CHAPTER ONE: INTRODUCTION

1.1 Background of the Study

Auditing is the accumulation and evaluation of evidence about information to determine and
report on the degree of correspondence between the information and established criteria.
Auditing should be done by a competent, independent person (Arenas et al., 2012). Internal audit
is an important part of corporate governance structure within an organization which includes
those oversight activities undertaken by the board of directors and audit committee to enhance
the integrity of financial reporting process. Internal audit significance increased with of a
consequence of corporate failure which started around the end of 20th century (Moeller, 2004;
Swinkels, 2012; Gamage, et al., 2014). Internal auditing is also performed in diverse legal and
cultural environments; within the organizations that vary in purpose, size and structure (Pitt,
2014). Internal audit function helps government organization to ensure accountability and
integrity, improves the execution of government programs and develops a sense of trust and
confidence among citizens and the various stakeholders in the public interest (Baharud-din et al.,
2014).

In the past, the internal auditors were seen just as an assistant of accountant’s but recently
internal audit is certainly is considered an independent profession, which is playing a significant
role in the management of organizations. For instance, the role of internal auditing is to assess
the effectiveness of the internal control system and to find out whether the system is functioning
as intended (Fadzil et al., 2005).

However, the internal auditors face many challenges from the organization they work. Some of
the challenges identified by the Ministry of Finance and Economic Development (2004), in their
internal audit manual are lack of management respect, lack of independence, assigned of internal
auditors to many tasks and being ignored (conflict of interest) and lack of professional
development and lack of IT resources. So, it is important to have effective internal audit unit as
part of modern governance system in public sector offices. a strong internal control system,
including an independent and effective internal audit function, is part of sound corporate

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governance (Goodwin-Stewart Kent (2006). And also, it will propose that internal auditors and
key employee of public bureaus are expected to work independently.

1.2 Statements of the Problem

We are living in a dynamic globe. Every business activity, every day, including its culture is
under a continuous change and improvement. While the complexity of business activities
becoming more and more, its internal control systems should also be well strong and adequate to
protect the interests of the organization and its stakeholders. One of the functions of management
in any organization is the participation in controlling activity. Nowadays, this controlling activity
has being supported by a profession called the internal auditing activity.

Internal audit functions play an important role in organizations by adding value and improving
their efforts to achieve set objectives through a systematic and disciplined approach to control
and evaluate operations. Thus, examining factors affecting internal audit effectiveness in
commercial banks of Ethiopia can contribute to have strong internal control system in
Commercial banks. In order to understand those factors, commercial banks of Ethiopia was
selected as the case study. This study, therefore, will try to identify and examine determinants of
effective internal audit and its roles on internal control, risk management and corporate
governance process in commercial banks of Ethiopia Mattu branch.

1.3.Research Questions
1. Does the bank have internal auditing practice?
2. Does the principle of internal auditing apply in the organization?
3. What factors affecting internal auditing practice of commercial banks of Ethiopia Mattu
branch?
4. What are the major drawbacks of Auditing practice of commercial banks of Ethiopia
Mattu branch ?
1.4 Objectives of the Study

1.4.1. General Objective

The main objective of the study is to identify and examine determinants of effective internal
audit practices in Commercial banks of Ethiopia.

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1.4.2 Specific Objectives
The researcher will try to achieve the following specific objectives related with the research
questions.
 To investigate the internal auditing practice in Commercial banks of Ethiopia.
 To identify the principle of auditing that applied in the Commercial banks of Ethiopia
 To assess factors that affect internal auditing practice of Commercial banks of
Ethiopia Mattu branch
 To identify the major drawback of internal auditing in Commercial banks of Ethiopia

1.5 Significance of the study

The major benefits of this study will enable the manager to aware of the importance and use of
internal audit in achieving intended objectives. It will be help the auditor in the bank know the
application of internal auditing principles. This will be used as an additional reference to the
existing literatures and can be used as spring boards for other researcher who wish to conduct a
research in the same area.

1.6 Scope of the study:

This study with a focus area of determinant for effectiveness of internal audit in Commercial
banks of Ethiopia based on the case study conducted on Fiche branch.

1.7 Organization of paper

The paper will be organized into five chapters. The first chapter deals with introductory part that
includes background of the study, statement of the problem, objective of the study, scope of the
study, and limitation of the study. The second chapter will concern with literature review. The
third chapter will concern with research design and methodology. The fourth chapter will
concern with data presentation and analysis and the last five chapter will be concerned with the
summery of the major finding, conclusion and recommendation.

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CHAPTER TWO: RELATED LITERATURE REVIEW

2.1 History of Internal Auditing

The profession of auditing in general, and internal auditing, in particular, is ancient. It was
“father of modern internal auditing” Lawrence Sawyer who said that word auditing comes from
ancient Rome. Ancient officials were performing public and oral verification of records that was
called “hearing of accounts”. This event was later described by the term, “audit”. It derived from
Latin “auditus” which means “a hearing” (Pickett, 2010).

Internal audit function started mainly as protection against fraud and asset loss. Organizations
grew in size and complexity which led to their decentralization. Management needed to
internally evaluate accounting information that was used for making decisions. They also
needed to control efficiency of work and to ensure that no deceitful actions took place. Then
first companies that realized the potential of internal auditing beyond audit of financial
statements were railroad, defense, and retail industries. Quickly, internal auditing became a
mean to verify all transactions and to summarize business and its activities. In this way
internal audit provided further insights and ensured integrity and objectivity (Rama-moorti,
2003).

Continuous and rapid development of internal auditing over the years has been fueled by
globalization, technological development, e-commerce and growing complexity of
organizational structures (Reding et al., 2013). In the same time, The Institute of Internal
Auditors expanded into 170 countries and territories with over 180,000 members world-wide. It
continuously conducts research and develops practices that allow internal audit to adjust and
respond to ever-changing needs of organizations.

2.2 The Development of Internal Audit in Ethiopia

The history of internal auditing in Ethiopia dates back to about the middle of the 1940s. The first
substantial development during this period was the issuance of Ministry of Finance directives in
1942. This was followed by the formation of the Audit Commission by Proclamation No.
69/1944 to undertake external audit of accounts of the Ministry of Finance (Government of
Ethiopia, 1944), which was subsequently mandated to conduct the external audit of other
budgetary institutions as well. This marks the start of today’s Office of the Auditor General of

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Ethiopia (OFAG), which, among other duties, monitors and regulates the accounting and
auditing profession in the country. The second development was the formation of the Office of
the Auditor General (OAG) was then established in 1961 by proclamation number 199/1961
(Government of Ethiopia 1961), which accorded the OAG greater authority than the Audit
Commission that was established in 1944 (Kinfu, 1990).

Internal audit as a separate function also appeared in this period (in 1987) when the Auditor
General was given the mandate to monitor and regulate internal auditing in government offices
and public enterprises (Argaw, 2000). This proclamation also gave the auditor general the
authority to issue minimum requirements for staff of internal auditors, provide training to
internal auditors, and require reports on internal audit of government organizations.

The Ethiopian government has also been providing enhanced support to the development of
internal audit since 1994 (Teklegiorgis, 2000). In 1994, the Prime Minister set up a task force
that forwarded recommendations to improve internal audit in government offices. Consequently,
the Ministry of Finance (MOF) has been mandated to develop a manual for internal audit in
government organizations. Moreover, Proclamation No. 68/1997 requires that, the Federal
Democratic Republic of Ethiopia’s (FDRE) new economic policy be supported by a modern and
reliable audit system in order to ascertain proper implementation through effective monitoring of
administrative, developmental and service rendering institutions in the Federal Public Sector
(Zeleke, 2007).

2.3 Concepts of Auditing

In the beginning, employers were controlling their business by themselves. Through time,
however, as their wealth grows from time to time they require someone to control their wealth by
asking their treasure on behalf of them and report the result periodically. People call this
someone during the medieval times as “auditor”, which was derived from a Latin word “audire”
which means “to hear”. As Kagermen (2008) defined auditing as 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. Auditing is analytical, not constructive; it is
critical, investigative, concerned with the basis for accounting measurements and assertions.
Auditing emphasizes proof, the support for financial statements and data.

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Auditing has its principal roots, not in accounting, which it reviews, but in logic, on which it
leans heavily for ideas and methods. The overall objective of every audit engagement includes:
to evaluate whether financial statements and accompanying footnotes are in accordance with
specified criteria, evaluate the effectiveness and appropriateness of internal control systems over
financial reporting, to evaluate the possibility of fraud occurring within the organization and to
evaluate the likelihood that the organization will continue as a going concern (Messier, 2008).

2.4 The Concept of Internal Auditing

The concept of internal auditing is contained in the definition of internal auditing as follows: an
independent, objective assurance and consulting activity designed to add value and improve an
organization’s operations. It helps an organization to accomplish its objectives by bringing a
systematic, disciplined approach to evaluate and improve the effectiveness of risk management,
control, and governance processes (Pitt, 2014).

The definition clearly mentions the aim of internal auditing as to add value to the entity by
improving the information quality for decision making. For this purpose, it needs to involve the
internal auditor in all operations of the organization to create and maintain an effective internal
control by providing assurance and consulting activities. These activities must be conducted in
an independent and objective manner. Furthermore, the activities of an internal audit include risk
management, control and governance processes that are carried out using a consultative approach
and focus on efficiency and effectiveness of operations (Bou Raad, 2000).Consequently, current
practice of internal auditing requires an auditor to have broad competency. Thus, the definition
of internal auditing contains some important components, such as assurance and consulting
activities; independent and objective nature of the internal auditing activities; the scope of work;
the performance of audit work and the professional proficiency of the internal auditor.

2.4.1 Scope of Internal Audit

As the manual document from (MOFED, 2004), indicates about the duties of audit, audit should
fulfill its duty by systematic review and evaluation of risk management, control and governance
which comprises the policies, procedures and operations in place to: Establish, and monitor the
achievement of the public body’s objectives;

 Identify, assess and manage the risks in achieving the public body’s objectives;

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  Ensure the economical, effective and efficient use of resources;
 Ensure compliance with established policies (including behavioral and ethical
expectations), procedures, laws and regulations;
 Safeguard the public body’s assets and interests from losses of all kinds, including those
arising from fraud, irregularity or corruption;
 Ensure the integrity and reliability of information, accounts and data, including internal
and external reporting and accountability processes.

Internal audit should devote particular attention to any aspects of the risk management,
control and governance affected by material changes to the public body’s risk
environment (MOFED, 2004). By providing the independent opinion and conclusions regarding
the operation, function, system and well-being of the organization the auditor can provide
assurance services; and by giving the advisory service based on the specified requests of an
engagement client the internal auditor can give the consulting service to the
organization (Haile, 2014).

2.4.2 Types of Internal Audit

Internal audit guideline of Wegagen bank Share Company, 2017, defines various types of audits
as follows:

 Financial Audits: These audits review accounting and financial transactions to

determine if commitments, authorizations, and receipt and disbursement of funds are
properly and accurately recorded and reported.
 Operations Audits: These audits examine the use of resources to determine if resources
are being used in the most effective and efficient manner to fulfill the organization’s
mission and objectives.
 Compliance Audits: These audits determine if entities are complying with applicable
laws, regulations, policies and procedures the company and government.
 Information Systems (IS) Audits: These audits review the internal control environment
of automated information processing systems and how people use these systems. The
audits usually evaluate system input, output; processing controls; backup and recovery
plans; system security; and computer facilities.

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2.5 The Role of Internal Audit to Improve Internal Control System
The internal audit activity must assist the organization in maintaining effective controls by The
internal audit activity must evaluate the adequacy and effectiveness of controls in responding to
risks within the organization’s governance, operations, and information systems regarding the:

 Achievement of the organization’s strategic objectives.

 Reliability and integrity of financial and operational information.
 Effectiveness and efficiency of operations and programs.
 Safeguarding of assets.
 Compliance with laws, regulations, policies, procedures, and contracts. Evaluating their
effectiveness and efficiency and by promoting continuous improvement.

Internal audit reviews the extent to which management has established sound systems of internal
control so that objectives are set and resources applied to these objectives in an efficient manner.
This includes being protected from loss and abuse. Adequate information systems should be
established to enable management to assess the extent to which objectives are being achieved via
a series of suitable reports. Controls are required to combat risks to the achievement of value for
money and it is these areas that internal audit is concerned with. Compliance, information
systems and safeguarding assets are all prerequisites to good value for money (Spancer, 2005).

2.6 Professional Qualification to Perform Independent Audits

In view of the reliance by third parties on the work of auditors engaged in performing the attest
function. It is understandable that there would be concern for the professional qualification of the
public accountants who do this work. Because in some states anyone who wishes may assume
the designation public accountants such a designation gives an indication that the person
qualified to render competent service to the public (Howard, 2008).

2.6.1 Importance of the Auditors Independence

In addition to possessing adequate training and professional experience the accountant who
makes an audit for the purpose of attesting to the fairness of a client financial statement must act
in an independent capacity. Because the accountants is an employee of the business the
accountant’s action are not subject to supervision by the management of the business and this

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situation alone creates considerable independence. Independence is also an attitude of mind and
independent though and actions are equally as important as the independent relationship between
accountant and client. Unless the accountant is independent the opinion expressed is no more
reliable than the statement which has been prepared by management (Arens, 2001).

2.6.2 Integrity and Objectivity

Integrity and objectivity are per-eminent qualities expressed in all auditors. An auditor should be
straight forward, hones and sincere in this approach to professional work. An auditor must be fair
and should not allow prejudice or bias to override this objectivity. He should ensure that he is
maintaining an important attitude he is reporting and the financial statement which are subjected
to his examination. He should both be and appear to be independent of any interest which might
be regarded whatever its actual effect as being in compatible with integrity and objectivity. In
other words, an accountant who is practicing auditing profession should be and seen to be
independent in each professional assignment he under takes of any interest which might detract
him from objectivity (Endaya and Hanefah 2013).

2.6.3 Due Professional Care

This standard requires the auditors to carry out every step of the audit engagement in an alert and
diligent manner full compliance with this standard with standard would rule out any negligent
acts or material omissions by the auditor of course auditors as well as members of other
professions inevitably make occasional errors in judgment but this human element does not
justify in difference or in judgment or intention to professional responsibilities (Mihret, and
Yismaw, 2007).

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CHAPTER THREE : RESEARCH DESIGN AND METHODOLOGY

3.1 Research Design

Research design helps researcher to provide data that can answer the research questions or attain
the research objectives. This study will employ cross-sectional design because it can only
measure differences between or from among a variety of people, subjects, or phenomena rather
than a process of change. Because cross-sectional designs generally use survey techniques to
gather data, they are relatively inexpensive and take up little time to conduct.

3.2 Research Methods

Quantitative research method will mainly use to test a theory by investigative the factors based
on the previous studies, identifying the research relationships and obtaining the findings. It can
generalize research findings when the study collects data from a purposive sample which
represents its population and it has sufficient sample size. Therefore, in order to achieve the
objectives of this study and thereby to give answer for its problems, quantitative research
approach will be used by the researcher.

3.3 Source of Study Population and Data

The source of populations will be the internal audit staff and managers in the commercial bank of
Ethiopia Mattu Branch. For this study, the sampling size will be all internal auditors and
managers in the study area in which the samples will be selected using purposive sampling
method.

Primarily source of data will be employed in this research. The survey questionnaires help us to
collect a primary source of data. That helps the researcher to have more insights about factors
that affecting the effectiveness of internal audit at the study area.

3.4 Data Collection Method

A questionnaire will be considered as a key tool in collecting data and it is the most widely used
tool in social research such as this study. It contains standardized questions whereby all
respondents may understand these questions in the same way.

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Data from the concerned study areas will be collected using self-administered questionnaires
which are hand-delivered and hand-collected. The questionnaire is related with the research
question and objective of this study.

The questionnaire for the managers deals about the effectiveness of the offices internal auditing
process, while the questionnaires for the internal auditors are about the independent variables
which determine the effectiveness of internal auditors.

3.5 Data Analysis

Data analysis will achieve through sequences of activities including editing, coding, entry, and
tabulation. The purposes of the data analysis will to check the completeness, internal consistency
and appropriateness of the answers to each of the questions. An analysis progress will be
developed using Statistical Package for Social Science (SPSS version 20). Mean, standard
deviation, non-parametric test of chi-square and descriptive statistics will be used to analysis and
find out the results.

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 CHAPTER FOUR : TIME AND BUDGET PLAN

4 .1 Schedule of the Study

No Activities Dec Jan Feb Mar Ap May June July

1 Proposal preparation


Finalizing and submission


2 of proposal

3 Data collection


Data organization and

3
submission of first draft 

4 Writing final draft

 
5 Submitting final draft

6 Defense

4.2 Budget Break Down

No Stationeries Unit price Quantity Total price

Bir cent Birr Cent

r

1 Paper - 1pac 500 -

2 Pen 10 - 1pac 200 -

Other

1 Type write 5 - 35 page 105 -

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 2 Duplication 2 - 35page 70 -

Total 805.00

REFERENCES

Arenas, Elder and Beasley, (2012). Auditing and Assurance Services Pearson, Education, Inc.
upper Saddle River New Jersey.

Arens (2001). Auditing integrated appears 7th edition jersey (USA).

Argaw, L.(2000) The State of Internal Auditing in Ethiopia-The way Forward to

Professionalism, Inaugural Ceremony of the Institute of Internal Auditors-Ethiopian Chapter
Addis Ababa).

Coram, (2008). Internal Audit, Alternative Internal Audit, Structures and the Level of
Misappropriation of Assets Fraud (Vol. 48).

Faudziah Hanim Fadzil, Hasnah Haron, Muhamed Jontan, (2005). Internal auditing practices and
internal control system. Managerial Auditing Journal.

Gamage, C., Lock, K. L. & Fernando, A., (2014). A Proposed Research Framework:
Effectiveness of Internal Control System in State Commercial Banks in Sri Lanka. International
Journal of Scientific Research and Innovative Technology, 1(5).

Goodwin-Stewart, J. & Kent (2006). The Relation between External Audit Fees, Audit
Committee, and Internal Audit.

Howard F., (2008). “Auditing principle” 4th edition prentice Hall of India.

K. A. Endaya and M. M. Hanefah (2013): Internal audit effectiveness: An approach proposition

to develop the theoretical framework. Research journal of Finance &
accounting, V-4.

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