overstating profits) or over-provision (understating profits), misleading stakeholders (Okafor & Udeh, 2020; Eze & Nwafor, 2019).

Another area of significance is the valuation of financial instruments. Banks hold complex financial instruments including government securities, corporate bonds, equities, derivatives, and structured products. Many of these instruments do not have active markets, requiring management to use valuation models (Level 3 fair value measurements). External auditors evaluate the appropriateness of valuation models, test inputs and assumptions, and may engage valuation specialists to independently estimate fair values. This scrutiny is essential for preventing manipulation of reported asset values and ensuring that shareholders and regulators have an accurate picture of the bank’s financial position (Kieso et al., 2019; Louwers et al., 2018).

The external audit also plays a critical role in detecting and preventing fraud. While the primary responsibility for fraud prevention and detection rests with management and those charged with governance (board and audit committee), external auditors are required to plan and perform the audit to obtain reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes assessing fraud risk, testing journal entries and other adjustments for evidence of possible misstatement due to fraud, and evaluating management’s override of controls. In the banking industry, where opportunities for fraud are significant (e.g., unauthorized loans, fictitious deposits, embezzlement), the external auditor’s role is particularly important (Arens et al., 2017; Okafor & Udeh, 2021).

The audit committee of First Bank of Nigeria Plc is a key governance body that oversees the external audit process. The audit committee, composed primarily of independent non-executive directors, is responsible for recommending the appointment of external auditors, approving the audit fees, reviewing the audit plan, discussing audit findings with the external auditors, monitoring management’s response to audit recommendations, and assessing the independence and objectivity of the external auditors. The effectiveness of the audit committee significantly affects the value of the external audit. A strong, independent, financially literate audit committee can enhance audit quality and ensure that audit findings are acted upon (FRCN, 2014; First Bank of Nigeria Plc, 2023).

The external auditor’s independence is fundamental to the value of the audit. If the auditor is not independent (e.g., has financial or personal relationships with management, or provides non-audit services that create self-interest threats), the audit opinion loses credibility. In the banking industry, where the external auditor may also provide tax, consulting, or other services to the bank, independence risks are significant. Nigerian law and auditing standards impose requirements to safeguard auditor independence, including mandatory audit partner rotation, restrictions on non-audit services, and cooling-off periods before audit partners can join the client. For First Bank, the external auditor (a major international audit firm) must comply with these independence requirements (Hayes et al., 2019; FRCN, 2014).

The relationship between external audit quality and corporate performance has been extensively studied. Higher quality audits (conducted by large, reputable audit firms with industry expertise) are associated with lower cost of capital, higher liquidity, fewer financial restatements, lower likelihood of fraud, and better access to financing. For banks, audit quality is particularly important because depositors and creditors rely on audited financial statements to assess the bank’s safety and soundness. A clean audit opinion from a reputable auditor signals that the bank is well-managed and financially healthy, attracting deposits and lowering funding costs. Conversely, a qualified or adverse opinion can trigger deposit withdrawals, regulatory intervention, and even bank failure (DeAngelo, 1981; Watts & Zimmerman, 1986).

The Nigerian banking sector has experienced significant challenges, including banking crises in the 1990s and 2000s (e.g., the 2009 banking crisis that led to the recapitalization of several banks). These crises highlighted the importance of high-quality external audits. In some cases, auditors failed to detect or report significant problems, leading to questions about audit quality and auditor independence. Since then, regulatory reforms have strengthened audit requirements, including mandatory audit firm rotation and enhanced auditor reporting to regulators. The experience of First Bank, which was not among the banks that required bailout in 2009, may reflect the value of sustained high-quality external audit (CBN, 2019; Okafor & Udeh, 2020).

The adoption of International Financial Reporting Standards (IFRS) in Nigeria (effective 2012) has increased the complexity of external audits. IFRS requires more extensive use of fair values, more detailed disclosures, and more judgment than the previous Nigerian GAAP. Auditing fair value measurements, impairment testing, and complex financial instruments requires specialized expertise. For First Bank, the transition to IFRS was significant, and external auditors have had to develop or acquire the necessary expertise to audit IFRS-based financial statements. The quality of IFRS audits directly affects the reliability of financial information for investors and regulators (FRCN, 2014; Adebayo & Oyedokun, 2020).

Finally, this study focuses on First Bank of Nigeria Plc as a case study because the bank represents a large, complex, systemically important financial institution where the significance of external auditors is most evident. By examining the external audit process at First Bank, the study can provide insights into the value of external auditing in the Nigerian banking sector. The findings will be relevant to regulators, investors, bank management, audit committees, external auditors themselves, and other stakeholders who rely on the credibility of audited financial statements. In an era of increasing regulatory scrutiny and public demand for accountability, understanding the significance of external auditors is more important than ever (First Bank of Nigeria Plc, 2023; Eze & Nwafor, 2019).

1.2 Statement of the Problem

External auditors play a critical role in examining the financial statements of banks and other public interest entities. However, despite the legal requirement for annual external audits, the actual significance of external auditors in ensuring the reliability and credibility of financial statements is sometimes questioned. Stakeholders may not fully appreciate the value that external auditors add, or may have unrealistic expectations about what an audit can achieve. At First Bank of Nigeria Plc, a large, complex banking institution, the external audit is a significant undertaking involving substantial time, expertise, and cost. Yet, it is unclear to what extent the external auditor’s work actually enhances the reliability of the bank’s financial statements, influences user decisions, detects material misstatements, and contributes to improved internal controls. There may be gaps between the expected role of external auditors (as defined by auditing standards and regulations) and the perceived significance of their work by stakeholders. Additionally, challenges such as auditor independence threats, audit quality issues, time pressure, and difficulty auditing complex areas (loan loss provisions, fair value measurements) may reduce the significance of the external auditor’s contribution. Therefore, this study is motivated to investigate the significance of external auditors on the examination of financial statements at First Bank of Nigeria Plc, assess how various stakeholders perceive this significance, and identify factors that enhance or diminish the external auditor’s contribution.

1.3 Aim of the Study

The aim of this study is to examine the significance of external auditors on the examination of financial statements, using First Bank of Nigeria Plc as a case study.

1.4 Objectives of the Study

The specific objectives of this study are to:

1. Examine the role of external auditors in the examination of financial statements at First Bank of Nigeria Plc.
2. Assess the contribution of external audit to the reliability and credibility of First Bank’s financial statements.
3. Determine the impact of external audit findings on management decision-making and internal control improvements at the bank.
4. Evaluate the significance of the external auditor’s opinion to stakeholders (investors, creditors, regulators) of First Bank.
5. Identify the challenges facing external auditors in examining the financial statements of First Bank and propose recommendations for enhancing audit significance.

1.5 Research Questions

The following research questions guide this study:

1. What is the role of external auditors in the examination of financial statements at First Bank of Nigeria Plc?
2. How does external audit contribute to the reliability and credibility of First Bank’s financial statements?
3. What impact do external audit findings have on management decision-making and internal control improvements at the bank?
4. How significant is the external auditor’s opinion to stakeholders (investors, creditors, regulators) of First Bank?
5. What are the major challenges facing external auditors in examining First Bank’s financial statements, and how can they be addressed?

1.6 Research Hypotheses

The following hypotheses are formulated in null (H₀) and alternative (H₁) forms:

Hypothesis One

• H₀: External auditors have no significant role in enhancing the reliability of financial statements at First Bank of Nigeria Plc.
• H₁: External auditors have a significant role in enhancing the reliability of financial statements at First Bank of Nigeria Plc.

Hypothesis Two

• H₀: There is no significant relationship between the external audit opinion and stakeholder (investor, creditor, regulator) confidence in First Bank’s financial statements.
• H₁: There is a significant relationship between the external audit opinion and stakeholder (investor, creditor, regulator) confidence in First Bank’s financial statements.

Hypothesis Three

• H₀: External audit findings have no significant impact on management decision-making and internal control improvements at First Bank.
• H₁: External audit findings have a significant impact on management decision-making and internal control improvements at First Bank.

Hypothesis Four

• H₀: Challenges such as auditor independence threats, time pressure, and audit complexity do not significantly affect the significance of external audit at First Bank.
• H₁: Challenges such as auditor independence threats, time pressure, and audit complexity significantly affect the significance of external audit at First Bank.

1.7 Significance of the Study

This study is significant for several stakeholders. First, the management, board, and audit committee of First Bank of Nigeria Plc will benefit from a systematic assessment of the significance of external audit, enabling them to strengthen the audit process, address challenges, and maximize the value derived from the external audit. Second, external auditors (the audit firm engaged by First Bank) will gain insights into stakeholder perceptions and expectations, informing audit planning, execution, and communication. Third, the Central Bank of Nigeria (CBN) and the Financial Reporting Council of Nigeria (FRCN) will benefit from evidence on the effectiveness of current audit regulations in the banking sector, informing future policy reforms. Fourth, the Nigerian Exchange Limited (NGX) and the Securities and Exchange Commission (SEC) will gain insights into the role of external audit in protecting investors, supporting listing and disclosure requirements. Fifth, investors (both current and potential) and creditors of First Bank will better understand the significance and limitations of the external audit, supporting informed investment and lending decisions. Sixth, other banks and financial institutions in Nigeria can use the findings as a benchmark for evaluating and improving their own external audit processes. Seventh, academics and researchers in auditing, corporate governance, and financial reporting will find value in the study’s contribution to the literature on audit significance in the Nigerian banking context. Eighth, professional accounting and auditing bodies such as the Institute of Chartered Accountants of Nigeria (ICAN) and the Association of National Accountants of Nigeria (ANAN) will gain insights into the challenges and expectations facing external auditors, informing training and CPD programs. Ninth, auditing students will find the study useful as a practical case study illustrating the role and significance of external audit in a large, complex organization. Finally, the broader Nigerian public and depositors will benefit indirectly as improved understanding of external audit significance leads to stronger audit practices, more reliable financial statements, and increased confidence in the banking system.

1.8 Scope of the Study

This study focuses on the significance of external auditors on the examination of financial statements, using First Bank of Nigeria Plc as a case study. Geographically, the research is limited to First Bank of Nigeria Plc’s operations in Nigeria, with primary focus on its corporate headquarters and key financial reporting functions in Lagos. The bank is a publicly traded, systemically important commercial bank with over 125 years of history. Content-wise, the study examines the following areas: the role of external auditors in the audit process (planning, risk assessment, testing, reporting); contribution to reliability and credibility of financial statements; detection of material misstatements (errors and fraud); evaluation of internal controls over financial reporting; impact of audit findings on management action; stakeholder perceptions of audit significance; and challenges facing external auditors (independence, time pressure, complexity, regulatory compliance). The study targets management (including the Chief Financial Officer, Head of Financial Reporting, and internal audit staff), audit committee members, external auditors (engagement partner, audit managers, and senior auditors), and external stakeholders (investors, financial analysts, regulators from CBN and FRCN). The time frame for data collection is the cross-sectional period of 2023–2024, though historical audit findings and financial statements (e.g., 5-10 years) will be analyzed. The study does not cover other banks in Nigeria (except for comparative context), nor does it cover internal audit (except as it relates to external audit), nor non-audit services provided by the external audit firm.

1.9 Definition of Terms

External Auditor: An independent professional, qualified and licensed, appointed by a company’s shareholders to examine the company’s financial statements and express an opinion on whether they present a true and fair view in accordance with applicable financial reporting standards.

Financial Statements: The formal records of a company’s financial activities, including the statement of financial position (balance sheet), statement of comprehensive income (profit and loss account), statement of changes in equity, statement of cash flows, and accompanying notes.

Audit Opinion: The conclusion expressed by the external auditor after completing the audit, which can be unqualified (clean), qualified (except for), adverse (material misstatements), or disclaimer (unable to obtain sufficient evidence).

Material Misstatement: An error or omission in the financial statements that could influence the economic decisions of users. Misstatements can arise from fraud or error.

Internal Controls: The policies, procedures, and mechanisms implemented by management to ensure reliable financial reporting, compliance with laws and regulations, and safeguarding of assets.

Audit Evidence: Information used by the auditor to support the audit opinion, including source documents, confirmations, observations, inquiries, and analytical procedures.

Audit Risk: The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk comprises inherent risk, control risk, and detection risk.

Audit Committee: A committee of the board of directors (typically composed of independent non-executive directors) responsible for overseeing the financial reporting process, internal controls, and the external and internal audit functions.

Auditor Independence: The ability of the external auditor to perform the audit without bias, conflict of interest, or undue influence from management or other parties. Independence is both in fact (actual) and in appearance (perceived).

True and Fair View: The standard of financial reporting that requires financial statements to present a complete, accurate, and unbiased picture of the company’s financial position and performance.

International Standards on Auditing (ISA): Auditing standards issued by the International Auditing and Assurance Standards Board (IAASB), adopted as Nigerian Standards on Auditing (NSA) by the Financial Reporting Council of Nigeria.

Materiality: The magnitude of an omission or misstatement that could influence the economic decisions of users. Auditors set materiality levels to guide the scope and evaluation of audit procedures.

Substantive Procedures: Audit procedures designed to detect material misstatements at the assertion level, including tests of details of transactions and balances, and analytical procedures.

Internal Control over Financial Reporting (ICFR): Controls specifically designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with accounting standards.

First Bank of Nigeria Plc: The oldest bank in Nigeria, established in 1894, a publicly traded commercial bank and financial services group, serving as the case study for this research.

Systemically Important Bank: A bank whose failure would cause significant disruption to the financial system and the broader economy, subject to enhanced regulatory oversight.

Loan Loss Provision (Allowance for Credit Losses): An estimate of the portion of a bank’s loan portfolio that is expected not to be repaid, requiring significant management judgment and auditor scrutiny.

CHAPTER TWO: LITERATURE REVIEW

2.1 Conceptual Framework

A conceptual framework is a structural representation of the key concepts or variables in a study and the hypothesized relationships among them. It serves as the analytical lens through which the researcher organizes the study, selects appropriate methodology, and interprets findings. In this study, the conceptual framework is built around two primary constructs: External Audit (the independent variable) and Significance of External Audit (the dependent variable). Additionally, the framework identifies the specific dimensions of each construct and the mediating and moderating variables that influence the significance of external audit (Miles, Huberman, & Saldaña, 2020).

The independent variable, External Audit, refers to the independent examination of an entity’s financial statements by an appointed external auditor. For the purpose of this study, external audit is conceptualized along six key dimensions: (a) audit planning and risk assessment (understanding the entity, assessing risks of material misstatement, setting materiality), (b) internal control evaluation (testing the design and operating effectiveness of internal controls over financial reporting), (c) substantive testing (detailed testing of account balances, transactions, and disclosures), (d) audit evidence gathering (collection of sufficient, appropriate evidence through inspection, observation, confirmation, recalculation, and analytical procedures), (e) professional judgment and skepticism (critical assessment of management’s assumptions, estimates, and representations), and (f) audit reporting (formation and communication of the audit opinion, including qualified, unqualified, adverse, or disclaimer opinions). Each dimension contributes differently to the overall significance of the external audit (Hayes, Dassen, Schilder, & Wallage, 2019; Arens, Elder, & Beasley, 2017).

The dependent variable, Significance of External Audit, refers to the value, importance, and impact of the external audit on the examination of financial statements and on stakeholders. For the purpose of this study, the significance of external audit is conceptualized along five key dimensions: (a) enhancement of financial statement reliability (the degree to which the audit increases confidence that the financial statements are free from material misstatement), (b) detection of material misstatements (the identification of errors, omissions, or fraud that would otherwise go undetected), (c) improvement of internal controls (the identification of control weaknesses and recommendations for improvement), (d) influence on stakeholder decisions (the effect of the audit opinion on investor, creditor, and regulator behavior), and (e) deterrence of fraud and misconduct (the preventive effect of the audit on management malfeasance). Each dimension captures a different aspect of audit significance and may be perceived differently by different stakeholders (DeAngelo, 1981; Watts & Zimmerman, 1986).

The conceptual framework posits a positive relationship between the quality and thoroughness of the external audit process and the significance of the external audit. Specifically, when the external audit is planned and executed with high quality—professional competence, independence, due care, and appropriate skepticism—the resulting audit is more likely to detect material misstatements, enhance financial statement reliability, improve internal controls, influence stakeholder decisions, and deter fraud. Conversely, when the external audit is of low quality (e.g., inadequate planning, insufficient testing, lack of skepticism), the significance is diminished, and stakeholders may not derive the expected benefits from the audit (Louwers, Ramsay, Sinason, & Strawser, 2018; Knechel, Krishnan, Pevzner, Shefchik, & Velury, 2013).

An important feature of this conceptual framework is the recognition of mediating mechanisms through which external audit achieves significance. The framework identifies four primary mediating mechanisms: (a) independent verification (auditors provide an objective, third-party check on management’s assertions, reducing information asymmetry), (b) expert assessment (auditors apply professional expertise to evaluate complex accounting and reporting issues), (c) risk reduction (audit procedures reduce the risk of undetected material misstatements), and (d) accountability enhancement (the audit creates a “paper trail” and accountability that encourages management to maintain good records and controls). Each mechanism operates through different channels and may be more or less important depending on the audit context (Kieso, Weygandt, & Warfield, 2019; Okafor & Udeh, 2020).

The framework also identifies several moderating variables that influence the strength of the relationship between external audit and its significance. These include: (a) auditor independence (the degree to which the auditor is free from conflicts of interest and management influence), (b) auditor competence and expertise (the technical knowledge, industry experience, and professional qualifications of the audit team), (c) audit firm reputation and resources (the size, reputation, and resources of the audit firm, which affect audit quality), (d) regulatory environment (the strength of audit regulation, enforcement, and oversight), (e) client characteristics (the size, complexity, and risk profile of the audited entity), (f) audit committee effectiveness (the independence, expertise, and diligence of the audit committee in overseeing the audit), (g) corporate governance quality (the overall governance environment, including board independence and management integrity), and (h) time and budget pressures (the constraints under which auditors operate, which may affect audit quality). For First Bank of Nigeria Plc, the specific values of these moderating variables will determine the actual significance of the external audit (Adebayo & Oyedokun, 2020; Eze & Nwafor, 2019).

The framework also distinguishes between the ex ante significance (expected value of the audit before it is performed) and ex post significance (actual value derived from the audit after completion). Ex ante significance influences stakeholder reliance on the audit before they see the audit opinion. Ex post significance is determined by whether the audit actually detected material misstatements, improved controls, and provided reliable information. For First Bank, both ex ante and ex post significance are important. The bank’s stakeholders (investors, depositors, regulators) rely on the expectation that the external audit will be significant (ex ante).