Vol. 11(8), pp.

168-174, 28 April, 2017

DOI: 10.5897/AJBM2017.8267
Article Number: ADF46A163919
ISSN 1993-8233 African Journal of Business Management
Copyright © 2017
Author(s) retain the copyright of this article
http://www.academicjournals.org/AJBM

Full Length Research Paper

Internal auditing and financial performance of public

institutions in Kenya: A case study of Kenya Meat
Commission
Nelius Wangui Muchiri* and Ambrose Jagongo
Department of Accounting and Finance, Kenyatta University, Kenya
Received 27 January, 2017; Accepted 17 March, 2017

Internal auditing provides audit services to the management at all levels, including board of directors
and audit committee, thus improving the organizations corporate governance. The objectives that
guided the research were effect of corporate governance on financial performance and effect of audit
committee on financial performance. The researcher used case study research design; this was due to
the fact that data was collected from one organization only, that is, Kenya Meat Commission (KMC). The
sample size was all fifty seven management staff at KMC. Open and close ended questionnaires were
used to collect primary data from the respondents. The data collected was quantitative. Descriptive
statistics, time series and regression analysis were used to analyze the data. The data was presented in
the form of tables. The data collected ascertained that internal auditing plays a major role in the
financial performance. The findings of this study, however, are at odds with the aforementioned position.
The researcher found that the relationship between the internal audit function existence and financial
performance at the KMC was insignificant. That is, existence of internal auditing does not influence the
profitability and return on investment. The researcher recommends that the internal audit function
should be more independent and manned by competent staff. There should also be an independent
oversight body to oversee the operations of the state corporation.

Key words: Financial performance, internal auditing, corporate governance audit committee.

INTRODUCTION

Internal auditing is often seen as an overall monitoring thereby providing an important element of global control.
activity with responsibility to management for assessing Internal auditing is an independent, objective assurance
the effectiveness of control procedures which are the and consulting activity designed to add value and
responsibility of other functional managers (Kent, 2003). improve an organization’s operations (Kent, 2003). Being
Internal auditing is taking on increased importance in independent and objective, internal auditing helps an
many of today’s global organizations by assisting organization accomplish its objectives by bringing a
management in evaluating controls and operations and systematic, disciplined approach to evaluate and improve

*Corresponding author. E-mail: [email protected].

Authors agree that this article remain permanently open access under the terms of the Creative Commons Attribution
License 4.0 International License
 Muchiri and Jagongo 169

the effectiveness of risk management, control, and company plays a key role in the success of an enterprise
governance processes. as it prevents possible deviations from the predetermined
According to Millichamp (2000), Mainoma (2007) and objectives and policies. Therefore, the study recommends
Sani (2009), internal auditing includes among others that public institutions should install exhaustive system of
reviewing the adequacy and effectiveness of internal accounting controls in order to better financial
control system, its compliance with government performance. The study focused on existence of
regulations, accounting rules and standards, securing the accounting systems and performance of public
asset of the organization in order to prevent institutions. However, it failed to establish the influence of
misappropriation. This ensures that the organizational internal auditing on financial performance. Therefore, this
goals and objectives are achieved. Internal auditing acts research seeks to investigate the ways in which internal
as an in-house consultant on control matters. Hermanson auditing influences financial performance in public
and Rittenberg (2003) deduced that an effective internal institutions in Kenya.
audit function existence leads to superior organizational
performance. Similar sentiments were expressed by
Prasad and Rao (1989). They observed that the internal RESEARCH DESIGN AND METHODOLOGY
auditor saves the organization from malpractices and
The research design adopted case study design. This is because
irregularities by acting as a watch dog. This helps ensure data was collected and analyzed from 57 management staff at
high level of productivity and profit. Kenya Meat Commission. A case study is an in depth investigation
Peursem (2004), a study undertaken in New Zealand, of an individual, group, institution or phenomenon (Mugenda, 2003).
internal auditors were required to evaluate the importance The target population comprised 57 management staff from all the
of their functions in connection with audit engagements. 15 departments at the Kenya Meat Commission. A census study will
The findings of the study were true professions exist be conducted. Primary data was collected from the respondents
using open and closed ended questionnaires. The reason for using
although it does not dominate auditors with high level of a questionnaire is because it is cheap and quick as compared to
experience and are in public practice have significant face to face interview. The questionnaires were developed from the
influence over the management. Additionally, if the three mentioned variables that is corporate governance and audit
auditors have accountancy training, their influence level committee which are the independent variables and financial
is high due to the fact that they are members of performance which is the dependent variable. It had four sections,
section one constituted the bio data of the respondents, section two
accountancy professional bodies. These findings are
had questions on internal auditing function in the institution, section
supported by Coopers and Craig (1983), Cooper et al. three had questions on the influence of internal auditing on financial
(1966) and Gramling (1997), who had portrayed performance and the last was on financial performance. The
reservations over the effectiveness of the role of internal indicators of each variable were used to develop questions using
auditors. Peursem conducted a follow up study in New the likert scale. Data was summarized in tables and the mean
Zealand to determine whether the auditor influences his values calculated for each variable as shown in Tables 2, 3 and 4.
The questionnaires were administered using drop and pick later
role. This involved checking on internal auditors’ method. This is because some of the respondents are seniors
objectivity while working with the management so as to officers and the researcher had difficult time accessing them due to
be able to report on their performance. their busy schedules. Data was collected in the month of July 2012.
The findings of the study were that for those internal The data collected was quantitative. Descriptive statistics and time
auditors who best balanced their role, they had external series were used to analyze the quantitative data. Time series is an
professional status and their organizations had both arrangement of statistical data in accordance with the time of its
occurrence. According to Yule and Kendall (2000), “When we
formal and informal communication network. Sunday observe numerical features of an individual or a population at
(2007) conducted a study on internal audit function and different points of time, the sets of observations constitute a time
corporate governance. The study established that there is series”. The following regression model was generated to show the
a positive relationship between quality of internal audit relationship between the independent variable and the dependent
function and quality of corporate governance. Makoju variable.
(2000) noted that bureaucracy and sluggishness of Y = a + β1X1+ β2X2 + е
government employees has resulted to the inadequate
performance of state corporations. The issue of high where Y = Financial Performance, a = Constant, X1 = Corporate
incidences of fraud and government staff employment Governance, X2 = Audit Committee, βj = Coefficient of Xj, and е =
being inclined to political affiliation rather than ability to Error Term
perform was also found to have contributed to the Table 1 gives an explanation of the independent and dependent
inadequate financial performance. variables used in the study.
In his study, Dogo (2003) established that the existence
of accounting systems of public institutions in Kenya does
not guarantee proper and up to-date financial records. RESULTS AND DISCUSSION
This made auditing of such institutions very cumbersome
if not impossible. The study also established that From the 57 questionnaires distributed, 50 filled in
accounting control practices such as internal auditing of a questionnaires were collected. Tables 2, 3 and 4 indicate
170 Afr. J. Bus. Manage.

Table 1. Description of variables used in regression analysis.

Variable Type of variable Explanation of variables

Corporate governance Predictor-X1 Whether there is indication of corporate governance factors
Audit committee Predictor-X2 Financial statements Integrity and independence of audit function
Financial performance Dependent-Y Annual profit targets

the mean and the standard deviation for the variables. management, the size and structure of the enterprise and
Table 2 shows the influence of internal audit the skills and experience of the internal auditor.
independence on financial performance. Table 3 shows The finding of the study that the internal audit
the influence of corporate governance on financial department of the company has inadequate staff that is
performance, while Table 4 shows the influence of audit qualified and experienced contradicts earlier studies of
committee on financial performance. The mean score of Sabari (2003) and Dandago (2000) who concluded that
the study ranges from 1.49 to 4.59, while the standard internal audit department should be properly organized,
deviation ranges from 0.045 to 1.61. For a five point likert adequately staffed and equipped to be able to effectively
scale, this is an indication that the study concepts were perform its functions. However, Sunday (2003), argued
being practiced in a reasonable level. Additionally, the that the internal audit function’s mandate depends upon
standard deviation is small. This implies that the study the size, structure and management of the organization.
sample is a reasonable reflection of the population Therefore, it is different for each organization. According
(Saunders, 2006). The study used both correlation and to Momoh (2005), the internal auditor should ensure that
regression analysis to test the relationship between all financial transactions comply with approved
dependent and independent variables. Tables 5 and 6 regulations and that there exists sufficient security in the
show the correlation, while Tables 7, 8 and 9 summarize undertaking.
the regression statistics for the regression model. These As shown in Table 3, accountability was rated the
include regression coefficients, F-statistic and the highest with a mean score of 4.91 followed by disclosure
regression coefficients. The parameters indicate that the and transparency with a mean score of 4.81. Leadership
regression model was significant. This means that the had a mean score of 3.98 while stakeholder’s rights had
independent variables not only have positive influence on a mean score of 3.40. This is an indication that all
financial performance but it is also significant. corporate governance factors considered in this study
As shown in Table 2, the mandate of the internal audit had impact on financial performance with accountability,
department is properly stated by company management disclosure and transparency and leadership taking the
was rated the highest with a mean score of 4.60 followed lead. The finding of this study reaffirms earlier study by
by management’s open door policy with a mean score of Sani (2009), who concluded that leaders must be
4.54. The internal audit reports being handled by top transparent and accountable. According to Fadzil et al.
management rather than the finance manager, the (2005), accountability is the whereby state corporations,
internal audit department authority is properly stated, and organizations and the people within them, are made
the appointment or removal, promotion and remuneration answerable for their decisions and actions, including how
of all internal audit staff is by merit were rated slightly they manage public funds and all facets of performance,
above average. Further, internal audit reports and and yielding themselves to appropriate external scrutiny.
recommendations are acted upon by company’s Adeniyi (2004) noted that people in leadership positions
management, and the internal audit department staff is are faced with different forms of accountability to their
adequate qualified and experienced was rated slightly various stakeholders. Dittenhofer (2001) concluded that
below average. No restrictions to any part of the efficient use of resources, strengthened accountability,
company or to any document, and autonomy in work improved management and service delivery can be
execution were rated lowest. The finding of the study that brought about by leaders who practice good governance,
the internal audit function’s mandate is properly stated by hence, contributing to reduction in poverty and
company management was highly rated as asserted in improvement in people’s lives. Bejide (2006) opined that
earlier studies by Sani (2009), who noted that internal transparency helps stakeholders have assurance in the
audit is responsible for the audit of all financial decision-making processes and actions of parastatal
transactions by conducting an ongoing carrying organizations. Therefore, corporate governance
examination of all accounting books and records essentially leads to accountability, disclosure and
maintained in the organization with a view to checking or transparency and effective communication to various
detecting fraud and correcting errors. According to stakeholders.
Mathison (2005), the scope and objective depend upon As shown in Table 4, financial statements integrity was
the responsibilities assigned to the internal auditor by the rated the highest with a mean score of 4.74 followed by
 Muchiri and Jagongo 171

Table 2. Internal audit function.

N Mean Std. Deviation

Variable
Statistic Statistic Std. Error Statistic
Company’s management has properly stated the mandate of internal audit function 57 4.5965 0.10871 0.82071
There is autonomy in work execution 57 1.8596 0.19460 1.46919
The management uses open door policy 57 4.5439 0.10931 0.82527
Appointment, removal, promotion and remuneration of all internal audit staff is by merit 57 2.60 0.194 1.462
The internal audit department authority is clearly stated 57 2.65 0.193 1.458
There are no restrictions to any part of the company or documents 57 1.49 0.146 1.104
internal audit reports and recommendations are acted upon by management 57 2.47 0.196 1.477
The internal audit department staff is adequate, qualified and experienced o 57 2.47 0.196 1.477
The internal audit reports are handled by top management reports rather than finance manager. 57 2.63 0.195 1.472
Valid N (listwise) 57 - - -

Table 3. Corporate governance and financial performance.

N Mean Std. Deviation

Variable
Statistic Statistic Std. Error Statistic
Disclosure and transparency 57 4.81 0.073 0.549
Leadership 57 3.98 0.213 1.609
Stakeholder’s rights 57 3.40 0.239 1.801
Accountability 57 4.91 0.045 0.342
Valid N (listwise) 57 - - -

internal audit function with a mean score of 3.98. individuals within the organization and it is found that the existence of internal audit function
External auditor independence and risk reflected both in the organization’s decision- in organizations results in improved performance
management systems had a mean score of 3.32 making procedures and in the quality of its and helps in undertaking forensic audit in cases of
and 3.05, respectively. The finding of this study financial and performance reporting. Internal audit corporate calamities like financial fraud. Thus,
concurs with Papadatou (2005), who stated that function was also found to have major impact on internal audit due to its nature of being a
integrity comprises both straightforward dealing financial performance which was reaffirmed by watchdog could protect the organization from the
and completeness. He noted that integrity Roe (2004), who stated that” the audit function unethical practices and irregularities hence
requires honesty and objectivity, and high level of evolution is as a result of search for information by allowing the organization to achieve its objectives
morality in the management of public funds and interested parties in order to assess performance of ensuring high levels of productivity and
resources, and management of an organization’s of others in whom they have vested interest”. He profitability. According to Millichamp (2000),
affairs. According to Papadatou (2005) integrity additionally argued that interested parties need internal audit constitutes independence, staffing,
relies on the control framework effectiveness and audit function as a monitoring mechanism as it training, relationship, due care, planning,
moral standards and professionalism of the enforces accountability. A study by KPMG (2007) controlling and recording, system control, evidence,
172 Afr. J. Bus. Manage.

Table 4. Audit committee and financial performance.

N Mean Std. Deviation

Variable
Statistic Statistic Std. Error Statistic
External auditor independence 57 3.32 0.163 1.227
Financial statements integrity 57 4.74 0.089 0.669
Internal audit function 57 3.98 0.213 1.609
Risk management systems 57 3.05 0.169 1.274
Valid N (listwise) 57 - - -

Table 5. Corporate governance-financial performance.

Corporate governance (X1)

Financial performance (Return on Investment) Correlation (r) 0.665
Sig. (2-tailed) 0.0322

Table 6. Audit committee-financial performance.

Audit committee (x2)

Financial performance (Return on Investment) Correlation (r) 0.518
Sig. (2-tailed) 0.0079

and reporting. Essentially, then, internal audit cannot On whether audit committee influenced the financial
undertake its functions without these key elements. performance of the company, the null hypothesis stated
Bejide (2006) established that internal audit service will that there was no relationship between the audit
help reduce overhead, identify efficiency improvement committee and the financial performance. The study,
ways and uncover possible losses as a result of however, revealed that there was a significant level of
insufficiently safeguarded company assets which result in relationship between the two as shown by the coefficient
reduced profitability. Similarly, Barrett (2002) had stated of correlation, that is, 0.518. The p-value was less than
that internal audit is key in performance improvement. the acceptable significance level of 0.05 (p-value < 0.05),
Fadzil et al. (2005) had established that internal auditors meaning that these findings were acceptable and can be
help in increasing shareholders value through running the generalized. Based on the results presented in Table 6,
company efficiently and effectively. Hermanson and the null hypothesis was rejected.
Rittenberg (2003) had concurred with these findings that A model summary was used to predict the value of the
the existence of an effective internal audit function is dependent variable using independent variables. This
associated with high levels of organizational performance. study’s dependent variable was financial performance of
Kenya Meat Commission (Return on Investment), while
the independent variables were corporate governance
Hypothesis testing and audit committee. The R-value was 0.6721, as
indicated in Table 7, meaning that there is a strong
The null hypothesis stated that there is no relationship positive relationship between the dependent variable and
between the corporate governance and the financial the independent variables. The R Square was 0.5824
performance of KMC. The study showed that there was a implying that 58.24% of the financial performance in KMC
strong positive relationship between corporate can be explained by the two independent variables
governance and financial performance of the company as covered in this study. The rest 41.76% of the financial
indicated by the correlation coefficient. These findings, as performance can be explained by other factors that are
indicated in Table 5, can be generalized given that the not captured in the study. The regression model used
significance level was below the acceptable level of 0.05 was significant with the F statistic being 0.0298 (as
(p-value < 0.05). It was 0.0322, while the correlation shown in Table 7), which was less than the acceptable
coefficient was 0.665. Based on these findings, the null significance level of 0.05. This means that the
hypothesis was therefore rejected. independent variables do not only have positive influence
 Muchiri and Jagongo 173

Table 7. Model summary.

Variable Regression statistics

Multiple R 0.6721
R Square 0.3273
Adjusted R Square 0.5824
Standard Error 0.4104
Observations 50

Table 8. ANOVA analysis.

Variable df SS MS F Significance
Regression 3 3.687086 1.229029 0.0298059 0.000433607
Residual 45 7.57822 0.168405 - -
Total 48 11.26531 - - -

Table 9. Regression coefficients.

Variable Coefficients Standard Error t Stat P-value

Intercept 1.6125 0.282829134 5.701322128 8.64902E-07
X1 (Corporate Governance) 0.296666667 0.33506704 0.497412896 0.021319788
X2 (Audit Committee) 0.241306818 0.298145914 1.050050217 0.009301717

on financial performance but also the influence is service results to reduction in overheads, efficiency
significant. Based on this outcome, the prediction of the improvement ways and uncovering of possible losses
outcome of the study using this model was acceptable, due to insufficiently safeguarded company assets all of
that is, determination of financial performance (return on which lead to reduced profitability. According to
investment) the independent variables, namely, corporate Hermanson and Rittenberg (2003), internal audit function
governance and audit committee. existence leads to increased organizational performance.
Using Excel, the values of the βs in the regression Similar sentiments were raised by Prasad and Rao
model (Y=a+β1X1+β2X2+e) used to determine the (2000), through their observation that the internal auditor
causal effect of the independent variables on the protects the organization from unethical practices and
dependent variable were determined. The following are irregularities due to their nature of acting as watch dogs.
the values as extracted from Excel. From the tabulated This ensures high levels of profitability and productivity
aforementioned figures, the completed model was: which are actually the organizational objectives. The
study findings however disputes the position stated
Y = 1.6125+0.29667X1+0.24130X2+e earlier. The researcher found that the relationship
between the existence of an internal audit function and
This means that 29.7% of the financial performance was financial performance at the Kenya Meat Commission
caused by corporate governance. Another 24.1% was was insignificant. This means, existence of internal
caused by the effectiveness and efficiency of the audit auditing does not influence the profitability of an
committee. There was another portion of the financial organization. This finding contradicts that of KPMG (2000)
performance of KMC that could be explained by other which established that internal audit function and financial
factors besides the factors covered in this study. performance have a positive association. A survey
conducted on 201 senior company executives in the
United States, the KPMG, established that the existence
CONCLUSIONS of internal audit function in organizations contributes
significantly towards performance improvement and
Generally, it is believed that the existence of internal identifying profit improvement opportunities.
auditing results in increased organizational financial The findings in this study are at odds with those of
performance. According to Bejide (2006), internal audit Fadzil (2005) which established that stakeholders’ value
174 Afr. J. Bus. Manage.

is increased because internal auditors helps in managing CONFLICT OF INTEREST

a company in a more efficient and effective manner.
However, these findings agree to that of Griffiths (2000) The authors have not declared any conflict of interest.
which found internal audit and performance are
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