CHAPTER ONE INTRODUCTION 1.1 BACKGROUND TO THE STUDY

An accounting system is an orderly, efficient scheme for providing accurate financial information and controls. Regulatory requirements and internal administration policies are key considerations in the design of an effective accounting system. Thus accounting systems show the books, records, voucher, and files and related supporting data resulting from the application of the accounting process. It involves the design of documents and transactions flow through an organization. The uniqueness of small and medium scale businesses call for careful consideration  in  the design  of accounting  systems. Small  and  medium  scale  enterprises  are a  vast majority  of  businesses  found  in  variety  of  primary  and  intermediate  production  of  the  economy.  These establishments have tremendous impact on the state and well being of the nation in employment generation, as sources  of  national  outputs  and  revenues,  providing  feedstock  for  large  corporations  They may lack  the sophistication  to  apply  the  detailed  accounting  processes,  yet  the  value  of  accounting  systems  to  these businesses is quite profound.

Small business (i.e. not more than 10 shareholders) purchases auditing services mostly because they would like to acquire credit from banks. It has been established that bankers seek audited financial statements in their lending decisions (Okwena, Okioma, and Onsongo, 2010).

An external auditor is an audit professional who performs an audit in accordance with specific laws or rules on the financial statements of a company, government entity and other legal entities or organization and who is independent of the entity being audited. (Institute of internal auditors) The concept of SMEs varies from one  country to  another  depending  on  the  indicators  used,  (Kitindi, Iwsi and Mganya, 2000).The  first  criteria,  based  on  the number  of employees, defines SMEs as those enterprises below a certain number of workers (i.e. can range from less than 10 to less than 50 employees).The second criterion defines the SMEs as the degree of legal formality, and has been used to distinguish between the formal and informal sectors. Here, Micro, small and medium enterprises (MSMEs) are considered as enterprises which are not registered and do not comply with the legal obligations concerning safety, taxes and labour laws. The third criterion defines SMEs as based on the limited amounts of capital  and skills per  worker. Aritho, (2010) categorize the micro, small and medium enterprises as follows: a micro enterprise as one with 1-5 workers, a very small enterprise with 6-9 workers and a small enterprise as one with less than 30 workers, and medium enterprise having as many as 250 workers.

Even though the definition varies from one country to another (depending on the economic structure), the regulatory and institutional framework for the Nigerian SMEs has been based on the number of employees and the company‟s annual turnover. For instance, the micro enterprises have been defined as those employing less than 10 workers with annual turnover of less than N500,000 and capital formation of less than N5 million for services, or less than N10 million for enterprises doing manufacturing. Small enterprises are defined as those that employ between 10 and 50 workers with annual turnovers between N500,000 and N5 million and capital formation between N5 million and Kshs20 million for services or between N5 million and N50 million for enterprises doing manufacturing.

The contribution of SMEs is more than double that of the large manufacturing sector, which stands at 7% of the GDP (Katwei, (2009). Overall, SMEs create 75% of all new jobs. Estimates based on the 1999 baseline survey show that, in the year 2002, the SME sector employed about 5086400 people, up from 4624400 in 2001. This was an increase of 462000 persons and consisted of 74.2% of total national employment (Hodge, 2003).

EU members have had individual definitions of what constitutes an SMEs for example, the traditional definition in Germany had a limit of two hundred and fifty five employees, while for example in Belgium it could have been one hundred employees. In July 2011, the European commission said that it would open a consultation on the definition of SMEs in 2011. In Europe, currently there are three broad parameters which define SMEs are companies up to 10 employees; small companies employ up to fifty workers, whilst medium sized contain up to two fifty employees. (Hodge, 2003) Furthermore, SMEs are defined as firms with either a turnover of ten to fifty (10-50) million or a balance sheet ten to forty three (10-43) million.

Carmichael, (2004), SMEs are unable to carry out the accounting functions internally because of inadequate knowledge and unqualified employees. For example, SMEs lack the necessary skills and resources to perform accounting functions in-house; access to the expertise and specialized knowledge of a professional accountant was evidently the most important reason to outsource (Baltaci, &Yilmaz, 2006). Indeed, majority of SME owner/managers have no professional, management and other formal qualifications (Baltaci, &Yilmaz, 2006). One possible way for a smaller firm to acquire competencies is to engage professional accountant  (Jokipii, (2010). Therefore, by relying on professional accountant, smaller firms can get the competence that they need (Jokipii, (2010). Therefore, this study seeks to examine the impact of accounting standard of on the development of Small and Medium Scale enterprises in Nigeria.

1.2 STATEMENT OF THE PROBLEM

The place of sound accounting and internal control systems in any business, irrespective of its scale, cannot be overemphasized. A vast majority of small-scale businesses cannot afford the complexity of a detailed accounting system even if they would have. Hence, the existence of single entries in their books and in some cases incomplete records (Wood, 1979; Onaolapo, et al., 2011).  Audits of small and medium scale enterprises have proven to be among the most worrisome for professional accountants because of the inadequacy of the internal controls. Except for statutory demands, small and medium scale enterprises hardly give serious thoughts to the process of sound accounting, yet the inadequacy and ineffectiveness of accounting processes have been responsible for untimely collapse of a host of them (Mukaila and Adeyemi, 2011).

Several studies have been conducted in a few advanced countries to search for the problems encountered in auditing a small company (United States, United Kingdom and Canada). Throughout the studies, the main problem facing the auditor was the implementation of the Auditing Standards that normally apply to large company rather than small company.

The problem with the Nigerian SME setting is that SMEs in Nigeria rarely use the services of a qualified accountant. This is demonstrated by the Rommel, (2006) who argued that their results showed that book keeping practice of the SMEs in Nigeria is not adequate and this may negatively affect the financial performance.Against this backdrop, this review of accounting and auditing practices in Nigeria is intended to provide inputs on appropriate measures to improve the financial reporting regime. This study therefore seeks to investigate the impact of accounting standard on the development of small and medium scale enterprises.

1.3 OBJECTIVES OF THE STUDY

The main objective of the study is to examine auditing of Small and Medium Scale enterprises in Nigeria. The specific objectives are as follows:

1. To determine whether compliance with accounting standards affects financial audit in SMEs in Nigeria.
2. To determine the extent to which sound accounting practice is carried out among these businesses.

iii. To examine the limitations of small and medium enterprises to implementing full accounting systems.

1. To determine the effects of audit evidence on financial audit in SMEs

 1.4 RESEARCH QUESTIONS

1. Does the compliance with accounting standards affects financial audit in SMEs in Nigeria?
2. Is sound accounting practice carried out among these businesses?

iii. Are there limitations of small and medium enterprises to implementing full accounting systems?

1. What are the effects of audit evidence on financial audit in SMEs?

1.5 RESEARCH HYPOTHESIS

HO: There is no significant impact of accounting standard on the development of Small and Medium Scale enterprises in Nigeria.

HI: There is a significant impact of accounting standard on the development of Small and Medium Scale enterprises in Nigeria.

1.6 SIGNIFICANCE OF THE STUDY

Users of financial information such as investors, government, organization and the general public, rely on the external auditor to present an unbiased and independent audit report. The primary role of external auditor is to express an opinion on whether entity financial statements are free of material statements and whether they reflect true and fair view.

Thus, the findings of this study will provide the audit firms with better insights on the determinants of poor audit performance in SMEs and facilitate the development of strategies to enhance their performance.

The results of the study will also be importance to businesses in the small and medium scale category with limited access to the long-term finance that rely more heavily on owner financing, trade credit and short- term bank loans to finance their needed investment. The study will aid policymakers in designing more effective strategies targeted at increasing the levels of quality audit in SMEs.

The findings of the study will also be of significance to the accountancy sector and other business sectors of the economy as they will be able to appreciate the importance of auditing in SMEs since SMEs are important force in development of Nigerian economy.

This study will contribute  to  the  growing  body  of  literature  on  financial  audit.  The conceptual framework developed in this study will provide a cohesive basis  for  conducting further  Study to provide empirical evidence that will enhance understanding the determinants of financial audit in SMEs. A further research can be conducted to highlight other determinants of financial audit in small and medium enterprises in Nigeria.

1.7 SCOPE OF THE STUDY

The study examines auditing of Small and Medium Scale enterprises in Nigeria. It will be too cumbersome for the researchers to study Rivers State at large. Therefore, the researchers decided to limit the study to some selected Small and Medium Scale enterprises in Port Harcourt metropolis, Rivers State which include Jamil Motors and Luminary Telecommunication Limited.

1.8 LIMITATION OF THE STUDY

In carrying out this research work, the researcher was constraint by lot of factors which include but not limited to the following:

TIME CONSTRAINT: The time frame provision for this study was short.

FINANCIAL CONSTRAINT: Usually, a study of this nature involved some level of expenditure therefore, finance was also a limiting factor.

POOR RESPONSE: poor response from the respondent and inability to access the entire population of the study.

1.9 DEFINITION OF TERMS

SMEs:    Small and Medium Scale Enterprises.

Joint Audit: A joint audit is an audit on a legal entity by two or more auditors to produce a single audit report, thereby sharing responsibility.

Financial Reporting: This is the process of producing statements that disclose an organizations financial status to management, investors, government and other users of financial information.

Auditor: An auditor is someone who prepares and examiners financial records.