Internal Audit Function and Audit Fees: Evidence from Nigeria

The purpose of this study is to analyse the relationship between audit fees and internal audit function in the Nigerian listed companies. This study observes 60 non-financial firms over four years (2012 to 2015) and uses random effect regression model to examine the hypothesis. The result of the study found internal audit to be significantly related with amount of audit fees paid by the listed firms. Specifically, this study found internal audit expertise and size of internal audit unit to have a positive and significant relationship with audit fees while no relationship was documented between internal audit certificate and the amount of audit fees. The study concludes that company with effective and adequate internal audit unit tend to pay higher audit fees to the external auditors.


Introduction
An essential link in the business and process of an organization's financial reporting is the internal audit (IA) unit. IA is critical to the organization because it identifies the area to improve risk management and monitors its risk profile. Moreover, the IA have the objective to improve the efficiency and effectiveness of the organization through constructive criticism.
There are five main components of IA: evaluating the logic and completeness of procedures, analysis of policy, verification of written records, and reporting recommendations for improvements to the management (Ejoh & Ejom, 2014).
IA is an essential mechanism of corporate governance that complements the activities of the board of directors and the audit committee. The internal corporate governance mechanism of a firm is made up of the interaction of these three actors (Ramly & Rashid, effectiveness of the board of directors and continuous visibility and relevance of the IA. Hence, it is necessary to integrate the IA into a higher level of authority (Prawitt et al., 2009;Akinteye et al., 2015). Previous studies show that certain qualities are required of IA to be relevant and efficient in helping the audit committee to monitor the firm's activities effectively and ensure financial reporting quality (Akinteye et al., 2015;Ejoh & Ejom, 2014).
The IA is crucial to companies as it provides services to its management in monitoring compliance to the government regulations and company policies, testing the internal control, and preventing fraud (Ali et al., 2012). It is also considered one of the vital components of risk management and its internal control structure (Anderson et al., 2012). The IA is carried out in different legal and cultural environments within organizations that differ in size, aim and structure, and individuals within or outside the organization (Fadzil, 2005). A survey conducted by the Malaysian Institute of Corporate Governance (MICG), the Institute of Internal Auditors Malaysia (IIAM) and Ernst and Young asserted that internal auditors are best placed on comprehending and articulating the business practices of the company, and they serve as consultants to lessen risks (Johl et al., 2013). By evaluating the governance, control and risk management, the IA can help an organization fulfil its goals and improve its performance (Carcello et al., 2005).
Besides the IA, there is another corporate governance mechanism that oversees the relationship between the shareholders and the managers, one of which is the presence of external auditors who provide a significant supervisory role in testing the credibility of financial statements provided by management on behalf of shareholders (Lin & Liu, 2009).
According to Al-Qadasi and Abidin (2018), large companies with high audit quality and solid corporate governance tend to pay substantial audit fees to create value for the organization. In addition, previous studies document that companies with adequate IA and effective corporate governance will hire among the Big4 auditors and pay high audit fees (Cassell et al., 2012, DeFond & Zhang, 2014. By doing this, the companies believe that they will increase the company's value and increase the investors' confidence Al-Qadasi & Abidin, 2018). Although, Hay et al. (2008) found that there will be lower audit fees when good corporate governance reduces the work intensity in the company. Meaning that the demand for the quality of auditors will decrease when there is adequate supervision by the company's internal mechanisms.
On the contrary, Srinidhi and Firth (2014) noted that high audit fees would be required for a company that has good corporate governance and request quality audit. Moreover, companies that invest in IA also invest in external audits (Dzikrullah et al., 2020). This fact corresponds with the concept that investment into a mechanism will impact additional investment into other instruments (Beasley & Salterio, 2001). Despite the importance of IA, there are limited studies that address the effectiveness of the IA in the literature (Ali & Handayani, 2018). Hence, several researchers have called for extensive research on the problems of IA its effectiveness (Ege, 2014). Therefore, the objective of this study is to analyze the association between audit fees and the characteristics of IA.

Literature Review
To respond to the growing ethical business practice, provide the transparent financial report, present cost management accurately, and improve corporate accountability, firms have continued to improve the risk management practices, internal control, and ultimately the governance practices (Hussain et al., 2018). However, despite the increasing focus on IA, there is limited literature that empirically studies the effectiveness of IA due to the lack of data availability. Most of the previous studies only rely on experimental or survey data. Moreover, earlier studies on IA have only examined the size of IA and the existence of IA.
One of the main supports for best practices on corporate governance is the existence and quality of an IA in a company (Prawitt et al., 2009). In addition, Al-Shetwi et al. (2011) suggest IA as an essential internal control of effective corporate governance. Also, IA is significant in creating a sense of security that contributes to the truthful presentation of financial statement and prevent fraudulent use of company's assets (Gay & Simnett, 2007). As a result, it is essential to have an effective IA that encourages a good governance practice.
Hence, checking the quality of corporate governance in a company is by checking whether the company has a competent and reliable IA team. Anderson et al. (2012) found the size of IA to be positive and significantly related to the use of sophisticated technology audit, the size of the organization, the number of foreign subsidiaries, missions focused on IT auditing, and the size of the audit committee. In addition,  Ho and Hutchinson (2010) found an association between accounting information disclosure and IA quality. The study revealed that firms would pay lower audit fees when they have high-quality IA because such a firm will vigorously protect the interest of the minority shareholders. Moreover, Johl et al. (2013) and García et al. (2012) posits that there will be less likelihood of earnings management when the firm has a high-quality IA. In addition, García et al. (2019) found a positive relationship between audit fees and the existence of IA. The study claimed that IA and external audit act as complementary mechanisms and not alternative means.
Furthermore, the internal auditors are parties that contribute to the internal supervision of the company (Felix et al., 2001). Also, researchers show that a company will pay high audit fees when there is effective governance because of adequate IA DeFond & Zhang, 2014). Therefore, this study aims to relate how IA characteristics influence the number of audit fees paid to external auditors. Hence, we proposed the following hypothesis based on the above discussions: H1: there is a positive effect of IA on audit fees.

Research Method
The sample used in this study involves 60 non-financial firms listed companies in the Nigerian stock exchange (NSX) from 2012 to 2015. Therefore, the data for this study were sourced from the annual accounts and reports of the companies collected from the NSX website and Thomson Reuter's data stream. In addition, the dependent variable in this study is audit fees. Audit fees are the amount a company pays concerning audit service performed by external auditors. At the same time, the independent variable used in this study is the IA function. This study measures IA as the number of internal auditors, internal personnel certification and essential accounting expertise (Dzikrullah et al., 2020).

Empirical Models
This study employed panel data models to analyze the direct effect of audit fees and IA. In addition, this study makes use of the following linear regression model to test the hypothesis.

Measurement of variable
The dependent variable of audit fees is measured as the natural log of auditor's fees. In addition, this study measures IA accounting expertise as a dummy variable, where one equal if the company has IA members with bachelor's in accounting and 0 if otherwise, size of IA is measured as a number of internal auditors in the company, IA certification is calculated as a dummy variable where one equal if the company have a certified auditor (CPA/CIA) as a member of internal auditors and 0 if otherwise. All the measurement were adopted from Dzikrullah et al. (2020). Table 1 below shows the summary of the size of the variables used in this study. The summary of the descriptive statistics of the dependent and independent variables is presented in Table 2. This study observes 60 firms over four years, making the total number of observation 240 firm-year. The table shows that the mean audit fees are N 43,892,000 with a minimum of N 3,175,000 and a maximum of N 102,251,000. Moreover, the average number of internal auditors is 32, with a maximum of 58 members. Also, 72.2% of the firms have internal auditors with an accounting background, while only 21.1% have a certified auditor.

Diagnostic Tests
This study goes through some diagnostic tests to account for the cross-sectional and time-series dimensions of the data. In specific, this study carried our test on multicollinearity, correlation, heteroskedasticity and variance inflation factor (VIF).

Variance Inflation Factor
The result of the multicollinearity through VIF shows that there is no problem of multicollinearity in this study as the model is within the acceptable range of 10 VIF and more than 10% tolerance value (Hair et al., 2014).

Heteroscedasticity Test
The result displayed in Table 4 shows the model is significant as the reported p-value is less than 0.05. This data indicates that the null hypothesis is rejected, indicating a problem heteroscedasticity in the model.  Table 5 shows that the regression model suffers a problem of autocorrelation because the p-value is significant at 5%. Hence, this study rejects the null hypothesis.

Test for Model Specification
Hausman test was carried out to determine the best fit model between the fixed effect and random effect. The result, as displayed in Table 6, shows that the null hypothesis is accepted. Hence the random effect model is appropriate in this study. This study examines the relationship between the characteristics of IA function and audit fees in the Nigerian stock exchange. As shown in Table 7, the result of the regression model shows that the overall model is fit and significant at 1% (F statistics 0.0000), and the R 2 value shows 72.3%, which indicates that the variance of 72.3% in audit fees is explained through the independent and control variables. Note: ***, ** and * represent significant at 1%, 5% and 10% levels respectively The regression results show that IA has a positive and significant relationship with the number of audit fees paid to the external auditors. This data indicates that there will be an increase in the supervision of the company through the external auditors if the company have an excellent IA function. Hence, the company will be willing to pay high audit fees. This data is consistent with the findings of Dzikrullah et al. (2020) and Al-Qadasi and Abidin (2018), who also shows that the company will be a willingness to pay high audit fees to achieve high auditor quality when they have solid internal governance. Specifically, the result indicates that IAEXP has a positive and significant relationship with audit fees. Furthermore, this information suggests that firms with accounting experts in the IA will be willing to pay high audit fees.
Moreover, this study shows a positive and significant relationship between IASIZE and audit fees. This data indicates that the size of IA positively influences the number of audit fees paid to the external auditors. At the same time, this study documents no relationship between audit fees and IACERT. As expected, this study found all the control variables to be positive and significantly related to audit fees in terms of the control variables.

Conclusion
As stated earlier, the purpose of this study is to analyze the influence of IA characteristics on audit fees of non-financial listed companies on the NSX from 2012 to 2015. This study found IA to have a positive and significant relationship with audit fees as a corporate governance mechanism. This information indicates that companies with effective and adequate IA functions will prefer to use the service of the Big4 external auditors and consequently pay high audit fees. Inconsistent with the predicted directions, this study found IAEXP and IASIZE to have a significant positive relationship with audit fees. In contrast, IACERT has an insignificant negative association with the number of audit fees paid to the external auditors. In addition, this study used four control variables: firm size, leverage, ROA, and Big4 auditors. The regression model results show that firm size is significantly related to the number of audit fees. The means that large firms tend to pay high audit fees. More so, leverage has a significant and positive relationship with audit fees. Meaning that company that operates with a high debt ratio will require the service of professional auditors and thus, pay high audit fees. Also, ROA shows a significant relationship with audit fees while Big4 auditors indicate a positive and meaningful relationship with the company's audit fees. Inconsistent with previous studies, this study has its limitations. Among others, data used in this study were randomly gathered from 60 non-financial listed firms in NSX. Hence, future studies should consider all the listed firms in NSX. In addition, due to adequate data availability, this study only covers four years (2012 to 2015). Future studies may consider a more extended period in other to generalize the result from this study.