CORPORATE GOVERNANCE MECHANISMS AND EARNINGS QUALITY OF LISTED MANUFACTURING COMPANIES IN NIGERIA

 

 CORPORATE GOVERNANCE MECHANISMS AND EARNINGS QUALITY OF LISTED MANUFACTURING COMPANIES IN NIGERIA

ABSTRACT

Corporate governance mechanisms are essential for establishing an attractive investment climate and an efficient capital market, but the accounting ethics of managers tend have tremendous affect on the quality of earnings and thus the investment climate is distorted. These motivated the researcher to investigate the relationship between some sets of corporate governance (CG) mechanisms and earnings quality (EQ) of listed manufacturing companies in Nigeria. Four null hypotheses were formulated in line with the objectives of the study to test the variables. Correlation research design and multiple regression were adopted as research design and technique of data analysis. The results indicate that the corporate governance proxies have a significant impact on earnings quality of Nigerian Manufacturing companies. This establishes the fact that corporate governance plays a significant role in checkmating the unethical behaviours of managers in the Nigerian manufacturing sector and thus improving the earnings quality. The study therefore, recommends that the proportion of independent directors’ on the board should be increased. More institutional shareholders should be allowed to invest, and audit committee members should comprise of persons with high integrity and experience to ensure effective monitoring. Also, the quantum of shares held by managers should be minimized to reduce unethical practice.

 

CHAPTER ONE

INTRODUCTION

1.1     Background to the Study

The financial scandals that sunk the once „high profile‟ companies such as Enron, Worldcom and Xerox in the United States, Parmalat in Italy and many other big companies around the world confirmed that there was an opaqueness in financial reporting that had hitherto not been penetrated. Corporate Governance (CG) was then introduced to facilitate and stimulate the performance of firms by creating and maintaining the incentives to motivate insiders to maximize the firm‟s performance and serve as control mechanism. The CG limits insiders‟ abuse of power over corporate resources and provides the means to monitor behaviour of managers for accountability and giving protection to investors (Ahmed, 2006). However, it becomes glaring that the existing Corporate Governance mechanisms are inefficient as they fail to protect the owners‟ interest. Consequently, the Sarbanese-Oxley Act was introduced in 2002 in the U.S. with a view to improving Corporate Governance practices. Many other countries, both developed and developing, followed suit. The Nigerian Stock Exchange (NSE) was not left out in the struggle for a better CG. However, despite the various measures adopted by Security and Exchange Commission (SEC) to foster efficient Corporate Governance structure and restore investors‟ confidence, there are still cases of manipulation or abusive accounting which is unethical by managers (Shehu, 2012).

 

Accounting information is relevant to the extent that it is capable of influencing a decision maker by helping him to form predictions about the outcomes of past, present, and future events or to confirm or correct prior expectations (Bushman, Cheng, Engel and Smith, 2004). In order for information to be relevant, it must be timely, and it must have predictive value or feedback value or both (Ahmad, 2006). Financial statements should always provide reliable information to assist users in decision making. The statements should disclose relevant, reliable, comparable and understandable information (Kamaruzaman, 2009). Reliability has to do with the quality of information which assures that information is reasonably free from error and bias and faithfully represents what it intend to represent. Financial statement of firms can never be completely free from bias, since economic phenomena presented in annual reports are frequently measured under conditions of uncertainty because many estimates and assumptions are included in the report (Shehu, 2011). Although complete lack of bias cannot be achieved, a certain level of accuracy is necessary for financial report to be decision useful (IASB, 2008). Therefore, it is important to examine the arguments provided for the different estimates and assumptions made in the annual report, if valid arguments are provided for the assumptions and estimates made, they are likely to represent the economic phenomena without bias (Jonas and Blanchet, 2000).

 

The need for a good Corporate Governance structure arose because of the seperation of ownerhip between a firm and its owners, which turns the firm into a nexus of relationship between it and all its stakeholders such as managers, employees, shareholders, creditors, government and all its stakeholders. The seperation of ownership and control by the sophistication of the modern day business redefines the relationship that exists between the owners and the managers to that of an agent and a principal. Being the agent, the manager is expected not to pursue goals that are geared towards the achievement of his own interest at the expense of shareholders‟ wealth maximization. The existence of conflict of interest between managers and owners naturally compromises the value of the firm and only transparency can eliminate the conflict. For a company to be transparent, it should be able to disclose financial information properly, that is, providing a full and frank account of a company’s activities (Thompson and Yeung, 2002). This is due to the fact that corporate transparency is the widespread availability of relevant and reliable information about the periodic performance, financial position, investment opportunities, governance, value and risk of publicly traded firm (Bushman and Smith, 2001).

 

Furthermore, it has long been recognized that financial statements play an important role in assessing managers‟ performance by the board of directors, outside investors and external regulators. It is therefore, not unlikely that managers will manipulate financial reports in order to produce a good image of themselves and the firms that they manage through unethical accounting by managing earnings. Earning management is the manipulation of earnings by firms using financial statement elements that are largely at the discretion of the managers to achieve personal or firms goals. These elements are peculiar to industries depending on their nature of operations and external regulatory framework. Researchers such as Klien (2002) have identified that accruals arising from depreciation are used to manipulate earnings in manufacturing firms. The use of discretion by firm managers to influence reported earnings has long being recognized by accountants and financial economists (Amat, Gothorpe and Perramon 2005, Ahmed 2006). Similarly, torrent of literature exists on the impact of corporate governance on firm performance using one or more of the governance variables of audit committee, board composition, ownership concentration and institutional shareholding (Sanda, Mikailu & Garba 2005: Belkhir 2009). Similarly, several studies conclude that good governance mechanisms can impact on the discretionery behaviour of managers (Warfield, Wild & Wild 1995, Klein 2002, Ahmed 2006 and Shehu, 2011). Specifically, this study concentrates on Corporate Governance mechanisms of board composition, institutional shareholdings, audit committee and managerial ownership in relation to Earnings Quality. The study is motivated by several factors such as the attributes of the manufacturing sector being a sector that occupies a crucial position of every economy yet little or no attention is given by researchers in ensuring its growth. Even though the banking industry is said to acts as an engine of any economy, and it dominates the Nigerian financial sector (Augusto, 2004), the manufacturing industry also plays a very significant role in providing labor to the grassroots. Added to these is that the issues of CG has long been accepted by most countries including Nigeria to be one of the easiest ways of combating financial irregularities, agency problems, and improving an attractive investment climate. However this is not always the case, and this is what the study intends to find.

 

1.2     Statement of the problem

Limited access to managerial information causes the providers of finance such as shareholders and debt holders to heavily rely on the financial statement of firms. As financial reporting provides value-relevant information to the external parties of the organization, the heavy reliance placed on accounting numbers create powerful incentives for managers to manipulate earnings to their own advantage (Rahman & Ali, 2006). Hence, it is important for financial accounts to provide the truthfulness and accuracy of financial information to enable the shareholders to make decisions wisely. The lack of accuracy in the financial results will lead to the shareholders and other users making wrong judgments and decisions.

 

Managers manage earnings to gain investors‟ confidence by encouraging and convincing stakeholders to invest, however, there are inherent activism that are unethical and fraudulent. The central concern of board composition (which is the extent to which outside directors are represented on the board) with earnings quality is that independent outside directors are expected to protect shareholders specific interest when there is no agency problem. However, this depends on who is on the board, and thus the composition of board members may significantly affect the quality of financial information. It is still not very clear whether the independent directors of Nigerian Manufacturing companies protect the interest of shareholders by preventing earnings management and thus earning quality is increased, does the independent directors of listed my companies in Nigeria protect the interest of stake holders by increasing earning quality? While for the institutional Shareholdings it is expected that the more the institutional investors‟ participate the more the minority shareholder‟s interest is protected. The significant increase in the institutional investors‟ shareholdings led to the formation of a large and powerful constituency to play a significant role in corporate governance. The question that still, remains is to what extent does an institutional shareholder checkmate the accounting ethics by managers, thus improving earning quality? The Audit Committee and Earnings Quality problem may be from the fact that the function of the audit committee is to monitor a firm‟s financial performance and financial reporting; the audit committee may have a more direct role in improving earnings quality. The presence of well enlightened audit committee may deter unethical intentions by managers thus; it is expected that the quality of earnings will be improved. However, the question that still remains is, to what extent audit committee play a role in improving Earning Quality.

The Corporate Governance Culture in Nigeria failed to be Responsible to the Stakeholders, Accountable to the Shareholders and has no deep-rooted mechanism to maintain a balance among the major players (board of directors, shareholders, and management) in corporate governance which have resulted in poor financial reporting quality (Shehu, 2011). The challenges and failure of corporate governance in Nigeria stems from the culture of corruption and lack of institutional capacity to implement the codes of conduct governing corporate governance. Company executives enjoy an atmosphere of lack of checks and balances in the system to engage in gross misconducts since investors are not included in the governing structure. How strictly the listed manufacturing firms comply with the provisions of corporate governance code? Studies such as (Mark 1996, Bello 2002, Klien 2002, Adams and Mehran 2003, Schipper and Vincent 2003, Park and Shinn 2004, Borgia 2005, Sanda et al 2005, Fodio 2006, Rahman and Ali 2006, Ahmad 2006, Devi and Hashim 2010), concentrated on either the banking sector or some sectors of manufacturing companies. In addition, most of the studies used Ordinary Least Square (OLS) without considering the robustness of the techniques, while this study conducted a robustness test to ensure the validity of the statistical inference derivable from the results. However, this study is said to fill the obvious methodological gap discovered by the previous studies specifically the robustness tool of analysis. The study therefore examines the influence of Corporate Governance mechanisms on the quality of financial reports of quoted manufacturing firms in Nigeria.

 

1.3     Objectives of the study

The main objective of the study is to examine the effect of Corporate Governance on Earnings Quality of listed Manufacturing companies in Nigeria. The specific objectives include:

i.                   To determine the effect of Board Composition on the Earnings Quality of listed manufacturing Companies in Nigeria.

ii.                 To determines the effect of Institutional Ownership on the Earnings Quality of listed manufacturing Companies in Nigeria.

iii.              To determine the effect of Audit Committee on the Earnings Quality of listed manufacturing Companies in Nigeria.

iv.              To determine the effect of Managerial Ownership on the Earnings quality of listed manufacturing Companies in Nigeria.

 

1.4     Hypotheses of the study

In line with the studies objectives, the following hypotheses were formulated in a null form. Ho1: Board Composition has no significant effect on Earnings Quality of listed manufacturing firms in Nigeria. Ho2: Institutional Shareholdings has no significant effect on Earnings Quality of listed manufacturing firms in Nigeria. Ho3: Audit Committee has no significant effect on Earnings Quality of listed manufacturing firms in Nigeria. Ho4: Managerial Ownership has no significant effect on Earnings Quality of listed manufacturing firms in Nigeria.

1.5     Scope of the study

The scope of the study is limited to the listed Manufacturing companies in Nigeria. There are 59 Manufacturing Industries in Nigeria which are divided into four strata, that is, Food and Beverages, Building Materials, Chemicals & Paints and Conglomerates. It covers period of 6 years (2006 – 2011). And the selection of the period is informed by the commencement of compliance investigation by SEC on the code of CG. The study focuses on only four of the CG mechanisms; that is Board Composition (BC), Institutional Ownership (IO), Audit Committee (AC) and Managerial ownership (MO) which stands for the independent variable and the accounting ethics which is measured as Earnings Quality (EQ) as the dependent variable.

1.6     Significance of the study

The findings of this study can have implications for users of financial statements such as shareholders, potential investors, policy makers, the regulatory bodies and also students. The study is expected to practically contribute in strengthening the areas of concern by practitioners such as external auditors and financial consultants in manning the financial records of Nigerian Listed Manufacturing Companies (NLMC) relating to the role of CG practice. Again, the Board of directors and regulatory agencies of NLMC in discharging their duties of policy making and regulating respectively. And also to consider the prominent roles or activities that CG mechanisms play in checkmating and preventing as well as minimizing the possible opportunistic accounting by managers in preparing the financial statement of the firms. Theoretically, the findings of this study is expected to provide additional literature in the areas of CG and quality of accounting numbers. This will go a long way in validating theories, such as agency that anchored CG mechanism and EQ in NLMC. In particular, financial statement users should be aware of income the users should be aware of income smoothing and the factors affecting such behavior when they rely on financial statements to help them make decisions. Specifically, users are expected to know the influence of the independent or non-executive directors, institutional shareholdings and the audit committee on such behavior. Further, since extensive accounting ethics may lead to inadequate or misleading income disclosure, thus regulators should concentrate their efforts where such practices are likely and most extensively to happen.

 

 

EFFECTS OF STANDARD COSTING ON THE PROFITABILITY OF MANUFACTURING COMPANIES

EFFECTS OF STANDARD COSTING ON THE PROFITABILITY OF MANUFACTURING COMPANIES

(A CASE STUDY OF NIGERIAN BREWERIES PLC, AMA, UDI LOCAL GOVERNMENT OF ENUGU STATE)

ABSTRACT

The topic of this research is effects of standard costing on the profitability of a manufacturing company. The purpose of this study was to discover if the application of standard costing techniques have any effect on profitability, to explore the relationship between standard costing and the profitability of manufacturing companies and also to determine whether standard costing techniques and principles are being adopted and practiced in Nigerian manufacturing companies (Nigerian breweries, Ama Eke, Udi local government of Enugu state). The design of this study is descriptive survey method and the study was conducted at Nigerian breweries, Ama which is the case study of this research work. The instrument of data collection was analyzed using the chi-square method. The researcher discovered the following as her data findings that proper accounting records are kept and are significantly necessary in the management of the company. That the company employs standard costing in costing their product and decisions are made with the standard costing information obtained in the company. That accounting reports are prepared and presented to the company’s management and that actions are taken promptly on the information given in the report. That effective application of standard costing has effect on the profitability of the company. That the company benefit in a significant way through the use of standard costing especially in the improvement of profit. The researcher came to a conclusion that standard costing is widely used in Nigerian manufacturing companies and that standard costing enhances adequate planning, control and decision making processes in the company. That standard costing aids manufacturing companies in the elimination of unprofitable products, provision of costing information and cost control.

CHAPTER ONE
INTRODUCTION

1.1 BACKGROUND OF THE STUDY

The effect of standard of standard costing on profitability has been a problem to manufacturing companies in Nigeria. The standard costing as a tool for either improving or not improving profitability. Unlike its contemporaries in the field of science, it deals with human beings and calculation significant information.

Lucey (2002) defines standard costing as a technique which establishes pre determined cost estimates of the cost of products and services and then compares these pre determined costs with actual costs as they incurred. Standard cost represent am estimated or pre determines total cost of product per unit for an organization. Adeniji (2009) argues that the process of estimating the total cost of production per unit is described as standard costing technique.

Standard costing as a long established concept is the management function of planning and control. In effect, yardstick has been of vital importance for planning and control exercise. As a matter of fact, problems associated with production and earning a profit was recognized for many years before the concept of standard costing was invented. Standard costing appeared in the early twentieth century when transaction volumes were overwhelming the record keeping system in the use at that time. Since then, prevalent use of computer systems and automated data entry systems have reduced the need for standard costing, though not entirely eliminated.

These standard costs reveals goals, spur actions and efforts for effective management and equally provide checks such that exceptional profit oriented goal performance can be achieved and the reserve adequate punishment to be exercised for bad performance. Standard cost cause appraisal to be made over production facilities and form management intentions and capabilities and is a first step strength and weakness appraisal. These led to the preference of standard costing system in 1920’s. it was brought into the system such that total variances might be accumulated as well as detailed variances. These steps gave rise to formal expression that significant costs were not actual and historical cost but standard or planning cost and their variances.

1.2 STATEMENT OF THE PROBLEM

In Nigeria today, the economy is extremely bad. In this respect, a lot of measures have been taken to measure the destining economic situation. Among the measures taken to revamp the economy includes;
Structural adjustment program (SAP) Second tier foreign exchange market Ban on importation etc.

These measures have adverse effect on the buying attitude of the consumers. Cost of production has increased in manufacturing sector of the economy which in effect has resulted to high prices of manufacturing goods. In effect, no applicable level of demand could be recorded by most manufacturers as the buyer’s purchasing power could no longer meet up with the rising price level. Most of the manufactured products were consumed by civil servants, public servants and other wage earners whose take home pay pocket can no longer take them home. In this regards, consumers utilize their little purchasing power mainly on foodstuff to sustain themselves first before luxury. With the economic reason, greater efforts should be made to keep cost to the lowest minimum through efficient and effective utilization of both human and material resources. The above mentioned does not end it up, more problems still come up from such areas like;

1. Irregular supply of water: The power holding company of Nigeria (PHCN) does not render adequate services to manufacturers. PHCN will take off power and the production would stop unscheduled thereby resulting to much damages which the costs are added to cover all productions.

2. Inadequate supply of water: water is always in short supply and in most cases, water board does not supply water manufacturers need it. The manufacturers resort to buy water needed for their production from the open market to see the manufacturing activities are going on. In this respect, the price of getting water is costlier than from water board in most cases, whether water is supplied or not, water board will require them to pay a reasonably monthly water rate.

3. Bad roads: in respect of transporting raw materials used from the extraction area and evacuation of finished goods from the manufacturing industry to the market where it is demanded, high transport costs are made due to bad roads in Nigeria with special reference to Eke, Udi LGA of Enugu state in particular.

4. Foreign competition: most of the indigenous manufacturers are not given protection from foreign competitors and in most cases are deprived of tax holidays.

There has been decreased profitability resulting from increased costs. In effect, requires a greater cost reduction and profit optimization. This can only be achieved through setting reliable standards, ensuring that such standards are mentioned and variances not adversely very large (significant) without proper cause. The system helps cost reduction to increase profitability. Another major problem centers on lack of adequate control of scarce resources by indigenous manufacturers. Most of the resources used require special storage facilities where they are stored before they are utilized to avoid spoilage. In most cases, the storage facilities might be beyond the reach of some manufacturers. Along the line, most manufacturers do not have adequate control over the resources as they are easily impact on the government. Government policies may be favorable or unfavorable to manufacturers in Nigeria; they can be evidenced to restriction an total ban as most of them are being imported.

The use of unqualified and inexperienced accountants by some industries pose a greater problems to such industries for the accountant cannot adequately apply the accounting techniques required of them on standard costing.

1.3 OBJECTIVES OF THE STUDY

While carrying out this research, the following aspects were borne in mind;

1. To discover if the application of standard costing techniques have any effect on the profitability of manufacturing companies.

2. To explore the relationship between standard costing and profitability in manufacturing companies in Nigeria.

3. To determine whether standard costing techniques and principles are being adopted and practiced in Nigerian manufacturing industries.

1.4 RESEARCH QUESTIONS

1. Does the application of standard costing techniques have any effect on the profitability of manufacturing companies?

2. What are the relationship between standard costing and profitability in manufacturing companies in Nigeria?

3. Are the principles of standard costing and standard costing techniques being adopted and practiced in Nigeria?

1.5 HYPOTHESIS OF THE STUDY

To achieve the objectives of this study which is on the effect of standard costing on the profitability of a manufacturing company, the researcher formulated three hypotheses that will be tested in the process of this study. They are as follows;

1. H0: The application of standard costing techniques has no effect on the profitability of manufacturing companies in Nigeria.

H1: The application of standard costing has effect on the profitability of manufacturing companies in Nigeria.

2. H0: There is no relationship between standard costing and profitability in manufacturing companies in Nigeria.

H1: There is a relationship between standard costing and profitability in manufacturing companies in Nigeria.

3. H0: The principle of standard costing and the standard costing technique are not being adopted and practiced in Nigerian manufacturing companies.

H1: The principle of standard costing and the standard costing technique are being adopted and practiced in Nigerian manufacturing industries.

1.6 SIGNIFICANCE OF THE STUDY

It is believed that standard costing aids management to plan for the future, and if any justification is required for this research project on the effect of standard costing on the profitability of manufacturing industries, the view of Robert Appleby, one of the early British industrialist should be released on. Appleby regards the key to managerial success as the setting of standards for all business activities and measurement of performance against the standards. He states that financial measurement should penetrate into any cranny of the enterprise and in doctrine all management in their working habit. In this regards, there is need to prove whether standard costing is a more viable and preferable option to other costing methods adopted for each products produced. There is a limit to the price charged to production.

In effect, cost should be given maximum attention since revenue less cost gives a balance of profit. Profit should be increased as it is every industry is aiming at.

1.7 SCOPE AND LIMITATION OF THE STUDY

This research project is restricted to the manufacturing industries of Nigerian breweries plc. The researcher focused on the Ama Brewery located at Eke, udi local government area of Enugu state as this industry operates under similar conditions as its counterparts within Nigeria an will present similar problems.

As regarding the limitations on this research project, it would be impossible to include all manufacturing industries of Nigeria brewery plc at every location, therefore, this study was limited to Ama brewery, Eke, Enugu state.

Time constraint was another strong factor that posed as a limitation to this research because the study was carried out when the researcher had so much work load. Thus, it was difficult for the researcher to meet up some of the appointment with respondents.

Another limiting factor to this research project was the uncooperative of some staff(s). Some of the staff(s) of the company taken into consideration refused to be interviewed for the fear of official reprisal, if they give out some committed information. This made it difficult for the researcher to collect much primary information.

1.8 DEFINITION OF TERMS

The concept of standard costing as predetermined or forecast estimates of cost is wide and varied. The terms used in this research work intend to have the same understanding with the definition of the standard cost by the institute of cost and management accounting (ICMA) as “the predetermined cost calculated in relation to the prescribed set of working condition. Co-relating technical specification and scientific measurements of materials, labor and wage rate expected to apply within the period which the standard relates within an addition of appropriate share of budgeted overhead. Its main purpose is to provide basis for control through variance accounting for the valuation of stock and work in progress, and exceptional cases for fixing selling prices. Some of the words used in this research project are defined as follows;

1.     Standard costing: implies setting up standard costs for goods and services.

2.     Standards an budgets: both standards and budgets are concerned with setting performance and cost levels for control purposes.

3.     Costing standards: meaningful standards which can be used for control purposes rest on a foundation of properly and standardized methods and procedures and comprehensive information system.

4.     Material standards: this implies setting the material content of a product.

5.     Labor standard: implies predetermining the exact grades of labor to be used as well the times involved. Planned labor time can be expressed in standard hours.

6.     Overhead standard: predetermined overhead absorption rates are the standards of overhead for each cost center using budgeted standard hours determined.

7.     Standard hour: this is defined as the quantity of work achievable at standard performance, expressed in terms of standard unit of work in a standard period of time.

8.     Variance accounting: this is an account that centers on future planning activities of an organization as compared with the historical activities, the activities being expressed in budgets, standard cost, standard selling price, standard profit margin and difference between those and the comparable actual results to be accounted to the management periodically and the responsibility centers, the analysis centering on the operating profit variance.

9.     Variance analysis: it is concerned with the section of variance accounting that relates to the analysis into constituent section and variances between planned and actual performance.

10.                        Cost variance: this refers to the difference between the standard (planned) cost and the comparable actual and historical cost incurred during the specified time period.

11.                        Controllable variance: it is a cost variance which can be identified as the primary responsibility of a specified person.

12.                        Sales variance: this is the difference between the budgeted value of sales and the actual value of sales in a given period of time.

13.                        Profit and loss variance:this is the difference between the planned profit and actual profit and loss.

14.                        Profitability: this means the ability to make profit from all business activities of an organization, firm, company or an enterprise.
Profit: this refers to the total income earned by the enterprise during the specified period of time

REFERENCES

Adeniji, A. (2009). Cost accounting: A managerial approach. Lagos: El-toda Ventures publishers limlited.

Lucey,T. (2002). Costing. New York: biddles limited, Guildford and king’s lynn.

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