Internal Audit Effectiveness As A Tool For Improving The Financial Performance Of A Company On

The Nigerian Manufacturing Industry.

Accounting Project Topics

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CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

Most research has proven to show what efficiency is to a Company but has failed to show it
effectiveness. While they sound similar, effectiveness means something entirely different than
efficiency. Effectiveness is the level of results from the actions of employees and managers, while
Efficiency in the workplace is the time it takes to do something. An effective employee produces at a
high level, while an efficient employee produces quickly and intelligently. (Adeyeye, 2017)

According to Robertson (1976), Internal Auditing may be defined in several ways depending upon
what purpose is to be served. Pickett (1976), stated that ―internal audit is an independent,
objective assurance and consulting activity designed to add value and improve an organization‘s
operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined
approach to evaluate and improve the effectiveness of risk management, control, and governance
processes. This definition actually seeks to demonstrate the depth and breadth of the internal audit
activity within an institution as against the previous orientation of reviewing payment transactions
over the years.

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 organization‘s agreed objectives. In addition, internal audit‘s 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 organization‘s objectives,
and through recommendations for improvement (Dumitrescu, 2004).

Most internal audit professionals argue that an effective internal audit function correlates with
improved financial performance. According to Bejide (2006), an effective internal audit service can, in
particular, help reduce overhead, identify ways to improve efficiency and maximize exposure to
possible losses from inadequately safeguarded company assets all of which can have a significant
effect on the bottom line. Similarly, Venables and Impey (1991) had stated that internal audit is an
“invaluable tool of management for improving performance”. Fadzil (2005) had also noted that
internal auditors help run a company more efficiently and effectively to increase shareholders’
value”. And Hermanson and Rittenberg (2003) had argued that the existence of an effective internal
audit function is associated with superior organizational performance.

At the empirical level, a survey conducted by KPMG (1999) found that the internal audit function in
organizations where it exists, contributes substantially to performance improvement and assist in
identifying profit evidence in corporate disasters, particularly financial fraud consistently documents
an association between weak governance (e.g. less independent boards or the absence of an internal
audit function) and the incidence of problems (e.g. Dechow, 1996; Beasley, 1996, Beasley 2000;
Abott 2000). Thus, internal audit by acting as a watchdog could save the organization from
malpractices and irregularities thus enabling the organization to achieve its objectives of ensuring
high level of productivity and profit.

Internal auditing is an independent, objective assurance and consulting activity designed to add
value and improve an organization’s operations (Institute of Internal auditors (IIA), 1999). The scope
of internal audit should be to cover the systematic review, appraising and appraising and reporting
on adequacy of systems of managerial, financial, operational and budgetary controls and their
reliability in practice (ACCA Internal Audit bulletin, 1999).

The financial statement audit is a monitoring mechanism that helps reduce information asymmetry
and protect the interests of the various stakeholders by providing reasonable assurance that the
management’s financial statements are free from material misstatements. The societal role of
auditors should be a key contribution to financial performance, in terms of reducing the risks of
significant misstatements and by ensuring that the financial statements are elaborated according to
preset rules and regulations. Lower risks on misstatements increase confidence in capital markets,
which in turn lowers the cost of capital for firms (Heil, 2012; Watts and Zimmerman, 1986)

The basic purpose of financial statements in the view of Meigs and Meigs (1981) is to assist decision
makers in evaluating the financial strength, profitability and the future prospects of a business entity.
The basic objective for preparing financial statement is to provide information useful for making
economic decisions. The objective of an audit of financial statements is to enable the auditor express
an opinion whether the financial statements are prepared in all material respects and also in
accordance with auditing standard.

The function of auditing is to lend credibility to the financial statement. The financial statements
preparation is the responsibility of the management, while auditor responsibility is to lend credibility
of the financial statements. The auditor also increases the credibility of other non-audited
information which is released by the management. For an audit to be credible and reliable, it must
be performed by someone who is independent and cannot be influence by position, power which
will affect its own conclusion. The securities exchange commission approved new auditor
independence regulation which requires that traded companies should disclose the level of fees that
were paid to their external auditor for non-audit services. (Olagunju, 2011)

1.2 Statement of the Problem

In developing countries like Nigeria, a company whether large, medium or small face the special
problem of audit ineffectiveness. These problems which include incomplete recording of accounts,
poor attitude to adhere to the accounting standards and guideline coupled with incessant fraud and
defalcation have warranted that the techniques of audit should be mastered by accountants.

Financial reports as stated in Igben (1999) are meant to be a formal record of business activities and
these reports are meant to provide an overview of the financial position and profitability in both
short and long term of companies to the users of these financial statements such as shareholders,
managers, employees, tax analyst, banks, etc. But in recent times, the financial manipulations, weak
internal control systems, ignorance on the part of the board of directors and audit committee,
manipulation on the part of the reporting auditor and other fraudulent activities that occur within
companies, creating a negative goodwill to the general public. A typical example of a financial
statement malfunction is the popular case of Enron. Enron was one of the largest energy companies
in the US. By fraud and bribery, Enron executives avoided income taxes, and this lead to the downfall
of this multi-billion dollar firm. Importantly, this wasn’t the first; a similar case appeared in 1973,
when equity funding, an insurance firm located in Los Angeles went bankrupt (Mclean and Elkin,
2003). In fact every year, a new business fraud is unravelled, often with similar components:
corporate instability, uniformed accountants, high-level connections, and broke investors (Swartz and
Watkins, 2003).

Enron started in July 1985 when Omaha-based inter-north merged with Houston natural gas.
Kenneth lay, who had originally held positions in academia and the government, became chief
executive and chairman. By 2001, Enron had grown to one of the largest energy companies in the
world (Mclean and Elkin, 2003). However, the company sudden by unravelled and collapsed.

Some other examples of corporate failure on the local scene are Lever plc. now Unilever in (1998)
and African Petroleum (2000). From the above discussions, there is need to ensure credibility of
financial statement of companies in order to increase users confidence and thereby affecting
investors behavior. This study seeks to investigate how Auditors Independence, Professional
Competence of an auditor and proper Audit Check affects the financial performance of an
Organization.

1.3 Objectives of the Study

The main objective of this study was to evaluate and determine the Internal Audit Effectiveness on
the Financial Performance of a Company. The specific objectives are to:

i. Examine the contributions of auditor’s independence on the financial performance of the

ii. Determine the effect of the Professional Competence of an auditor on the financial
performance of a company.

iii. Examine how Audit Checks affects the Financial Performance of a Company.

1.4 Research Questions

In order to give direction to the study, the following questions were answered in the course of
carrying out the study:

1. What effect do the contributions of auditor’s independence have on the financial

2. What impact does the professional competence of an auditor have on the financial
performance of a company?

3. How does audit checks affects the Financial Performance of a Company?

1.5 Research Hypotheses

In carrying out this study, the hypotheses were formulated in line with the specific objectives.

Hypothesis one
H0: There is no significant relationship between the contributions of auditor’s independence and the
financial performance of the company.

H1: There is a significant relationship between the contributions of auditor’s independence and the
financial performance of the company

Hypothesis Two

H0: There is no significant relationship between the Professional Competence of an auditor and the
financial performance of a company

H1: There is a significant relationship between the Professional Competence of an auditor and the
financial performance of a company

Hypothesis Three

Ho: There is no significant relationship between audit Checks and the Financial Performance of a
Company.

H1: There is a significant relationship between audit Checks and the Financial Performance of a
Company.

1.6 Significance of the Study

Considering the above aims and objectives, there is the need to inform other users of the company’s
financial information on the effectiveness of internal audit as the tool for improving company’s
financial performance. The aim of this research is to show how an effective internal audit can prevent
fraud because if fraud is detected and prevented on time, the corporate objective will be attained on
time.

This research work will also be of benefit to the Manufacturers Association of Nigeria (MAN). MAN
prides itself on its ability to advocate policy, business information and development, etc. This
research work will help them in the area of policy making.

Audit is an effective tool for a Business Management, as internal audit is conducted in order to
ensure the policies are being followed. It also aims at showing how an effective audit will increase
the performance of a company and also enable them to make valuable suggestions for improvement
and to formulate future policies of a business.

In view of this, the researcher seeks to investigate the effectiveness of internal audit to a company.

The study will further be of use to other researchers who will embark on this topic, building on any
gap found in it, or diversifying to any part that is not touched by reason of the research.

1.7 Scope of the Study

For the purpose of this research work, the researcher focused her attention on the effectiveness of
internal audit as a tool for improving company’s financial performance using Flour Mills of Nigeria
and Cadbury Nigeria as a case study. The concentration on the above named companies is as a result
of the fact that the research envisaged a possible danger the effectiveness of carrying this research
work on a longer scope to embrace all the companies in Nigeria will seriously be hampered by many
inevitable factors. The data centre for this work is McPherson University, Ogun State.

1.8 Limitation of the Study

The research cannot treat all aspect and kind of internal audit effectiveness because the field is
simply too wide. So only those relevant to these studies were dealt with.

It is impossible to cover all the manufacturing companies in Nigeria and as a result a sample of two
manufacturing companies- Cadbury Nigeria plc and Flour Mills of Nigeria plc were scheduled and
inferences made from these.

There are limitations on resources for reference purposes especially responses on collection of data,
many respondents give bias responses probably because of job protection, officer’s name and image
protection, personal reluctance, unnecessary fear of legal implication and so forth. The general
information of the question was structured in a way that the respondent remains anonymous.

This work should not be viewed as a final solution to the effect of internal audit on financial
performance.