The Role of Internal Auditor on the Effectiveness of Internal Control System
Chapter One
Purpose or General Objective
The purpose of this research is to determine, examine and establish the relationship between internal auditing, internal control systems and financial performance in an Institution of Higher Learning in Nigeria.
Objectives or Specific Objectives
Internal controls in an organization are normally instituted to provide practical assurance about the achievement of the entity’s objectives with regard to reliability of the financial reporting, financial performance, in internal auditing, effectiveness and efficiency of operations and compliance with applicable laws and regulations.
These will ultimately translate into improved financial performance. The study will therefore attempt to establish the relationship between internal control systems and improvement financial performance in an Institution of Higher Learning in Nigeria. In particular the researcher will focus on the following specific objectives:
- Determine and examine the functionality of Internal Control systems in an Institutions of Higher Learning in Nigeria.
- Determine and examine financial performance of an Institution of Higher Learning in Nigeria.
- Determine and examine the relationship between internal control systems and financial performance in an Institution of Higher Learning in Nigeria.
- Determine the relationship between internal control and internal audit.
- Determine the performance of internal control and internal audit in Higher education of Nigeria.
CHAPTER TWO
LITERATURE REVIEW
Theoretical Framework
Insurance Theory
The insurance theory differs from the agency relationship theory and it applies when auditors are involved in litigation. It suggests that audit services provide investors with a form of protection in the event of an audit failure (Wallace, 1980; Menon & William, 1994; Stice, 1991). In other words, the legal system allows the investors to recover their investment losses from the auditor if the audited financial statements contain a misrepresentation or a low quality audit. The probability of recovering such claims increases if the auditors are among the larger audit firms or those known as “deeper pockets” (Schwartz & Menon, 1985).
Wallace (1980) provides four explanations of why managers choose auditors as insurance in preference to insurance companies. Firstly, society assumes that managers who fail to guarantee that they are fully independent of their actions, without the auditors‟ attestation, are committing fraud or are involved in negligence. Secondly, the improvement in accounting and auditing firms that employ legal staff, legal services and in-house counsels, suggests that they are more efficient compared with insurance companies.Thirdly, the insurance companies use the cost-benefit approach when deciding whether to enter a legal defense or to decide on an out of court settlement. However, both the auditors and the firms that are involved in litigation will consider the effect on their reputation and thus, with a similar common interest, they will ensure that they protect their reputations. Fourthly, if investors suffer from losses because of an audited financial statement, the courts are likely to hold the auditors responsible and to require them to bear the losses. An auditor’s contributions to an investor’s losses are viewed by the court as „socializing risk‟.
Lennox (1999) posited that the lower the audit quality undertaken by the auditors, the higher the potential of such auditors to be sued they argued that, in the case of the big-size auditors that gain their “quality” from reputation they have built. However, the insurance theory considers the auditor’s litigation to be a poor indicator because the auditors are likely to be sued if they are insufficiently conservative, but they will not be sued if they are too conservative. Although the big-size auditors provide higher audit quality than a smaller size auditor,for not been sufficiently conservative. Lennox‟s findings suggest that the big-size auditors are more likely to be sued because they are more fearful of a potential litigation claim than of losing their client-specific rent or reputation capital.
Monitoring Theory
The monitoring theory is based on the agency relationship. Agency theory suggests that agency cost is a potential solution to agent-principal conflicts and that one of the answers to the problem is provided by an independent audit (Jensen & Meckling, 1976). According to Wilson (1983), the monitoring role of audit minimizes the moral hazard and adverse selection problems that arise from the information asymmetries problem. Wilson (1983)explainsthe case of a moral hazard problem, the managers responsible for protecting a firm’s assets may misuse the assets or fail to maintain them, in which case such actions are not directly observable by the owner and potential investors. In the case of an adverse selection problem, such assets have their own fixed values. The managers have more information about these values and they are able to manipulate information for their own personal gain.
Wallace (1980) posits that an independent audit provides an assurance that the financial reports that are provided by the managements have been carefully prepared and they are free from material errors. Thus, the market participants including the potential investors can use the audited financial statements without any hesitation. Moreover, an independent audit also mitigates financial statement fraud and illegal reporting and improves the internal control and operational efficiency of a firm (Wallace, 1980; Chow, 1982). For instance, when managers know that their financial reports will be examined by auditors, fraud and illegal behaviour can be minimized indirectly because they are worried that such actions will be discovered by the auditors. In addition, when auditors perform an audit review or audit testing on the internal – control system of a firm, they will discover if certain internal control procedures are missing or have not been performed properly. Thus, auditors typically provide recommendations to improve existing internal control systems. Such restrictions and recommendations are able to improve the effectiveness and efficiency of a firm’s operation.
In summary, these observations suggest that audit services not only provide a monitoring tool for owners, managers and potential investors, but also for the whole organization including its employees and creditors. We therefore, adopted monitoring/agency theory to underpin this research.
CHAPTER THREE
METHODOLOGY
Research design
The study was conducted using a combination of Research designs mainly Surveys, relationship and Case study. Survey (according to Oso and Onen, 2008) “present a leaning methodology used to examine population by selecting samples to examine and discover occurrences”. The same Authors explain Correlation as the determination of whether or not and to what extent an association exists between two or more variables. They also note that case study is “an Intensive descriptive and analysis of a single entity or a bounded case”. Survey was used for its economy, rapid data collection and capability to understand a population from a part (Oso and Onen, 2008). Correlation was used as a means of trying to examine the relationship between internal audit, internal control systems and financial performance. Case study was used since NAEAC was chosen as a representative of an institution of higher learning where results of the study can be simulated and applied to other Institutions of higher learning. Case study was also chosen because the study focused on the main campus as a delegate of other NAEAC centers.
Study Population
The study will focus on internal control, finance and finance related departments of the University targeting particularly Finance and Accounts personnel, Deans, Associate Deans and
Heads of Departments of the University. The University has a 1200 full time staff (NAEAC HR 2013). Currently Finance and Accounts offices have 115 members of staff (NAEAC HR 2011). All these are predictable to be interviewed. The financial management process of the University involves a cross section of individual and most importantly the departmental heads of the university (especially during the budgeting process). This was basically due to the decentralized policy adopted by the University. The Units of analysis therefore included all Deans, Associate Deans, Department heads, and Finance and Accounts staff of the University.
Area of the study
The study focused on NAEAC main campus and focusing particularly of internal auditing, internal controls (particularly control environment, internal audit and control activities).
CHAPTER FOUR
DATA PRESENTATION AND DISCUSSION OF FINDINGS
Introduction
This chapter presents the output of data analysis. The presentations are in form of tables and statements. The presentation is according to the objectives of the study and the hypotheses generated.
Quantitative data presentation and discussions
The background information of respondents was deemed essential because the aptitude of the respondents to give suitable information on the study variables greatly depends on their environment. The background information of respondents solicited data on the samples and this has been presented below categorized into; gender, education levels, position held, age and length of service in the organization.
CHAPTER FIVE
SUMMARY FINDINGS, CONCLUSION AND RECOMMENDATION
Introduction
This part presents summaries of the study findings as per the study objectives, conclusions based on those findings and recommendations which are based on both the study findings and other relevant literature measured essential and vital to be used in future to improve the study condition.
Summary findings
This part presents the summarized results and explanation (findings) based on the study objectives as established at the beginning of the study.
Functionality of the internal control system
The study found out that management of the institution is dedicated to the controls of the University and they energetically participate in monitoring and supervision of the actions of the University. The study also reveals that all the activities of the Institution are initiated by the top-level management. On the efficiency of the internal audit, the study found out the internal audit section is not competent doesn’t behavior usual audit activities and doesn’t create normal audit reports. They however, have the same opinion that the few reports that are formed in the department deal with the weaknesses in the system. The study also found that the internal audit department is understaffed and this could be one of the reasons for not producing reports as predictable. Regarding control activities, the study found that, there is a clear division of roles, supervision of activities by senior staff, weaknesses that are realized are addressed, and there is a training program for ability building in the institution. However, the study also found out that there is be short of information sharing in the University and also no safety measures are put in place to defend the assets of the University.
The financial performance of the Institution
The study found out that the Institution does not have sufficient cash to meet its future goals, and that the cost that the University charges on the students is not suitable to cover the costs. The study additional reveals that all the fees that are theoretical to be remitted to the University are not composed. However, it was also found that all revenues and expenditures are properly classified, and that assets of the University have generally improved.
Internal control system and financial performance
The study examined and recognized an important association between internal auditing and internal control system and financial performance. This association was examined during the scope of internal control systems and that of the financial performance chosen for this particular study. The scope of internal control systems (control environment, internal audit, and control activities) were connected to the scope of performance (liquidity, accountability, and reporting). Particulars show that control environment is associated to liquidity (r = 0.294, p ≤ 0.01) control environment is also connected to accountability (r = 0.338, p ≤ 0.05), and control environment is associated with reporting (r = 0276, p ≤ 0.01).
Similarly, the study found that internal audit as a measurement of internal control system, is associated with all the scope of financial performance in the following details; internal audit and liquidity are linked (r = 0.091, p ≤ 0.01), internal audit is related with liability (r = 0.447,p ≤ 0.01), and internal audit and reporting have important relationship (r = 0.389, p ≤ 0.01).In addition, control activities as a measurement of internal control system and all the scope of financial performance are related; control actions and liquidity are related ( r = 0.291, p ≤0.01), control activities and liability are related (r = 0.411, p ≤ 0.01), and control activities and reporting are related (r = 0.299, p ≤ 0.01).
Conclusions
This study was carried out on the role of internal auditor on the effectiveness of internal control system. Based on the findings of the study, it is completed that the institution has an efficient internal control system as supported by the study findings of clear division of roles, supervision, training, and promise of management. However, there are challenges in the completion of controls particularly considering that the audit function is not well absolute to the upcountry centers which obviously has precious their efficiency as revealed by this study On financial performance of the institution, the study concludes that the liquidity position of the University is not suitable, details of which are directly in the study, although the study reveals an better assets value as well as classification of its revenues and expenditures. The final conclusion of this study is that there is a significant positive relationship between internal control system (control environment, internal audit, and control activities) with financial performance (liquidity, accountability, and reporting).
Recommendations
Since it was clear in the study, that the staffing level in the internal audit department is not sufficient to cover the entire University set up, evidenced by not conducting regular audit activities, not operating efficiently as well as their reports not being regular, the study therefore recommends capability profiling which should be based on what the University expects the internal audit to do and what suitable number staff would be required to do this job.
The study also recommends that the institution establishes and manages knowledge in order management system within the institution so as to allow all parties within the institution to without restraint access and use the official information.
The study also recommends that the institution establishes a strategy for improving the generation of additional finances for the operations of the University. This could be done through writing projects, other ready for action endeavors which are directly expected at charming funds for the University.
Finally, the study recommends that there should be a on purpose attempt to behavior a study which establishes the relationship of management’s promise based on factors that are external to the University such as behavioral issues of the students, financial stress of parents, and information technology.
Suggestions for further research
- The power of ICT on the efficiency on internal control system.
- The result of cultural and behavioral factors on the performance of a higher institution of learning.
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