The independence of the external auditor is a subject that has attracted both professional and academic attention in recent times (Ali and Nesrine 2015). This attention has been intensified in light of recent scandals in the corporate world; prominent among these is the collapse of Enron and subsequently its audit partner, Arthur Anderson due to their failure to expose the inappropriate dealings of the company (Li 2010). These events led to a series of activities across various countries which were aimed at strengthening corporate governance as well as the audit practice to ensure responsibility and transparency in the way corporations are run. Hence, the purpose of this study focused on the audit environment in Libya to understand the factors that enhance or threaten auditor independence. The audit practise is involved in this because the external auditor is seen as a vital player in advising the management of corporate organisations perform their roles in a responsible manner; to be able to carry out their functions in a professional and responsible manner, the importance of independence of the external auditor cannot be overemphasised. Against this backdrop it was important to understand the factors which have the capacity to influence the audit exercise by hampering the independence of the external auditor.
⦁ Concept of Auditor Independence
According to Caswell and Allen (2001), auditor independence is a fundamental requirement of the auditing profession and is the foundation for public trust in the audit function. This is because the role of the external auditor is critical in establishing the credibility of the financial statements of companies, hence the need for auditor independence. Auditor independence is important in ensuring that the audit exercise is unbiased and impartial and this contributes to enhancing objectivity in the financial reporting process. McGrath et al (2001) opine that when independent auditors provide impartial audit choices, it supports user reliance on the financial reporting process and consequently boost capital market efficiency.
Auditor independence can be explained as “avoidance of situations which would tend to impair objectivity or permit personal bias to influence delicate judgement” (Carey and Doherty, 1966).
In particular, auditor independence has been described as absence of impact on the matter of the auditor’s opinion, action and conduct (American Accounting Association Committee, 1973). In addition, auditor independence basically indicates the auditor’s ability to express his opinions honestly and impartially. Moreover, auditor independence is one of the most important matters because the efficacy of the audit is reinforced by ensuring that the auditors plan and perform the audit objective. According to Okolie (2007) the qualities of audit promote the credibility of the financial reporting process and facilitate most select allotment of capital by external investors and other users of the financial statements.
The nature of the audit profession requires auditors to be independent from the influence of any party so that the auditor would be able to give an objective opinion on the audit exercise which is carried out. Auditor independence is therefore a significant element as evidence of it gives boosts the confidence of the end users that the reports generated are authentic and valid and present a true picture of the organisation.
1.3 The Accounting and Audit Practice in Libya
In recent months, there has been a professional and academic discussion on external auditor independence in both developed and developing countries. Libya is one of the developing countries which are undergoing an essential program of economic and social development following the detection of oil in 1955. However, before the oil detection, the audit market in Libya was less developed due to the lack of regulations. Since then Libya has experienced an accelerated economic growth and this has contributed to the growth of other commercial activities such as investments and flow of goods in and out of the country, not forgetting agriculture and the services industry. This flourishing of various activities has led to improving accounting practice in Libya. With the significant economic growth, the number of users of financial information has been increasing and hence, there is therefore a need to ensure that the integrity of the information obtained from the financial reports of companies is not compromised (Hamuda and Sawan, 2014).
The regulatory body for the accounting and auditing profession in Libya is the Libyan Accountants’ and Auditors’ Association (LAAA), while the Institute of Financial Auditing (IFA) is responsible for governing all state-owned entities in Libya. The LAAA was formed with the passing of the Libyan Government Act 116/1973. However there are no official auditing and accounting standards in the country, which makes the role of the LAAA extremely limited. In 2005 the Central Bank of Libya enacted Law 1 of 2005 to require that all organisations within the banking sector should comply with the international accounting and auditing standards (Hamuda and Sewan 2014); this was aimed at improving the quality of their financial statements and ensures they meet up with international best practices. The audit market itself consists of large local audit offices, small local audit offices and the branches of the Big Four audit firms. The accounting practise in general is considered to be oriented towards the accounting practise in UK and USA (Faraj and Akbar, 2010).
1.4 Research aims and Objectives
The main aim of this research is to study and identify the factors that influence auditor independence within the audit environment in Libya. The objectives are therefore formulated as follows:
⦁ To establish whether the tenure of an audit firm has an impact on the auditor’s independence within the audit environment in Libya.
⦁ To determine whether the audit fee has an influence on the auditor’s independence within the audit environment in Libya.
⦁ To ascertain if the existence of an audit committee has any effect on the independence of the external auditor within the audit environment in Libya.
⦁ To establish whether the size of the audit firm has a bearing on auditor independence within the audit environment in Libya.
⦁ To determine if the provision of non-audit services to clients such as management advisory services has an effect on auditor independence within the audit environment in Libya.
⦁ To ascertain if the competition level in the audit services market has an influence on auditor independence within the audit environment in Libya.
1.5 Research questions
This research will investigate whether there are factors affecting the independence of the external auditors who are licensed by the Libyan Association of Accountants and Auditors. Based on the objectives highlighted above, this study will aim to answer the following research questions:
⦁ To what extent is the external auditor independence within the audit environment in Libya perceived to be independent?
⦁ What are the determinants of external auditor independence within the audit environment in Libya?
1.6 Research hypothesis:
Based on the objectives of the study and the research questions, the following null hypotheses were proposed:
H1: The external auditor independence within the audit environment in Libya is not perceived to be independent
H2: There are no significant determinants of external auditor independence within the audit environment in Libya
1.7 Research methodology
This research will depend on the quantitative research method in order to test the hypotheses formulated by the researcher. The reason for using quantitative methods is that it will allow for tests to be conducted scientifically and objectively. In particular, correlation analysis will be considered because it can detect the significance of relationship as well as the direction of relationship between the independent factors and the dependent variable.
1.7.1 Population and research sample
Given that there are quite a number of audit firms in Libya, the population of this research consist of external auditors from audit firms who are licensed by the Association of Accountants and Auditors, with the exclusive objective of determining the factors that directly influence the auditor’s independence within the audit environment in Libya. The sample size included 40 external auditors listed in the Association of Accountants and Auditors will be selected as a sample for this research.
1.7.2 Data collection
This research uses a closed ended questionnaire as a primary data collection method as this is considered as the most appropriate method for this research to determine the factors which influence the auditor’s independence within the auditing practice environment in Libya. The questionnaire is the preferred data collection instrument because of its capacity to yield a satisfactory range of reliable data (Blanche et al, 2006). The advantage of selecting this instrument is that it keeps track of those who do not return the questionnaire on time and need to be reminded again. The questionnaire also makes it easier for the researcher to reach a large population of 40 samples with relatively low levels of effort; this is important in the current research as there is a strong constraint on the resources and manpower available to conduct the research. It also allows the respondents to provide their responses at their convenience. It is a format that is relatively very well-known and therefore is eminently suitable for the current research.
It is important to note that, the majority of questionnaires do not need to know the identity of respondents, thus encouraging them to voice their opinions by maintaining their anonymity. Therefore, the researcher will be able to design the questionnaire in a way that simplifies analysis. The questionnaire will be divided into two sections. The first section will consist of questions about personal details such as age, educational background and working experience in an audit environment. The second section will consist of questions which enabled the respondents to evaluate different information about factors affecting auditor’s independence in Libya. The items will present in form of Likert- five point Scale, “strongly agree” (5), “Agree” (4), “Neutral” (3), “Disagree” (2), “Strongly disagree” (1). The questions were in line with the recommendations of Blanche et al (2006) who suggest that a short and simple questionnaire is recommended because it gives a high response rate. According to Easterby-Smith et al (2007), the questionnaire should be used to examine the opinions and perceptions of external auditors. Consequently, this research will address the relevant research questions in order to answer the questions.
1.8 Significance and Implications of the research
This research is set to identify factors which influence the external auditor’s independence within the audit environment in Libya. Currently, there is very little research in the area of accounting practise in Libya. This makes it very difficult for practitioners to identify, and provide evidence for any changes that they wish to make to further the profession in the country. It is safe to say that the development of the profession in the country depends on the availability of appropriate and accurate information of the subject matter; this study therefore contributes to literature on the subject of auditor independence in Libya and could serve as a reference point for future research on the subject. This is because the study is expected to help identify the factors that are detrimental to the independence of the external auditors in the country and could provide some insight on how the audit environment in the country can be strengthened. The current research can also help to understand the important factors in the accounting environment in Libya, which has been largely neglected by mainstream research. It is hoped that this contributes to the development of accounting and auditing in Libya spurring further research in the area and lead to the greater development of Libyan accounting research and professional development in the field.
1.9 Limitations of the research
This research does not involve the total population of external auditors who are licensees of the Association of Accountants and Auditors in Libya. However, this research will take a sample from the total population of auditors in order to arrive at a representative sample that can represent the total population of auditors in Libya. In essence, inclusion criteria are that the respondents must be auditors who have been issued a license by the Association of Accountants and Auditors to practice this profession since its inception until 2014. From the onset, consideration was also made by the researcher of the specific time frame, and the effort needed to finish the research.
The research is largely academic in nature and therefore it may be constrained by lack of adequate resources. The researcher is a student and therefore this research project was very much a learning exercise. Therefore there will be significant limitations in terms of the research methods and methodologies employed, in terms of the analysis and conclusions derived. However the researcher will strive to ensure that these limitations are minimised especially with the guidance of the supervisor. The research also suffers from very strict time constraints. As an academic project the research has to be completed within a strict time frame. This means that there may be options that have been left unexplored on account of the lack of time. It is thus important to note that this study will not be exhaustive but will create a platform on which further studies can build on.
1.10 Outline structure of the research
This study will be composed of five chapters as follows:
In particular, the first chapter is the introduction which consists of background of the research, concept of auditor independence, the accounting and audit practice in Libya and the aims and objectives of this research. It also gives an insight into the research questions and the research hypotheses as well as an overview of the methodology, the research sample and data collection. In addition, the significance and implications of the research, and limitations of the research have been described in chapter one. As for the second chapter will give a general view of auditor independence and the literature review which will discuss the views of the past researches relevant to the factors affecting the independence of the auditor. The third chapter will extensively discuss the research methodology to be used in this research. Methods to be used in data collection will also be discussed along with the methods to be adopted for the data analysis. The fourth chapter will discuss findings and results that have been obtained in the study field. Finally, the last chapter will be the conclusion and will include a brief summary of the research findings and it will present the most important results reached from the study, and provides a set of recommendations based on the results.
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