KENYA METHODIST UNIVERSITY

SCHOOL OF BUSINESS

D: RESEARCH METHODS

TOPIC: AN ANALYSIS OF FACTORS AFFECTING IMPLEMENTATION OF INTERNAL AUDIT REPORTS IN KENYAN ORGANIZATIONS- A CASE STUDY OF K-Rep bank LIMITED

PRESENTED BY:

PRESENTED TO: On:

PREPARED IN PARTIAL FULFILMENT OF BACHELOR OF COMMERCE DEGREE OF KENYA METHODIST UNIVERSITY TABLE OF CONTENTS..........................................................................................................................Page CHAPTER ONE..............................................................................................................................................5

1.0 INTRODUCTION.....................................................................................................................................5 1.1 RESEARCH BACKGROUND.............................................................................................................5 1.2 RESEARCH PROBLEM STATEMENT............................................................................................8 1.3 RESEARCH OBJECTIVES................................................................................................................9 1.4 RESEARCH QUESTIONS..................................................................................................................9 1.5 IMPORTANCE OF THE STUDY......................................................................................................9 CHAPTER TWO...........................................................................................................................................11 2.0. LITERATURE REVIEW.......................................................................................................................11 2.1 THE ORIGIN OF AUDITING..........................................................................................................11 2.2. HISTORICAL Development ............................................................................................................13 2.3. Statement of Responsibility...............................................................................................................14 2.4. Definition of Auditing.......................................................................................................................15 2.5 DEFINITION OF OTHER TERMS.................................................................................................18 2.6 Newly defined Internal Audit function..............................................................................................19 2.7 Factors influencing Audit Function .................................................................................................21 2.8 Independence of Auditor:...................................................................................................................22 2.9 INTERNAL AUDITING....................................................................................................................23 2.10 Role of the Internal Audit................................................................................................................24 2.11 SCOPE AND OBJECTIVES OF INTERNAL AUDITING...........................................................26 2.12. Qualities of an Effective Internal Audit department .....................................................................27 2.13 General Advantages of an Audit......................................................................................................28 2.14 Types Of Audits.................................................................................................................................29 2.15 General principles of an audit..........................................................................................................30 2.16 Criticisms Of Internal Audit Reports...............................................................................................31 2.17 The Agency problem need for auditors.........................................................................................32 2.18 The Auditor and management of corporations...............................................................................32 2.19 Audit Demand...................................................................................................................................33 2.20. Nature Of Internal Audit Reports In Kenyan Organizations .......................................................34 Objective of an audit.................................................................................................................................36 3.0. Research methodology ..........................................................................................................................37 3.1 Description of Area of study ..............................................................................................................37 3.2 Research design .................................................................................................................................37 3.3 Target population ..............................................................................................................................38 3.4 Sample of the study/sampling design ................................................................................................38 3.5 Instruments for data collection .........................................................................................................38 3.6 Pilot study ...........................................................................................................................................39 3.7 Procedure for data collection ............................................................................................................39 3.8 Data Analysis .....................................................................................................................................39 REFERENCES ............................................................................................................................................40 APPENDIX 1: INTRODUCTORY LETTER...............................................................................................42 Appendix 2: Questionnaire ..........................................................................................................................43 APPENDIX 3: PROPOSED BUDGET PLAN............................................................................................49 APPENDIX 4: TIME SCHEDULE FOR THE RESEARCH: FEB - AUG 2007......................................49

2

APPENDICES Appendix 1: Appendix 2: Appendix 3: Appendix 4: Introductory letter Questionnaire Proposed budget Time Schedule

LIST OF TABLES Table1: categories of respondents ABBREVIATIONS AAA ICPA (K) IASC IAS American Accounting Association Institute of Certified public accountants of Kenya International Accounting Standards Committee International Accounting Standards

AICPA American Institute of Certified public Accountants

3

CICA IFA CPAs IIA SPSS ISA CEO IRS USA GAO GIAS

Canadian Institute of Certified accountants International Federation of accounts Certified Public Accounts Institute of Internal Auditors Substantial Package for Social Sciences International Standards of Auditing Chief Executive Officer International Reporting Standard United States of America General Accounting Office German International Accounting Standards

CHAPTER ONE 1.0 INTRODUCTION OVERVIEW This chapter on introduction covers the following: Research Background Research Problem Statement Research Objectives

Research Questions Importance of the study 1.1 RESEARCH BACKGROUND According to the GIAS (2001) Internal Audit is an objective and independent appraisal service within an organization on risk management, control and governance by measuring and evaluating their effectiveness in achieving the organizations agreed objectives. In addition, internal audits findings are beneficial to the Board of Directors and line management in the audited areas. The service applies the professional skills of internal audit through systematic and disciplined evaluation of the policies, procedures and operations that management put in place to ensure the achievement of the organizations objectives, and through recommendations for improvement.

4

For most of its history internal auditing as served as a simple administrative procedure comprised mainly of checking documents, counting assets, and reporting to Board of Directors, Management or External Auditors. In recent times, however, a combination of different forces has led to a quiet revolution of the profession. Organizations have to demonstrate accountability in the use of shareholders money and efficiency in the delivery of services. Organizations now demand great competency and professionalism from internal auditing, and scarce resources must be deployed more efficiently to minimize and manage risks. Technological advancement makes it possible to track and analyze data with continually increasing speed thus making it essential for organizations to be well advised by the internal audit department. Internal auditing varies from one organization to another, and making change to modern internal auditing can be a substantial undertaking. The transition from merely ensuring compliance with rules and regulations to truly delivering added value requires more than just organizational changes. In many organizations staff is poorly paid and unmotivated, ethical standards are weak, and governance practices are ineffective. Furthermore, many organizations lack support from senior management and regulatory bodies, and in most cases the internal audit function is often anything but independent. This research study will be based on K-Rep bank ltd in general but its Internal Audit Department in specific. K-Rep was founded in 1984 as an intermediary organization to address the financial, management and technical shortfall experienced by existing nongovernmental organizations (NGOs) involved in small and micro-enterprise after a study conducted in 1983 to assess the institutional needs of NGOs by USAID. At that time, USAIDs interest was to promote micro-enterprise development globally as means of poverty alleviation. Starting as a fiveyear project, the Rural Private Enterprise project, a private voluntary organization of the World Education Inc. based in Boston, with a strong focus on the development of small micro-enterprises in the rural areas, KRep provided 100% grants to other non-governmental organizations for onlending to small and micro-enterprises.K-Rep then entered into another five-year cooperative agreement with USAID in 1987 named Private Enterprise Development (PED) project. With a well-founded support from USAID, PED was registered as WEREP a Kenyan owned company limited by guarantee and with no share capital. In 1992, WEREP changed its name to K-Rep, an abbreviation for Kenya Rural Enterprise Programme. Change in Operations

5

PED facilitated the growth of the K-Rep Group since it provided K-Rep with an identity, authority and autonomy for making independent decisions with which KRep instituted several changes in its operations. For example, K-Rep reduced its involvement with non-governmental organizations; changed its approach of providing 100% grants to non governmental organizations to 30%; made the non governmental organizations accountable for any funds given; adopted a minimalist approach by eliminating all other technical support other than those related to credit management; engaged in direct lending; developed in house training and indulged more in research activities. Eventually, K-Rep ceased wholesale lending to other non-governmental organizations and concentrated on retail and direct lending. K-Rep Activities K-Rep activities were distinctly categorized into two divisions: financial and non financial divisions.

(i) The financial division dealt with both retail and wholesale lending, through the latter was ceased in 1994. K-Rep financial division generated some income through interest rate earnings, which was ploughed back to the program. K-Reps goal was not to maximize profits but to ensure sustainability. (ii) The research and evaluation department monitored the performance of the credit program providing recommendations and policies. Research was conducted to deeply understand the small and micro-enterprises operations and results used to expand the program. Consulting services on the other hand involved extending advisory services to other organizations interested in designing, implementing and researching micro-enterprise related development activities. The popularity and growth of consulting services stemmed from the wealth experience that K-Rep had gathered over many years. Today the financial division is now known as K-Rep Bank Limited, the first microfinance bank in Kenya. The non-financial services division is now KRep Development Agency, the research and development arm. K-Rep Advisory Services Limited, the consulting and business development arm and K-Rep Fedha Services Ltd,offers management services to Financial Services Associations .

T 1.2 RESEARCH PROBLEM STATEMENT Internal audit operations and recommendations do not only have short-term effect on the running of an organization but is the backbone of an organization and it dictates the prosperity or the down fall of the particular organization. Its effectiveness and acceptability should be stressed at all levels and especially the management to enhance its viability. However it seems that laxity has crept in and it is in light of this view that we seek to analyze the factors affecting implementation of internal audit reports in Kenyan organizations and more specifically K-Rep bank ltd.

6

1.3 RESEARCH OBJECTIVES 1. 2. 3. To identify the factors affecting implementation of Internal Audit Reports To identify the role and functions of internal audit department. To identify the effectiveness of the internal audit department, that is, to examine to what extent the management and/or the external auditors implement the internal audits reports and recommendations. 4. To establish ways and means of strengthening the internal audit department.

1.4 RESEARCH QUESTIONS 1. 2. 3. 4. What are the factors affecting implementation of internal auditors reports? What is the scope and purpose of the internal audit department and how independent is it? To what extent are the audits reports implemented or effected by the management or Board of Directors? What are the challenges and weakness of the internal audit department?

1.5 IMPORTANCE OF THE STUDY This study will help in increasing the role and image of internal auditing in K-Rep Ltd to make it more effective and professional This study will help the shareholders appreciate the role of the internal audit department as one of the most important managerial control systems in an organization required to safeguard their interests To look for ways of making Internal Audit department a completely independent group, completely separated from the management thus making it more effective. For scholars it will help them to appreciate and enhance their knowledge of internal auditing so as to adhere to the professional ethics as required by the IAS. .

7

CHAPTER TWO 2.0. LITERATURE REVIEW 2.1 THE ORIGIN OF AUDITING According to Walter W.BIGG (1972), the origin of auditing had its origin in the necessity for the institution of some system of check upon persons whose business it was to record the receipt and disbursement of money on behalf of others. In the early stages of civilization the methods of account were so crude, and the number of transactions to be recorded so small, that each individual was no doubt able to check for himself all his transactions, but as soon as the ancient States and Empires acquired any coherent organizations, systems of check were applied to their public accounts, as

8

evidenced by exact records; the ancient Egyptians, the Greek and the Romans, all utilized systems of check and counter-check as between the various financial officials.

It was not until the fifteenth century that the great impetus given to trade and commerce generally by the Renaissance in Italy led to the evolution of a system of accounts which was capable of recording completely all kinds of mercantile transactions, and the principles of double entry were first published in 1494 at Venice by Luca Pacioli, although the system had been more or less utilized during the preceding century. It thus became possible to record not only cash transactions, but also all transactions involving matters of account, and the duties of the auditor correspondingly increased. The increase in volume of trading operations, necessitating the use of more capital than was the disposal of the average trader, induced him to combine in partnership with others for the purpose of obtaining the requisite funds, and this tendency was a potent factor in the evolution of a more perfect system of accounts. In the same way, no doubt, it had a material effect on the practice of auditing, but the audit of business accounts did not become common until the Nineteenth century. The enormous increase in trade in that period, which was fostered by the discovery of steam power and by mechanical inventions generally, led to the formation of numerous joint stock companies, and other corporate undertakings, involving the use of large sums of capital under the management of a few individuals. Under these conditions the advantages to be obtained from utilizing the services of auditors became apparent to the commercial public generally, and a great increase in the practice of auditing resulted; at the present day it forms the most important part of a professional accountants practice. 2.2. HISTORICAL DEVELOPMENT According to Howard F.Stettler (1977), internal auditing appeared on the business scene much later than auditing by public accountants. The principle factor in its emergence was the extended span of control faced by management in concerns employing thousands of people and conducting operations from widespread locations. Defalcations and improperly maintained accounting records were obvious problems under these circumstances, and the growth in the volume of transactions presaged a substantial bill for public accounting services for the businesses that endeavored to solve the problem by continuing the traditional form of audit by the public accountant. The solution was, of course, to provide the needed auditing service on an internal basis, particularly as the magnitude of the problem made it possible for one or more persons to specialize in such auditing

9

services and devote their full time to needs of a single company. Other advantages also resulted from an internal approach to the problem: internal auditors tended to become better acquainted with the procedures and problems of the company, and the auditing activity could be carried on continuously, rather than once a year when outside auditing services were utilized. As a further inducement to the development of internal auditing, public accountants were at about this same time finding an increasing demand for independent audits leading to the expression of an opinion on financial statements, and they recognized that they could seldom perform the older type of detailed verification as effectively or efficiently as could the companys own specialist. Railroads were one of the first groups to employ internal auditors, although as the practice developed at the turn of the century, the title customarily used was `traveling auditors. The traveling auditors main function was to visit the railroads ticket agents and determine that all tickets and cash had been properly accounted for. The scope of internal auditing services that developed from this elementary beginning is set forth in succeeding sections of this chapter.

2.3. STATEMENT OF RESPONSIBILITY (Stettler, 1977) suggested of the relatively recent origin and maturation of internal auditing was the fact that the first extensive treatise on the subject was published in 1941, and that year also marked the formation of a national organization of internal auditors- The Institute of Internal Auditors. In the intervening years the institute has incorporated, has become international in scope, and has developed a professional examination program leading to the designation Certified Internal Auditor. The institute, understandably, held a relatively advanced concept of the internal auditors function in business and the responsibilities associated with that function, and the 1971 revision of the 1947 statement of the institute in this connection represented a useful starting point for a discussion of internal auditing.

2.4. DEFINITION OF AUDITING According to Jach C. Roberston(1976),Auditing may be defined in several ways depending upon what purpose is to be served. Four definitions are given below, beginning with the most general one produced by a committee of the American Accounting Association. The latter three definitions exhibit three different purposes served by independent auditors, and governmental auditors.

10

Auditing is a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users. (The AAA committee on basic auditing concepts (1971)) The American Accounting Association definition discussed above is broad and general enough to encompass all auditing activity. However, other definitions also exist. Presented below are three definitions promulgated by organizations that have direct professional responsibility for the practice of auditing. CONTROLLER GENERAL OF THE UNITED STATES (GAO) The U.S. Comptroller General is the chief executive officer of the U.S. General Accounting Office, which is an accounting, auditing and investigative agency of the U.S. Congress. The first basic premise given in the 1972 statement entitled Standards For Audit of Governmental Organizations, Programs, Activities and Functions expresses a broad description of governmental auditing. The term audit may be used to describe not only work done by accountants in examining financial reports but also work done in reviewing (a) compliance with applicable laws and regulations, (b) efficiency and economy of operations, and (c) effectiveness in achieving program results. The GAO considers auditing not as restricted to financial reports alone, as is implied by the AICPA statements, but extends audit interest to three elemental areas. The 1972 standards report defines each of these elements as follows; Financial and compliance-determines (a) whether financial operations are properly conducted, (b) whether the financial reports of an audited entity are presented fairly, and (c) whether the entity has complied with applicable laws and regulations. Economy and efficiency- determines whether the entity is managing or utilizing its resources (personnel, property, space and so forth) in an economical and efficient manner and the causes of any inefficiencies or uneconomical practices including inadequacies in management information systems, administrative procedures, or organizational structure. Program results-determine whether the desired results or benefits are being achieved, whether the objectives established by the legislative or other authorizing body are being met, and whether the agency has considered alternatives, which might yield results at a lower cost.

11

THE INSTITUTE OF INTERNAL AUDITORS (IIA) The institute of Internal Auditors has officially adopted a statement of responsibilities of the internal auditor (modified in 1947, 1957, and 1971). The definition of auditing offered therein is as follows: Internal auditing is an independent appraisal activity within an organization for the review of operations as a service to management. It is a managerial control, which functions by measuring and evaluating the effectiveness of other controls. Internal auditors view auditing as extremely broad, as does the GAO reaching not only to accounting data but also to compliance, control effectiveness, and performance quality. The internal auditors also add new dimension-reports recommending operating improvements. The full statement of responsibilities of the internal auditor contains a concise description of internal auditing. Observation on Definitions In comparison to the GAO and Internal Auditors, the AICPAs definition appears to recognize only a small portion of audit practice possibilities. Such an observation is literally accurate. However, the GAO and IIA statements of definition and objective serve to define all professional practice of governmental auditors and internal auditors. Likewise the AAA definition is stated broadly to include a wide variety of auditing practice. In contrast the AICPA definition pertains to only one part of the professional practice of Certified Public Accountants. Many CPA firms perform the same tasks as governmental auditors and internal auditors, but such engagements are either performed as management advisory services or are audits in every sense of the broadest definition except for the absence of the attestation report. Independent CPAs generally are reluctant to call an engagement an audit unless its end product is an attestation opinion, regardless of the substantive nature of the work performed. The principal reasons for this reluctance have to do with legal liability questions. 2.5 DEFINITION OF OTHER TERMS INTERNAL AUDITORS

12

These are employees within an organization whose primary responsibility is to determine whether organizational policies and procedures are being carried out correctly and to safeguard organizational assets as well as assessing the efficiency of internal control system. INTERNAL CONTROL SYSTEM Many accounting institutions such as ICPAK, IASC and AICPA define internal control system as the whole system of controls, financial and otherwise established by management in order to carry on the business of the entity in an orderly and efficient manner, ensure adherence to management policies, safeguard the assets secure as far as possible the completeness and accuracy of the records, the individual components are known as internal controls. According to ISA 315 internal control system is the process designed and effected by those charged with governance, management and other personnel to provide reasonable assurance about the achievement of the entities objective with regard to financial reporting, effectiveness and efficiency of operations and compliance with a appropriate laws and regulations. AUDIT COMMITTEE This is a committee consisting primarily of non-executive Directors, which is able to view a companys affairs in a detached and independent way and liaise effectiveness between the main board of directors and the external auditors. AUDITNG PROCEDURES: AICPA (1963) Defines auditing procedures as the acts performed by the auditor in the courser of attaining the objectives of the examination of financial statements

2.6 NEWLY DEFINED INTERNAL AUDIT FUNCTION (Albert L. Nagy, William J. Cenker) in their research, An assessment of the newly defined internal audit function, presented some insight and opinions about the newly defined internal audit function and related issues from several internal audit directors of large companies. As the above responses reflect, the internal audit function varies significantly among companies from a traditional assurance orientation to that of a value-added and consulting orientation, with most companies landing somewhere in the middle. Furthermore, the orientation or role of internal auditing appears to be

13

determined primarily by management, and not from the profession, internal audit professionals, or the audit committee. Some of the interviewed directors raise the question of whether the internal audit function could and/or should be defined by the profession in the first place. These directors believe that top management is appropriately defining their organizations internal audit function, and that the profession should concentrate its efforts on providing guidance and support. Despite this viewpoint, the directors responses suggest that most of their internal audit departments have shifted toward a more value- added or operational focus, which is consistent with the new definition. Therefore, the new audit definition appears to better describe the current practice of internal auditing, at least among the organizations included in this study, even if it may be a few years late in coming. A concern expressed by several of the directors is whether the internal audit department and the external auditor adequately coordinated their efforts to address the recent shift in internal audits focus toward operations. That is, because of limited resources most internal audit departments were forced to reduce their level of traditional assurance services as a result of their shift in orientation. Ideally, the external auditor would increase their level of assurance testing in order to compensate for internal audits reduction in this area. Unfortunately, most of the interviewed directors believe that this is not occurring, especially in the area of reviewing the quarterly statements. We encourage future research to address this area. All but one of the directors do not feel threatened or feel an increased need to justify their services to top management and believe that management respects and understands the value of the services that internal audit provides. The directors support the new internal audit definitions suggestion that risk assessment is a key function of internal audit. Interestingly, however, those directors from companies that have formal risk assessment departments indicate that the level of coordination between internal audit and the risk assessment department is minimal at best. The responses also suggest that the internal audit department are capable and have an adequate level of expertise to carry out proper risk assessment procedures. Given the wide variety of risk assessment techniques employed by the sampled companies, the directors are apparently still searching for the most effective risk assessment method. We encourage future research to aid the internal auditing profession in identifying and assessing effective risk assessment methods and techniques. 2.7 FACTORS INFLUENCING AUDIT FUNCTION The auditor should consider several major factors (discussed below) when performing the auditing function.

14

I)

INTEGRITY OF MANAGEMENT

When one or a few individuals who lack integrity dominate management, the likelihood of significantly misrepresented financial statements auditors function. When management has an adequate level of integrity for the auditor to accept the engagement (Willingham, 1971) but cannot be regarded as completely honest in all dealings, auditors normally reduce acceptance audit risk and also increase inherent risk. II) RESULTS OF PREVIOUS AUDITORS is greatly increased. The integrity of management affects the

Misstatements found in the previous years audit have a high likelihood of occurring again in the current years audit. This is because many types of misstatements are systematic in nature and organizations are often slow in making changes to eliminate them. Therefore, an auditor would be negligent if the results of the preceding years audit were ignored during the development of the current years audit program. MANAGEMENT STRUCTURE If a small number of individuals dominate the management of a company without an effective oversight or board, there may be an increased risk of error. III) CHANGES IN BUSINESS

When significant changes occur it may be more difficult to report accurate financial information because of a lack of familiarity with new types of transactions or a new line of business. IV) CLIENTS CONCERNS ON INTERNAL CONTROL STRUCTURE

Many companies establish a system for control so as to help in meeting its own goals. The system consists of many specific policies and procedures designed to provide management with reasonable assurance that the goals and objectives will be met (Cecil, 1985). 2.8 INDEPENDENCE OF AUDITOR:

15

According to the Institute of Internal Auditors (UK) in the book Standards For The Professional Practice Of Internal Auditing (1979), internal auditors must be independent of the activities they audit. Such independence permits internal auditors to perform their work freely and objectively. Without independence, the desired results of internal auditing cannot be realized. In setting these standards the following developments were considered. Boards of directors are being held increasingly accountable for the adequacy and effectiveness of their organizations systems of internal control and quality of performance. Members of management are demonstrating increased acceptance of internal auditing as a means of supplying objective analysis, appraisals, recommendations, counsel and information on the organizations control and performance. External auditors are using the results of internal audits to complement their own work where the internal auditors have provided suitable evidence of the independence and adequate, professional audit work. 2.9 INTERNAL AUDITING This has been defined by the institute of internal auditors a a series of processes and techniques through which an organizations own employees ascertain for the management by means of first hand observation on the job whether established management controls are adequate and are effectively maintained, record and reports reflect actual operations accurately and promptly and that each division, department or other unit is carrying out the plans, policies and procedures for which it is responsible. According the Institute of internal Auditors (ISA 610), internal auditing is defined as an independent, objective, consulting and accurate activity designed to add value in an organization; they improve the organization by reviewing the operational effectiveness and efficiency of the internal control systems contribute to the governance process and ensuring compliance with laws and regulations. 2.10 ROLE OF THE INTERNAL AUDIT According to Cooper and Craig (1983): this was the first known empirical study on the role of internal audit in the Asia Pacific region. This seminal research on internal audit in Australia found a number of issues that were of concern to the profession. It was found that there were a number of misconceptions about what internal auditors were doing and what their chief executive officers (CEO) perceived was being done and in fact there were expectations by the CEOs that internal audit could do more than the traditional financial auditing work mainly being done at the time. There was nevertheless strong support

16

for internal audit by CEOs and at the time it was seen as offering long-term career prospects. However, the profession in Australia in the early 1980s suffered from an image problem, it did not have a strong professional body to represent its interests as it has now, and there were no generally accepted professional qualifications recognized as necessary to practice as an internal auditor. The study was undertaken before the development of modern internal auditing, as we know it now. It did, however, set the scene for a number of subsequent studies in Australia, Hong Kong and Malaysia. According to Van Peursem (2004), a major study has been undertaken in New Zealand on internal auditors role and authority. In this study, internal auditors are asked to come to a view on whether functions they perform in connection with audit engagements are essential, and to what degree they feel they enjoy the authority over, and independence from, management that we might expect of a professional. The research constituted a survey of New Zealand auditors, all of whom were members of the New Zealand branch of the IIA. A very high percent (73%) response rate was achieved over the original and follow-up survey. The study found that characteristics of a true profession exist but do not dominate. Significantly, and as subgroups, Van Peursem (2004) also observed that public practice and experienced auditors may enjoy greater influence over management, and accountancy-trained auditors may enjoy greater status owing to the mystique of the activities emanating from their membership of well-known accountancy professional bodies. The research supports prior studies by Coopers and Craig (1983), Cooper et al. (1966) and Myers and Gramling (1997), which all expressed serious reservations about the effectiveness of the internal auditors role. In a follow up study in New Zealand, Van Peursem (2005) examined the role of the New Zealand internal auditor and conceptualizes on the auditors influence over that role. The fundamental question is how an effective internal auditor can overcome the tension of working with management to improve performance, while also remaining sufficiently distant from management in order to report on their performance. The research found that there are three concepts characteristic of those who best balanced their role: the internal auditor external professional status; the presence of a formal and an informal communication network; and the internal auditors place in determining their own role. Informing these concepts is the auditors ability to manage ambiguity. This was a qualitative study using a multiple case-based approach in which the researcher made observations, examined documents and interviewed senior internal auditors in six New Zealand organizations. However, it is a very thorough study and offers insights arguably not readily available in more traditional quantitative research. 2.11 SCOPE AND OBJECTIVES OF INTERNAL AUDITING 1) Facilitate the integrity and reliability of the financial statements by ensuring that: The financial statements have been prepared in compliance with IAS and IFRS

17

Safeguarding the companys assets by ensuring that proper records are maintained to proof their existence and periodic physical count to ensure the assets are in existence and their conditions are okay. Ensure compliance with the relevant laws and regulations and in the event of breaches the financial statements should disclose such.

2) Review the operational effectiveness and efficiency and ensure economic utilization of resources, targets of the economy are achieved and managers display efficiency in discharging their duties. 3) Review the accounting system in use and the related internal control system to ensure their design and effectiveness are suitable, monitor their operations and recommend improvements thereto. 4) Assist in the governance process. Governance process is the way the board of directors manage the affairs of the company. Internal audit contributes by doing the following: Ensure adherence to the code of conduct and promote the ethical culture. Assist the Board Of Directors to discharge their duties ethically by informing them of the weaknesses and recommendations of the strategies employed. Ensure the recommendations of the external auditors are implemented within the prescribed/reasonable time. Internal auditors are secretaries to the audit committees and acts as a link person between external auditors and audit committees 2.12. QUALITIES OF AN EFFECTIVE INTERNAL AUDIT DEPARTMENT The institute of internal Audits practice standard (1980) includes five categories of guidance that takes into consideration financial and operational auditing, independence, professional proficiency, scope of work, performance of audit and management of their internal auditing department. 1. Independence: This is an essential element to the effectiveness of the internal auditing function and requires internal auditor to the independent of all the activities that they may be required to audit. 2. Competent personnel: The proper functioning of any system depends on the competence and integrity of those operating it. The staff employed should therefore be competent and experienced in their files. If need be, staff should be continuously updated through in house and /or off the job training. 3. 4. Professional proficiency: internal audits should therefore be performed with proficiency and due professional care Scope of work: The scope of work of the internal audit department should encompass the examination and evaluation of the adequacy and effectiveness of the organizations system of internal control and the quality of performance in carrying out assigned responsibilities.

18

5.

Programmes for review:

The internal audit department should have comprehensive

programmes so as to ensure that no major aspect of operations is overlooked. The department should avoid being involved in activities not falling within their audit to function as this may prevent it from following their normal programme closely. Collect, analyze, interpret and document information to support audit results. Report 6. Report: Proper reports should be written after every audit and communicated periodically to all interested parties within the organization. Recommendations made on such reports should e clear and achievable. 2.13 GENERAL ADVANTAGES OF AN AUDIT The institute of internal auditors-Standards For The Professional Practice Of Internal Auditing (1979) gives a number of inherent advantages in having accounts audited, even where there is no statutory provision for this to be done. Disputes between partners regarding the accounts may be largely avoided, especially where complicated profit-sharing arrangements subsist. The admission of a new partner is facilitated if sets of audited historical accounts are available for examination. Any partnership change (i.e. death, retirement or alteration of profit sharing) will require to be reflected in the accounts, and its usual for the partnership assets, including goodwill to be revalued at such a time. Since such revaluations directly affect the respective shares of each partner, its advisable to have the post charge Accounts audited. Applications to banks and other outside parties for the purpose of raising funds are greatly enhanced by the availability of audited Accounts. Audited Accounts (albeit adjusted) submitted to the Inland Revenue for tax assessment purposes carry greater authority than accounts, which have not been audited. The presence of a qualified auditor is useful because o the variety of other capacities in which he is able to assist. In addition, a number of partnerships and other agreements incorporate a provision for the auditor to act as arbitrator in the event of dispute on specified issues. 2.14 TYPES OF AUDITS According to Emile Woolf (1990), audits are viewed as falling into three major types:

19

Audit of Financial Statements-this covers the balance sheet and the related statements of income, retained earnings, and changes in financial position. The goal is to determine whether these statements have been prepared in conformity with GAAPs. Firms of Certified Public Accountants normally perform financial statements audits; the user groups include management, investors, bankers, creditors, financial analysts and government agencies. Compliance Audits- This is dependent upon the existent of verifiable data and of recognized criteria or standards, established by an authoritative body. A familiar example is the audit of an income tax return by an auditor of the Internal Revenue Service (IRS). Such audits seek to determine whether a tax return is in compliance with tax and IRS regulations. Operational Audits- This is a study of some specific unit of an organization for the purpose of measuring its performance. The operations of the receiving department of a manufacturing company, for example, may be evaluated in terms of its effectiveness, i.e. its success in meeting its stated goals and responsibilities. Performance is also judged in terms of efficiency i.e. success in using to best advantage the resources available to the department. Because the criteria for effectiveness and efficiency are not as clearly established, as are Generally Accepted Accounting Principles, the operational audit tends to require more subjective judgments than do audits of financial statements or compliance audits. The end product of an operational audit is usually a report to management containing recommendation for improvement in operations. 2.15 GENERAL PRINCIPLES OF AN AUDIT The auditor should comply with the code of ethics for professional Accountants issued by the International Federation of Accountant. Ethical principles governing the auditors professional responsibilities are: Independence Integrity Objectivity Professional competence and due care Confidentiality Professional behavior Technical standards

20

The auditor should plan and perform an audit with an attitude of professional skepticism recognizing that circumstances may exist that cause the financial statements to be materially misstated. An attitude of professional skepticism means the auditor makes a critical assessment, with a questioning mind of the validity of audit evidence obtained and is alert to audit evidence that contradicts or brings into question the reliability of documents or management representations. 2.16 CRITICISMS OF INTERNAL AUDIT REPORTS Positive 1) 2) 3) 4) Negative 1) Audit reports may not give the holistic view of what is actually happening hence giving room for a material misstatement. 2) Auditor carrying out internal audit examination may be biased not to make negative opinions on areas especially touching the top management or fellow workmates in the organization. 2.17 THE AGENCY PROBLEM NEED FOR AUDITORS Berle and Means (1932) noted the consequences of separating ownership and control when they cautioned against separating owners and managers of firms. They established the basis for what became known as the agency theory that has since seen the establishment of internal audit committees and corporate governance policies in most organizations. For the agency problem to be solved there calls for an independent evaluation of the firms effectiveness, thus the need of auditing to ensure good governance, Taylor and Glezen (1985). Identify areas of weakness and internal control system within a good time. Adds strength to the existing mechanisms Audit reports prevent conflicts because they put into light possible disagreements between management and employees Saves an organization from conflicts of interest

2.18 THE AUDITOR AND MANAGEMENT OF CORPORATIONS Manasseh (2001) describes the managerial functions that are effected through the office of the internal auditor. By looking at the key managerial functions that determine a firms success, they emphasize the relevance of the auditing office in making sure that there is (1) An effective Organization plan (2) Proper record keeping (3) Segregation of duties to enhance accountability (4) Authorization (5)

21

Supervision of work (6) Safe guarding of assets (7) Well organized internal audit (8) competent staff are employed (9) proper accounting control Saleemi and Ajowi (2000) observed that the auditor has two sets of objectives to accomplish. These they group as; Primary objectives and Secondary objectives Primary objectives of the Auditor In describing the audit objectives, Saleemi and Ajowi (2000) explained that the auditor has statutory requirements to prove the true and fair view or otherwise of the companys state of affairs, to confirm that proper books of accounts are kept and to communicate his findings to the shareholders for effective decision making by the latter. Secondary objectives of the Auditor Saleemi and Ajowi (2000) further explains that other than the primary objectives, the auditors are required to perform the following; detect errors and fraud, prevent occurrence of errors and fraud, assist their clients improve their accounting systems and finding out whether there are proper systems of internal control in the clients firm. 2.19 AUDIT DEMAND Taylor and Glezen (1985) explain the demand for auditors as being aroused by the needs of the present and potential investors, and the need for stewardship accounting. They observed that it is the need of the auditor to provide the investors with unbiased expert opinion by examining the operations of the company. Hubbard T. D. (1983) observed that there exists conflict of interest between owners and managers, and that it is the responsibility of the auditor as a corporate strategist to resolve this conflicts. Taylor and Glezen (1985) describes the corporate functions of the auditor as to include; (a) Auditing, (b) Tax advisory services, (c) Management advisory services, and (d) Accounting services. 2.20. NATURE OF INTERNAL AUDIT REPORTS IN KENYAN ORGANIZATIONS The Companys Act CAP 486 states the following; Sec 156

22

(1)

The Profit and Loss account, and, so far as not incorporated in the Balance Sheet or Profit and Loss account, any group accounts laid before the company in general meeting shall be annexed to the balance sheet, and the auditors report shall be attached thereto.

(2) (3)

The board of directors shall approve any accounts so annexed before the balance sheet is signed on their behalf. If any copy of a balance sheet is issued, circulated or published without having annexed thereto a copy of the profit and loss account or any group accounts required by this section to be so annexed, or without having attached there to a copy of the auditors report, the company and every officer of the company who is in default shall be liable to a fine not exceeding one thousand shillings.

Sec 162 (1) The auditors shall make a report to the members on the accounts examined by them, and on every balance sheet, every profit and loss account and all group accounts laid before the company in general meetings during their tenure of office, and the report shall contain statements as to the matters mentioned in the 7th schedule. (2) (3) The auditors reports shall be read before the company in general meeting and shall be open to inspection by any member. Every auditor of a company shall have a right of access at all times to the books and accounts and vouchers of the company, and shall be entitled to require from the officers of the company such information and explanation as he thinks necessary for the performance of the duties of the auditors. (4) The auditors of a company shall be entitled to attend any general meeting of the company and to receive all notices of and other communication relating to any general meeting which any member of the company is entitled to receive and to be heard at any general meeting which they attend on any part of the business of the meeting which concerns them as auditors. According to the International Standards On Auditing (2005); NO. 86 Auditors report Basic elements Title Addressee Opening paragraph Scope paragraph Opinion paragraph Date, address and signature

23

No. 93 Other information The auditor should read the other information to identify material inconsistencies with the audited financial statements. No. 94 communication The auditor should report on a timely basis, to those charged with governance: Potential effect of any significant risks and exposures. Audit adjustments, whether recorded or not, that have or could have, a significant effect on the entity financial statements. Material uncertainties casting significant doubts on the entitys ability to continue as a going concern

No. 135 Auditors shall be appointed and their duties regulated in accordance with section 159 to 162 of the Act.

The (ISA) IAASB HAND BOOK has the following; OBJECTIVE OF AN AUDIT The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements are prepared in all material respects, in accordance with an identified financial reporting framework. The phase used to express the auditors opinion is give a true and fair view or present fairly, in all material respects which are equivalent terms. Although the auditors opinion enhances the credibility of the financial statements, the user cannot assume that the opinion is an assurance as to the future liability of the entity nor the efficiency or effectively with which management has conducted the affairs of the entity.

24

CHAPTER 3 3.0. RESEARCH METHODOLOGY 3.1 DESCRIPTION OF AREA OF STUDY The study will be conducted in Nanyuki. This is because it is convinient to the researcher and the targeted respondents are in great numbers here. This will thus enable/provide an easy way of data collection, location of respondents. 3.2 RESEARCH DESIGN A case study is to be developed on K-Rep bank Ltd. This is in line with Rist (1982) who asserts that case studies give an in-depth analysis of superficial statistical portrayal of populations. Hence case studies are commonly used in research. A policy research is the process of conducting research on or analysis of fundamental special problem in order to provide policy makers with action oriented recommendations or alleviating the problem. Maychvzak (1987). Hence the case study will enable the researcher to assess the internal audit procedures move critically and above all/answer the research questions. 3.3 TARGET POPULATION The population of interest in this study will consist of clients both coporate and retail that benefit from the services of K-rep bank Ltd, management and employees of K-Rep bank LTD at large and a selected number of auditors from the Institute of Internal Auditors (IIA)

3.4 SAMPLE OF THE STUDY/SAMPLING DESIGN The sample of the study will comprise of thirty-five respondents Table 1: categories of respondents categories sample size

25

managers employees IIA 3.5 INSTRUMENTS FOR DATA COLLECTION

5 25 10

Structured questionnaires will be used for data collection. They will have both open and close-ended questions. 3.6 PILOT STUDY A brief pilot study to test the validity and reliability of the questionnaire will be conducted using a small sample of 10 respondents (28.6%) of the sample size. This will be through issue of questionnaires to the various categories of respondents to pre determine the response rate. 3.7 PROCEDURE FOR DATA COLLECTION The study will purely rely on primary data. This will be collected by use of structured questionnaire. The researcher will administer these, and this is to be made effective by availability of the researcher to assist the respondents who will need classification on any questions. 3.8 DATA ANALYSIS The data collected will be analyzed by descriptive analysis. The data will then be presented in a tabular format to be generated by use of SPPSS (statistical package for social sciences) computer programme. There will be the use of mean, percentage and frequency. The mean will give the average of respondents who agree or disagree. The frequency will show how many times a certain factor appears and the parentage that agreed or disagrees on various issues. Other forms of data presentation will be the use of graphs, charts. These will assist/enable the researcher to come up with data that is easy to draw conclusions from.

26

REFERENCES AAA (1973), A Statement of Basic Auditing Concepts, Sarasota, Florida. AICPA, Statement on Auditing Procedure No. 33. Anderson R. J. (1984), The External Audit, 2nd edition Toronto Clarke Pitman. Barefield R. M. (1975). The Impact of audit frequency on the Quality of Internal Control AAA Brasseaux J. H. (1965) Readings in Auditing 2nd edition, south western publishing company, Cincinnati, Ohio. Burns W. H. and Waterhouse J. M. (1975) Budgetary Control and Organization Structures, Journal of Internal Control, AAA, Sarasota. Cadmus et al (1955) Internal Control Against fraud and Waste, Englewood Cliffs, Prentice hall, Inc. Cashin et al (1958) Internal Auditing. The Ronald Press Company, New York. Cecil G. (1985) Accounting systems, procedures and Methods, 3rd edition, Prentice Hall, India. Cockburn D. J. (1994) CA Magazine, august. Cooper D. R. & Emory C. W. (1995). Business Research Methods 5th edition Mcgraw Hill companies Inc. US. Gibson J. L. et al (1976) Organizations Behaviour Structure process. Business Publication, USA Harried A. and Imdieke F. (1988) Advanced Accounting, 4th edition. John Wiley and Sons Inc. Canada. Haskins M. E. (1987), Client Control Environment: An examination of Auditors Perception. The Accounting Review, July. . ICPAK (K), Kenya Auditing Guidelines : Operational No. 6, Nairobi. IFA (2000), Technical Pronouncements. Jensen D. L. et al (1980) Advanced Accounting 2nd edition Random House, USA

27

Loebecke et al (1994), Auditing: An Integrated approach, Prentice hall, Canada. Mautz R. K. (1964) Fundamental of Auditing 2nd edition New York, Wiley Meigs w. B. et al (1988), Principles of Auditing, 5th edition, Richard D. Irwin Inc. USA Millichamp (1996). Auditing: An Instructional Manual for Accounting Students, DP Publications. Scheneider A. (1988), The Management Accounting Magazine, July, the other side of Objectivity in operational auditing. Staffer H. f. (1980) Auditing Principles, Prentice Hall India. Stetler (1974) Systems Based Independent Audit 2nd edition Prentice hall inc. Englewood Cliffs. The Institute of I Internal Auditors Practice standards (1980). Wallance W. A. (1991) Auditing, 2nd edition Boston PWS, Kent Publishing Willingham J. J. (1971). Auditing concepts and Methods, New York, Mc graw Hill companies Inc, USA.

APPENDIX 1: INTRODUCTORY LETTER C/O BACHELOR OF COMMERCE OFFICE SCHOOL OF BUSINESS UNIVESITY OF NAIROBI P.O BOX 30197 NAIROBI------------------------------------------------------------------------------------------------------Dear Sir/ Madam RE: request for Research Data We are undergraduate students at the University of Nairobi(UON) pursuing a course leading to award of a Bachelor of Commerce Degree (BCOM). In partial fulfillment of the requirements of this course, we are conducting a study on analysis of factors affecting implementation of internal audit reports. The study will concentrate on activities of internal auditors. Your firm has been selected to form part of this study. We therefore kindly request you to assist by completing the attached questionnaire to the best of your knowledge.

28

The information required is purely for academic purpose and will be treated with strict confidentiality. A copy of the findings of this study will be made available to you upon your request. Thank you for your co-operation Names of students: Mary Kiarie Jane Mango Lincoln Gachuki Jesca Kochwa Faith Kibe APPENDIX 2: QUESTIONNAIRE The questionnaire below is in two parts. Part A is aimed at giving a general background of your organization. Part B is concerned with the operating procedures in your department Part A 1. [ [ [ [ ] ] Ownership (Please tick the appropriate) Foreign Partly local (.% ordinary shareholding) and partly foreign (.% Ordinary shareholding) ] government owned ] local (including jointly owned with government) Supervising Lecturer MR. Wainaina Gituro University of Nairobi P.O BOX 30197 NBI E-MAIL:wainainagituro@yahoo.com

2. [ [ [ [ 3. [ [ [ [

What is the industry classification of your company? (please tick one) ] Agricultural ] commercial and services ] finance and investment ] Industrial and allied For how long has your firm been operating in Kenya? (Please tick one) ] 1- 5 years ] 6 10 years ] 11 15 years ] over 15 years

29

4. [ [

Do you have an internal audit department (please tick one) ] Yes ] No

Part B 5. 6. 7. 8. What is the title of the person in charge of the internal audit department? ____________ To which position in the organization does the above in charge report? what was the total number of internal audit employees as at 31.12.2006 What is the qualification of your audit staff in numbers? The column shows academic

qualifications and rows shows the professional. If 10 employees are CPA (K) and have a first degree. Then put 10 where the two intersect. qualifications CPA (K) CPA 2 CPA 1 KATC others specify 9. [ [ [ [ O level a E I M Q A level b f j n r First degree c g k o s second degree d h i p t

Does the position occupied by your department in the overall organizational structure permit ] Yes ] No ] Yes ] No a.. b.. c.. d.. e.. f..

the department to accomplish its audit responsibilities? (please tick one)

10. Is the work performed checked by other people? (please tick one)

11. state the number of staff in your department falling within the following experience categories 0 1 years Over 1 year below 2 years Over 2 years below 3 years Over 3 years below 4 years Over 4 years below 5 years Over 5 years

12. How would you rate on average the familiarity of your staff with the professional code of conduct (Please tick one) [ [ [ ] very familiar ] Familiar ] Some how familiar

30

[

] Not familiar

13. Which of the methods below do your staff use in communicating with each other (Please tick one) [ [ [ ] mostly memos ] Memos and personal discussion ] Mostly personal discussions

14. How frequently do your staff including yourself participate in CPE (continuous professional education) (Please tick one) [ [ [ ] All CPE programmes ] Some ] None of internal audit tests carried out in the firm by your

15. how would you rank the extent department (Please tick one) [ [ [ [ 16. ] Very expensive ] expensive ] Somehow expensive ] Not expensive

How frequently do you and your staff attend seminars on auditing? (Please tick one) [ [ [ ] Frequently ] Occasionally ] Infrequently

17.

Who in your firm performs the following functions (please tick in each category as appropriate) Both internal auditor & dept. heads a. establishes control b. Reviews control Verifies the e f g h the a external auditor only b Internal only c d auditor Only dept heads

system of internal

system of internal c. the i j k l

31

reliability accuracy records d. accounts Ensures compliance

and of and m with n o p

policies, laws and procedures f. Determines what to audit g. Ensures economic use of resources 18. Do you use audit programmes in performing your audits? Please tick one [ [ 19. ] Yes ] No U Y v z w aa x bb

In what form is your work communicated to your boss? (please tick one) [ [ [ ] Written report ] Verbally during meetings ] Both oral and written

20.

where you have made recommendations do management allow you to follow up to ensure compliance (please tick one) [ [ ] Yes ] No

21.

How do your external auditors perform their audit work? (Please tick one) [ [ [ [ ] They have their own approach ] they always take my word ] They take my word in some cases only ] I do some work for them.

22.

do you review all aspects of the organization (Please tick one) [ [ ] Yes ] No

23.

If no state the areas that you do not audit

32

_________________________________________________________________ _________________________________________________________________ _________________________________________________________________ Thank you for your co-operation.

APPENDIX 3: PROPOSED BUDGET PLAN 'ITEMS TRAVELLING COSTS DATA COLLECTIONS AND ANALYSIS PRINTING, STATIONERY AND BINDING CONTIGENCIES 1000 TOTAL 9000 'COST (KSHS) 5000 2000 1500

APPENDIX 4: TIME SCHEDULE FOR THE RESEARCH:APRIL - AUG 2010 APRIL RESEARCH PROBLEM FORMULATION MAY JUNE JUL AUG

33

LITERATURE REVIEW

PROPOSAL WRITING

DATA COLLECTION

DATA ANALYSIS

REPORT WRITING

34