CHAPTER ONE

1. INTRODUCTION
1.1. Background of the study

Different literatures (Rupsys, 2005),(Marika and Giovanni 2004), (Sarens ,2009), (Lekshmy,
(2004) and others indicate that the roots of internal auditing do date back into the nineteenth
century, and real expansion did not occur until the early part of the twentieth century with the
growth of the large corporate forms of business. The extended span of control faced by
management in business employing thousands of people and conducting operations in many
locations is considered to be the major factor in the emergence of internal auditing. In
addition, defalcations and improperly maintained accounting records were also major
problems, and the growth in the volume of transactions resulted in a substantial bill for public
accounting services for the organization that tried to maintain control by continuing the
traditional form of audit by the public accountant.

“As a result of changes in organizational needs, technology and complexity of organizations’

activities and systems, the nature of the services sought from the internal auditors has been
transforming over the years from an emphasis on traditional/compliance audit where
independence has been the core paradigm, to a value-adding role where partnering with
management is accorded greater significance.” (Desalegn and Getachew, 2008)

In the earlier times, internal auditors were considered merely as fault finders and box tickers.
Shekhar and Lekshmy, (2004) stated that the major role of internal auditing initially focused
on an accounting oriented function that has been gradually transformed into management-
oriented profession. Consequently, internal auditors were seen just as assistants to
accountants and to an external auditor, but recently internal auditing is considered as an
independent profession, one which is playing a significant role in the management of
organizations.

According to the Standards for the Professional Practice of Internal Auditing, the nature of
work of internal audit function is to evaluate and improve the effectiveness of the risk

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management processes, control processes and governance processes. Risk management
processes comprise identification and evaluation of potential risks that might affect the
achievement of objectives of an organization and determination of adequate corrective
actions. Policies, procedures, and activities, which ensure that risks are kept within the limits
defined by management in the risk management process, are defined as control processes.
Governance processes include procedures which allow stakeholders to evaluate risk and
control processes defined by management.

Rupsys, (2005) also strengthens this fact in the following statement “Reporting relationships
of internal auditing has changed and developed together with the progress of internal
auditing. At the beginning reporting lines of internal auditors went to the accounting
level and external auditors, who saw internal auditors mainly as assistant in financial
audits. Accordingly as functions and roles of internal auditing expanded, changed and
shifted more to management oriented matters than accounting matters, reporting lines have
also been transformed and currently in many countries internal audit reporting have also been
transformed. Internal audit reporting lines are ideally classified in to administrative and
functional., The chief audit executive should reported to the functionally to the board
and/or audit committee and the administratively should also reported to the chief executive
officer of the organization”

As to the internal audit practice in Ethiopia, According to the W/Ruphael (1998) states that
The IAFs considered their responsibilities in broader terms although the reality is that the
internal auditing still focuses on traditional activities. On the other hand, Zeleke (2007)
believes that the internal auditing has been considered a good contributor to corporate
governance. The ideas of these to literatures are dlightly contradictory. The gap between
these two assertions maybe due to the fact that there is a time gap between the writers and
Zeleke might have seen a sort of improvement in the function after W/Ruphael’s statements.
So these gaps should be narrowed. As a result, how much the current IAF is contributing to
corporate governance currently in the selected enterprises and to what extent the function is
free from the traditional practices and where the current practices deviate from the modern
theoretical assumptions and the reasons for the deviations should be identified.

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1.2. Statement of the problem

Today, several forces have led to a quiet revolution in internal audit. Democracy requires
government to be accountable in its use of public money and in providing effective, efficient,
and economical service delivery. Ever larger and more complex systems require greater
competencies, thus internal audit has had to become ever more professional. (Van
Gansberghe, 2003.)

The old concept of internal auditing can be compared to a form of insurance: The major
objective was to discover fraud more quickly than it could be discovered by a public
accountant during an annual audit. That is, the internal auditor was performing a function
similar to a police officer or detective. The modern concept of internal auditing is that of an
arm of management. Today, internal auditors are an integral link in the management process
and are just as concerned with waste and inefficiency as with fraud. Part of the development
probably can be attributed to the change in technology. As accounting became mechanized
and computerized, records became subject to automatic checking procedures. Thus, the need
to check every transaction declined, giving internal auditors time to reach beyond the
historical clerical limits. (IIRF, 2004)

Regarding the current situation of the internal audit scope W/Ruphael, (1998) states that
reality is that internal auditing today still focuses on traditional activities, such as financial
and compliance auditing. Less attention is given to operational audits or the application of
modern techniques like flowcharting, statistical sampling, and computer auditing. Internal
auditors often must solve day-to-day problems both at the head offices and in branches.
Nevertheless, they spend most of their time ensuring that accounting records are properly
maintained and reliable; that the assets of the enterprises are adequately safeguarded and
properly maintained; and that the organization is in compliance with established policies and
procedures.

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However, in the past decades, limited studies have been conducted in IA activity in Ethiopia
with different issues and study area (Wubishet & Dereje, 2014; Mihret A.G., 2011; Mihret,
2010; Mihret & Woldeyohannis, 2008; Mihret & Yismaw, 2007; Belay, 2007). From those
studies conducted on Ethiopian perspective except Wubishet & Dereje, (2014) focused on
public sector and financial sector without considering the government Seed enterprise

which is a back bone of the country economy (Tadiwos, 2016)

Therefore, the study will be aimed to fill the gaps by conducting an assessment on the
internal audit practice by taking particular references Oromia Seed Enterprise, Arsi branch
with special emphasis on reporting relationships, role of the internal audit function in
government enterprise, the scope and independence of internal audit function (service), the
challenges the internal audit practice faced and recommend suitable solutions to the
problems.

1.3. Significance of the study

The problems that will be identified and to which relevant solutions will be recommended by
this research will be helpful not only to these specific enterprises, but also to other public
enterprises, as the enterprises are governed by the same internal audit manual and same
agency.
The research can also be used as an initiation to further similar studies on the public
enterprises. It will also give an insight to the role and scope of the modern internal audit and
its contribution to good public enterprise governance. It is hoped that interested academics
would benefit from careful study of the suggested research questions and the lines of inquiry
that they open up for future research investigation.
1.4. Objectives of the study
1.4.1. General objective
The study’s basic objective is to assess whether the internal audit practice in the selected
enterprises is being conducted in conformity with the modern internal auditing assumptions
and to identify the gaps and degree of deviations from these assumptions and recommend

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possible ways to cope up the problems identified from the research result, so as to promote
the image of internal audit profession.

1.4.2. Specific Objectives

The study designed will be address the following specific objectives

I. To investigate the internal auditor’s independence in the surveyed enterprise impaired by the
existing reporting relationship.
II. To investigate the board of the scope of the IAF in the surveyed enterprises i.e. is set
free from the influence of the traditional perceptions.

III. To investigate to what extent the Internal Audit practice and the scope of internal
audit have escaped from the influence of the traditional auditing practices.
IV. To evaluate the contribution of the internal audit function in adding value to the
management.
V. To examine whether managers or employees of the selected organizations have
proper understanding knowledge and support for internal audit role in good public
enterprise management.
VI. To identify the challenges to the internal audit function in the Oromia Seed enterprise,
Arsi branch.

1.5. Research questions.

1. Is the internal auditor’s independence in the surveyed enterprise impaired by the

existing reporting relationship?
2. How broad is the scope of the IAF in the surveyed enterprises? Is it set free from the
influence of the traditional perceptions?
3. To what extent the Internal Audit practice and the scope of internal audit have
escaped from the influence of the traditional auditing practices?
4. What is the contribution of the internal audit function in adding value to the
management?

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 5. Do the managers or employees of the selected organizations have proper
understanding knowledge and support for internal audit role in good public enterprise
management?

6. What are the challenges to the internal audit function in the Oromia Seed Enterprise,
Arsi branch?
1.6. Research Hypotheses
Based on the gap in the existing literatures the researcher tried to fill it by developing the
following guiding research hypotheses. They are formulated to achieve the broad
objective.
H 1: Competence of IA teams is positively associated with the practices of IA OSE.
H 2: Independence of IA is positively associated with the practices of IA in OSE.
H 3: Quality of IA work is positively associated with the practices of IA in OSE.
H 4: Management supports are positively associated with the practices of IA in OSE.

1.7. Scope of the study

It will have been good has the research will be conducted on all public enterprises through
the country. But due to the financial and time constraints, the coverage is limited only to
Oromia Seed enterprise, Arsi branch. Moreover, on the subject to be investigated ,the study’s
specific focus is on assessment of the internal audit practice with emphasis on investigation
on reporting relationships, independence, scope of the internal auditing functions, its
contribution to public enterprise , challenges being faced etc. It does not aim at evaluating the
other auditing relating issues rather than described above. The data will be collected from the
July to September 2018.

1.8. Organization of the paper

The study report divided into five chapters. Chapter one is the introduction part which
contains background of the study, statement of the problem, research objective, research
hypothesis, significance of the study, scope and limitation of the study, and organization of
the research paper. In chapter two deals with the review of related literature on the issues

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such as auditing, role of internal auditing, background of the study area; internal auditing
theories, Practices of IA, conceptual framework, and literature gaps are included. Chapter
three embraces the research methodology consists; research design, data type and sources,
population and sampling of the study, procedure of data collection and methods of data
analysis. Chapter four present results and discussions. Finally, chapter five will brings an end
of the study with summary, conclusions and recommendations are forwarded and suggestions
and an area for further research will be given.

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 2. REVIEW OF RELATED LITERATURE
2. 1 .Introduction
Comprehensive definition of auditing expressed on Arens, et al (2012) as follow:
“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.
2.1.1. Brief History of Auditing
The term audit is derived from the Latin word ‘audire’ which literally means ‘to hear’. In the
older days when the proprietor of a business enterprise suspected a fraud, some independent
persons were appointed to hear verbal explanations from those responsible for keeping the
book, judge the facts, and thereafter on the basis of their examination announce the result of
the enterprise to the owner(s). This practice was known to have existed in the ancient
Egyptian, Greek and the Roman civilizations. (Kumar and Sharma, 2005)

Initially the aim of audit was to know whether any cash had been embezzled and if so who
embezzled it and what amount was involved. But, as businesses grew both in size and
complexities, the owners found it more difficult to maintain a complete knowledge of all
aspects of their businesses.

Especially, since the birth of a company form of business organization, a need was felt to
appoint an independent person who would examine the company’s affairs on behalf of the
shareholders, who have no hand in actual running of the business. Consequently, there arose
a demand for independent auditors to examine business undertakings’ financial statements
and to report on their correctness.

Thus, for a period of time the work of auditors switched in emphasis from searching for fraud
to judging the fair presentation of financial statements. (Kumar and Sharma, 2005)

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The last decade of the 15th century, witnessed a great impetus in trade and commerce,
inspired by the renaissance in Italy. This led to the evolution of a system capable of recording
completely all kinds of business transactions. The principles of double entry were published
in 1494, in Venice by Luca Pacioli, although the system had already been in existence in the
preceding century. The author of the principles also defined and described, for the first time
the duties and responsibilities of ‘an auditor’ in detail. Since then, the duties and
responsibilities of an auditor have increased enormously. (Gupta, 2003)
2.2. Internal Auditing
Many writers have defined Internal auditing in different ways. The definitions range from the early
definitions which look at the term from a narrower scope of fault finding to the recent definitions
provided by the IIA which takes into account the value addition contribution of the field. Jain, (1993)
defined internal auditing as “the examination of accounts of a business concern by its employees,
specially appointed for the purpose. The internal audit is devised with a view to detect frauds, errors
and irregularities when they have already been committed and could not be prevented or detected by
internal check arrangements.” We can see in this definition that the author has limited the scope of the
IA to fraud detection.

The Institute of Internal Auditors (IIA) defined internal Auditing as “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
recent definition elaborates that the scope of the IA function is a broader one and not limited to fraud
detection. (IIA, 2004)

2.3. Brief history /Evolution of Internal Auditing

Internal audit is undergoing a significant shift from traditional/compliance audit to value-added

internal audit. “For centuries, internal audit was a simple administrative procedure of checking
documents, counting assets, and reporting on past events to various types of management. Several
forces in our times have led to a quiet revolution in internal audit. (Van Gansberghe, 2005)
“Originally, a demand for internal auditing arose when managers of early large corporations
recognized that annual audits of financial statements by CPAs were not sufficient. A need existed for
timely employee involvement beyond that of the certified public accountants to ensure accurate and

9
timely financial records and to prevent fraud. These original internal auditors focused their efforts on
financial and accounting matters…” (Whittington & Pany, 2006)

The beginning of the twentieth century saw the birth of many large and very large corporations,
which fuelled the demand for accounts and control. The Institute of Internal Auditors was established
in 1941, and was, the driving force behind the professionalization of internal audit and the
development of internal audit. It now serves approximately 94,000 members in internal auditing,
governance and internal control, IT audit, education, and security worldwide. The world's leader in
certification, education, research, and technological guidance for the IA profession, the institute
serves as the profession's watchdog and resource on significant auditing issues around the globe, as
shown by its motto “Progress through Sharing”. (Van Gansberghe, 2005)

Changing the perception towards the IA was not a simple task. Moeller & Witt, (1999) explained this
fact as follows “…in the early years after The IIA was established, internal auditing was still
perceived as a closely related extension of the work of external auditors — they were frequently
called upon to assist external auditors in financial statement reviews or perform accounting-related
functions such as bank reconciliations. Internal auditors were seen to be playing a fairly modest role
within organizations and had only a “limited responsibility in the total managerial spectrum”

Whittington& Pany, (2006) added that the today’s IA practice is not a result of a onetime act but
rather is of a gradual development. They state that the role of internal auditors expanded to
encompass overall operational policies and procedures gradually and companies in the defense
industry were among the first to demand such services. These companies recognized the need for
reliable operating reports because they were used extensively by management to make decisions. The
reports were often expressed not in dollars, but in terms of operating factors, such as quantities of
pairs in short supply, adherence to schedules, and quality of the product. Work by the internal
auditors devoted to ensuring the dependability of these operating reports was better spent than
additional audit effort devoted to financial and accounting matters.

Generally, in the past, internal auditors were taken as faultfinders and intruders and their
contributions were measured in the number of frauds they detect in the course of their audits. They
were considered as specialists in negative reporting, focusing on what is wrong within an
organization and in discovering others’ mistakes. The passage of time has shown some dramatic

10
changes on the image of internal auditing. Gradually internal auditing has changed from a “watch
dog” to a “help dog”. In other words, the image of internal auditors has changed from feared police
officers to more and more to internal consultants and as valued employees who understand the
problems of management and are capable of providing the needed controls and problem solving
skills. (W/Ruphael, 1998). Almost two decades after the founding of The IIA, the following definition
of internal auditing, laying the ground for an “operational auditing” orientation, was presented by
Brink and Cashin (1958):

The internal auditor, like any auditor, is concerned with the investigation of the validity of
representations, but in his case the representations with which he is concerned cover a much wider
range and have to do with many matters where the relationship to the accounts is often somewhat
remote. In addition, the internal auditor, being a company man, has a more vital interest in all types of
company operations and is quite naturally more deeply interested in helping to make those operations
as profitable as possible. Thus, to a greater extent, management services comes to influence his
thinking and general approach.”

Several relatively recent events have been important to the evolution of internal auditing profession.
The first was the enhancement of the foreign corrupt practices act of 1977 and the issuance in 1987 of
the Report of the National Commission on Fraudulent Financial Reporting (Whittington & Pany,
2006)

The objectives of early internal auditors were primarily built around the protection of assets. The
National Industrial Conference Board’s study of internal auditing explained the early motives as
follows:“ Protection of company assets and detection of fraud were the principal objectives.
Consequently, the auditors concentrated most of their attention on examinations of financial records
and on the verification of assets that were most easily misappropriated. A popular idea among
management people a generation ago was that the main purpose of an auditing program was to serve
as a psychological deterrent against wrongdoing by other employees.”

That same study recognized the internal auditor of yesteryear did not perform the same duties as the
modern-day internal auditor. In addition, there was no need for the pioneer internal auditor to perform
all of the functions that are handled by today’s internal auditors. In less complicated times, of course,
management frequently maintained control over company operations by personal supervision. There

11
were not so many levels of authority separating policy makers from production workers, and demands
on senior executives’ time were neither so numerous nor so urgent.

Only very recently, during the last 15-20 years, has internal audit become a true profession with
major potential to influence the management of public finances. This means that developed countries
have only recently made the transition to modern internal audit, making their experiences relevant for
other countries currently trying to achieve this conversion. It also means that the concerns related to
internal audit are shared globally. (Van Gansberghe, 2005)

2.4. Brief history of Auditing in Ethiopia

The issuance of Ministry of Finance directives in 1942, which focused on public sector fund
utilization, marked the development of modern auditing in Ethiopia. Kinfu, (1990). The formation of
the Office of the Auditor General in 1961 (Government of Ethiopia, 1961) with subsequent
refinements of duties and responsibilities in 1979 (Government of Ethiopia, 1979) and 1987
(Government of Ethiopia, 1987) was another significant development in public sector auditing in the
country. The Office of the Auditor General undertakes external audits of government ministries and
their respective offices to ensure accountability. (Desalegn & Aderajew, 2003)

2.5. Empirical studies in Ethiopia context

Internal Auditing's importance in Ethiopia was formally recognized in the early 1930s by the
country's first Constitution. This document referred to the proper collection of state revenue
and the necessity for procedures to control expenditures. In 1944, another milestone occurred
when a proclamation established the Commission for Audit, charged with auditing the
Ministry of Finance accounts. The development of state budget practices, an emphasis on
fraud deterrence, and growth in trade and industry subsequently added impetus to the growth
of the profession. (W/Ruphael, 1998)

As to Lemma Argaw, the ministry of education, ministry of national defense and the ministry
of finance were pioneers in implementing the internal audit practice in Ethiopia. He revealed
this fact as follows. ‘An Internal Auditing function has existed for quite a long time in
Ethiopia; however, it got legal recognition in late 1980s. The internal Auditing function

12
started in the budgetary public sector as part of internal control. However, the latter part of
the 1940s witnessed the establishment of Internal Audit functions in the Ministry of National
Defense, Ministry of Education, and Ministry of Finance. It was also at this time that the
Internal Auditing units began to sprout in non-budgetary public sector (Public enterprise) like
Ethiopian Highway Authority, Ethiopian Airlines, Ethiopian Telecommunication, and
financial sector that formed the modern layer of the National Economy” (Lemma, 2000)

Perhaps the most direct impact on the current status of internal auditing in Ethiopia came
from another important document issued in 1987. Proclamation No.13. (W/Ruphael, 1998.)
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)
Generally, the history of internal auditing in Ethiopia dated back to the 1940s just about the
time the profession was also evolving in Europe and in the United States. (Lemma, 2000)
2.6 Scope of the Internal Audit Function
The internal auditing function has undergone significant changes in the last century. The
main objective of the IAF has moved from that of fraud detection to assisting management in
making decisions beginning with a risk assessment. The IA staff of today is considered a
good training ground for management-level personnel, but many organizations have
outsourced the entire IAF.

Richmond, (2006) as quoted by Samuel Mulugeta, (2008) says that ten years ago, internal
audit has been considered as an adjunct of external audit, or as a box-ticking, faultfinding
function that provided nothing much in the way of constructive value. But attitudes have
changed, people have changed their minds about what internal audit can deliver and a lot of
internal audit customers are educated about internal audit profession role and scope. This
connotes the scope and the service expected from internal auditor.

Internal audit is changing significantly in a short period as the scope of internal audit
changes. Nowadays, internal audit activity covers many functional areas:

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• Assessment of internal controls
• Operational audits
• Compliance audits
• Fraud investigations
• Partial or full participation in financial audits
• Involvement in risk management process
• Other activities. Tong et.al, (2003)
The scope of internal audit is getting broader from time to time following the changes in the
profession. The changes in the belief towards the profession led to the change in its scope.
Many writers and the IIA itself have shown this fact in different times. The growth in the
internal auditor’s scope of responsibility can be observed through a comparison of the 1947
Statement of Responsibilities of the Internal Auditor and the 1957 revision of the same
document. The 1947 version stated that internal auditing dealt primarily with accounting and
financial matters but may also properly deal with matters of an operational nature. That
emphasis was to change in just one decade.

The IIA described the broad role of internal auditing with its 1957 Statement of
Responsibilities of the Internal Auditor. Whereas the 1947 Statement said that an auditor
might also deal with operating matters, the 1957 Statement stated that the auditor should be
concerned with any phase of business activity. The 1957 Statement included these internal
auditor (IA) duties:
 Reviewing and appraising the soundness, adequacy, and application of accounting,
financial, and operating controls
 Ascertaining the extent of compliance with established policies, plans, and procedures
 Ascertaining the extent to which organizational assets are accounted for, and
safeguarded from, losses of all kinds.
 Appraising the quality of performance in carrying out assigned responsibilities.
(Gupta &Arora, 2004)

Kinfu, (2000) as quoted by Samuel Mulugeta on his article entitled, “ The Upstream and
Down Stream of Internal Audit.” explains that internal audit has been evolving from

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downstream of internal audit which focuses on the origins of transaction recording and
balancing in to the upper management task and becoming tool of management for planning,
organizing, and control (upward stream of internal audit.) and this evolution demand the
interlocking capacities in order to effectively perform its role, which are: advisory capacity,
implement active capacity, reporting capacity, and routine testing responsibility and the
article concludes that these capacities and responsibilities definitely enlarge the internal audit
role and function ever wider, demanding more extensive knowledge and not specialization in
traditional fields.
2.7. Role of the Internal Auditors
The role of internal auditors is increasing from time to time owing to the complexities and
growth of organizations. “Internal auditors are not merely concerned with the organization’s
financial controls. Their work encompasses all of the organization’s internal controls. They
evaluate and test the effectiveness of controls designed to help the organization meet all its
objectives. Also, many progressive internal auditing departments provide a wide range of
other assurance and consulting services to the management of their organizations.”
(Whittington & Pany, 2006)

Van Gasberghe, (2005) also insists that the IA must contribute to performance improvement
and be proactive in communication with management and that its function must be in a
position to match its skills set to the organization’s needs and use enabling technology and
work smarter. Internal auditors assist members of an organization in performing their
responsibility by furnishing those analyses, appraisals, recommendations, and counsel. In
performing these functions, internal auditors can be thought of as a part of the organization’s
internal control. They represent a high-level control that functions by measuring and
evaluating the effectiveness of other controls.” (Whittington & Pany, 2006)

Internal Auditors' roles include monitoring, assessing, and analyzing organizational risk and
controls; and reviewing and confirming information and compliance with policies,
procedures, and laws. "(Cornel University, 2007)
2.8. Challenges to internal Audit Function

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The value proposition of the internal audit function also needs to become one of a positive,
forward-looking contribution to the management of risks in the organization. Making the
shift from a “policing” role toward a positive value contribution for enterprise-wide risk
management is a major challenge for the internal audit function in many organizations. It is
dependent on a clear appreciation and explicit need for internal audit services that will
support risk management activities in the organization. Increased size and complexity in
organizational structures will maintain a demand for traditional internal audit, but it is
incumbent on the internal audit unit to demonstrate that it can contribute to effective and
efficient service delivery in order to drive the demand for enhanced internal audit. (Van
Gasberghe, 2005)

Many countries are still struggling with very limiting environments for IA with poor internal
control, poorly paid and motivated staff, lack of an ethical organizational culture, weak
governance, lack of support from senior management and limited human resources. There
may also be a lack of appropriate regulations, resources and IA can suffer from low status
and lack of independence.

Conflict of interest is another challenge for internal audit. “Due to the fact that different
customers of internal audit services may have different interests, potential conflicts may rise
serving these customers. For example, senior management may be interested in activities,
which may directly affect the bottom line in the profit (loss) account, i.e. potentially their
bonuses. On the other hand, operational management may be interested only in
recommendations on improving the efficiency or effectiveness of operations. Audit
committee may be more concerned with managing their own risk and request a greater focus
on risk management and control activities. (Rupšys, 2005).

Another major challenge is to professionalize the internal audit function. Auditors need to be
increasingly competent in many different areas in order to do a good job: risk and control
analysis, financial analysis, computer technology, etc. These skills need to be recognized,
which is most easily done through a system of certification. Furthermore, there is increasing
pressure on auditors to undertake more audits, and of a more complex character, than before

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(Value for Money audits, for instance). Rewards, both financial and non-financial, need to be
commensurate with the time, skill and educational demands placed on auditors. (Van
Gasberghe, 2005)

2.9. Challenges to internal auditing function in Ethiopia

Although, the prologue of internal auditing in our country counts half a century and all the
endeavors has made to the development of internal audit in Ethiopia, there are challenges that
hinder or slow the speedy growth of internal audit. (Lemma, 2000.) .Most audit committees,
which at one time examined and discussed issues raised in auditors' reports, have now been
dissolved. As a result, the audit report is the only forum available for internal auditors to
present and discuss findings with members of management.

The majority of internal audit departments do not have a written audit charter. Therefore, the
objectives, authority, scope, and responsibilities of internal auditing are not spelled out in
most organizations, and no measures exist to ensure that the internal audit department is
recognized as acting with the authority and support of senior management.

These are not the only challenges that the IAF faced in Ethiopia. W/Ruphael, (1998) argues
that accountancy only is not enough to be an IA. He seems to take side on having a separate
recognized certification in internal auditing (degree or diploma in internal auditing). He
states that “Internal auditing also is handicapped by a critical shortage of appropriately
trained and skilled manpower, inadequate organizational status, and a lack of professional
independence and Internal auditors are typically recruited from internal or external
accounting departments, and the key qualification is still accountancy-based, which
constrains the role and scope of internal auditors. The 1991 OAG study found that
approximately 71 percent of surveyed internal audit staffs held diplomas and degrees in
accounting; none had the requisite professional qualification in internal auditing.

The inadequacies in professional education and the lack of a coordinated comprehensive

training program are critical obstacles to strengthening internal auditing in Ethiopia. The

17
government, public enterprises, and private organizations must attend to these areas to realize
the full value of effective internal auditing.”

2.10. Reporting Relationships

Obviously reporting relationships of internal auditing has changed and developed together
with the progress of internal audit discipline. At the beginning (when internal auditors mostly
were dealing with accounting and financial issues) reporting lines of internal auditors went to
the accounting level and external auditors, who saw internal auditors mainly as assistant in
financial audits. Accordingly as functions and roles of internal auditing expanded, changed
and shifted more to management oriented matters than accounting matters, reporting lines
have also been transformed. Moreover, if at the beginning reporting lines of internal auditing
were generally simple and straightforward; together with changed functions of internal audit
they have made a shift to more complex and difficult relationships. (Rupsys, 2005)

The Institute of Internal Auditors also suggests that regardless of the reporting relationship
the organization chooses, there are key measures that will ensure that the reporting lines
support and enable the effectiveness and independence of the internal audit function. These
key measures are summarized below:
 The head of internal audit should meet privately with the board/audit committee
without the presence of management. This will reinforce the independence and direct
nature of the reporting relationship.
 The board/audit committee should have the final authority to review and approve the
annual audit plan and all major changes to the plan.
 The board/audit committee should review the performance of the head of internal
audit and the overall internal audit function at least once a year, as well as approve
the compensation levels for the head of internal audit.
 The charter for the internal audit function should clearly articulate both the functional
and administrative reporting lines for the function as well as its principal activities.

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  The reporting line should be to someone with sufficient authority to provide internal
audit with sufficient support to accomplish its day-to-day activities.
 The reporting line should facilitate open and direct communications with the CEO,
the senior executive group and line management.
 The reporting line should enable adequate communications and information flows so
that internal audit receives adequate and timely information concerning the activities,
plans and business initiatives of the organization.
 Budgetary controls and considerations imposed by the administrative reporting line
should not impede internal audit in accomplishing its brief. (Tong et.al, 2003)
2.11. Internal auditor’s Independence and Reporting relation ship
In auditing, independence is a key factor for the effective achievement of the goals which the
auditing function is expected to attain. One of the cares that should be taken to do so is
maintaining the independence of the internal auditing function in the organizational structure.
The organizational structure of the internal audit unit poses a practical constraint or a limit on
the independence and/or objectivity of internal auditor. For example, if the internal audit unit
is situated in the finance’s department with the director of internal auditing reporting directly
to the CFO, it is difficult, if not impossible, for internal auditor to objectively evaluate the
performance of peer offices under the controller. In general, the higher the reporting level,
the greater is the independence and / or objectivity of internal auditors. (IIARF, 2001)

Nevertheless, one main concern is the degree of independence accorded to internal audit in
government structures and organization. As there are still, in many cases, challenges for
external audit to become independent of the executive independence (structural and
financial) for internal audit is yet another step to take. Internal audit must add value to
management, while at the same time not becoming its servant, but faithfully report on the
status to the board or other equivalent governing body. (Van Gasberghe, 2005)

The IA needs to be truly independent, have a good understanding of the situation in the
organization and the issues it is facing, as well as being responsive to management’s needs.
To understand the situation, IA must be able to assess key business risks in order to advise
and assure the management.

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“It is imperative that the internal auditors be independent of the department heads and other
line executives whose work they review. Thus, it would generally not be desirable for the
internal auditing staff to be under the authority of the chief accountant. Regardless of their
reporting level, however, the internal auditors are not independent in the same sense as the
independent auditors. The internal auditors are employees of the organization in which they
work, subject to the restraints inherent in the employer-employee relationship”
(Whittington& Pany, 2006).

The chief audit executive should be responsible to an individual in the organization with
sufficient authority to promote independence and to ensure broad audit coverage, adequate
consideration of engagement communications, and appropriate action on engagement
recommendations. He/she also should have direct communication with the board, audit
committee, or other appropriate governing authority. Regular communication with the board
helps assure independence and provides a means for the board and the chief audit executive
to keep each other informed on matters of mutual interest. Independence is also enhanced
when the board concurs in the appointment or removal of the chief audit executive.

Zeleke, (2007) enhances this fact as follows “Independence and objectivity of internal audit
function depends on to whom it reports. In an organization where there is audit committee,
the internal audit function should report to the audit committee.”

Ideally, the Chief Audit Executive (CAE) (a person who is primarily responsible for internal
audit functions) should report functionally to the board or audit committee and
administratively to the chief executive officer of the organization. (Rupsys, 2005)
2.12. Role of Internal audit in corporate governance
Internal audit assists the board discharge its corporate governance responsibilities. Internal
audit can play a key role in supporting the board in ensuring adequate oversight of internal
controls and in doing so form an integral part of an organization’s corporate governance
framework. The key role of internal audit is to assist the board and/or its audit committee in
discharging its governance responsibilities by delivering:

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  An objective evaluation of the existing risk and internal control framework.
 Systematic analysis of business processes and associated controls.
 Reviews of the existence and value of assets.
 A source of information on major frauds and irregularities.
 Ad hoc reviews of other areas of concern, including unacceptable levels of risk.
 Reviews of the compliance framework and specific compliance issues.
 Reviews of operational and financial performance.
 Recommendations for more effective and efficient use of resources.
 Assessments of the accomplishment of corporate goals and objectives.

Lemma, (2005) stated on the occasion of a conference held on ‘Alliances for Integrity
Government and Business Roles in Enhancing African Standards of living.’, has emphasized
that internal auditing plays roles beyond and above the traditional beliefs about the
profession and has clearly put that it has a value addition and other roles in the following
statements “… internal auditing is one of the indispensable elements of corporate governance
providing value-adding audit services to organizations, audit committees, and boards.”
To better serve management and make their presence known, internal auditors must be
responsive to the changing environment and take full advantage of new opportunities. They
must keep pace with developments, and the responsible officials must ensure auditors are
equipped to meet these developments as they occur.” (W/Ruphael, 1998).

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 2.13. Conceptual Framework

Practices of Internal Audit

A. Value Adding Role
B. Improve Department’s Performance
C. Improve Organizational Performance

I. Internal Auditors Competence III. Internal Audit Quality

A. Effective Audit Planning and
A. Proficiency of Internal Auditors Supervision
B. Experience of Internal Auditors B. Internal Audit Field work
C. Effective Communication with Audit C. Reporting, Finding and
tee. Recommendations
D. Training and Development D. Follow-Up of Internal Audit
Recommendations
E. Access to Information Technology
E. Effective Communication with
External Auditors

IV. Management Support

A. Senior Management Support
II. Internal Auditors Independence
B. Size of Internal Auditors
A. Existence of Effective Audit Committee
C. Resources of Internal Audit Team
B. Individual Internal Auditors
Independence
C. Organizational Independence of Internal
Audit Function

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(Source: researcher own design)

3. RESEARCH DESIGN AND METHODOLOGY

In the following sections, the types of data used in conducting this research, the sources these
data are extracted from, the methods employed in measuring, analyzing and interpreting
them, the sample size and the sampling technique will be discussed.
3.1. Research design

According to (Heron, 1998, Saunders et al. 2007 & as cited In Newman, 2013) a research
design refers to a plan for collecting and utilizing data so that desired information can be
obtained with sufficient precision. It is the conceptual structure within which research will be
conducted. It constitutes a blue print for the collection, measurement and analysis of
data .The study planned will be applied descriptive. Descriptive research determines and
reports the way things are and described the phenomena as it is and also the data that is going
to be collected, will describe the existing facts using various ways of analysis.

3.2. Data Type

In this study, the researcher will use both primary and secondary data.
3.3. Data sources
3.3.1. Primary data sources
Data about the scope of the internal audit function, the independence of the internal auditors,
the reporting lines, the internal auditing’s contribution corporate governance, and the
challenges to internal auditing will be collected from primary sources. Data about the
respondents especially about the internal auditors’ sufficiency, competence, educational
background and experiences also will be gathered from primary data sources.
3.3.2. Secondary Data Sources
On the other hand, data regarding the manuals, directives, charters and similar items that the
enterprises are using will be gathered from secondary data sources.
3.4. Methods of data collection

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The primary data will be collected by distributing structured questionnaires to respondents
from the internal audit service, the finance section, audit committee members, production
units, and human resource sections. Similarly, structured interview questions will be prepared
and a face to face interview will be made. The researcher will also make his own observation.
The data that is collected using the appropriate data collecting instruments will be tabulated,
analyzed and interpreted using percentages, bar graphs, pie charts and figures.
3.5. Sample size
The population of this study is the Intern auditor, Accountant, the finance and admin
department, which are 23 professionals in number working in the enterprise purposely. The
researcher will be used purposive sampling method in this study. Because, the use of
purposive sampling method is linked to the nature of the study and recommended to the
Ethiopian setting in order to get reliable and dependable information’s from the concerning body’s.
(Mihret, et al., 2010)
3.6. Sampling technique
Regarding the sampling methods used in selecting the respondents, the non-probability
method of sampling (judgmental method) is used. This method is selected because all
respondents may not be relevant to answer questions about internal auditing. The respondents
should be people who have access and professionals to the internal audit function.
3.7. Data analysis techniques
The study will be employed both descriptive and inferential analysis. The descriptive statics
will employee in the study is percentages, frequencies, and cumulative frequencies. Mean
minimum, maximum, variance and St, deviation. In addition, to determine the relationship
the correlation and regression will be applied to investigate the relationship between variable
and to test the research hypothesis.
.

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 4. Time and Cost Budget

4.1. Time Schedule

No Activities Jul Aug Sept Oct Nov Dec
1 Reviewing various literatures related to the study
2. Writing the proposal
3. Preparing questionnaire
4 Distributing and collecting the questionnaire
5 Coding , analyzing and interpreting the data
6. Submitting the research

4.2. Cost Budget

No Items Quantity Measurement Cost per Total cost Remark
unit Br
1 Stationary materials
 Paper 3 Rim 130 390
 Pen 5 No. 5 25
2 Printing 300
3 Transportation(taxi, Bajaj etc.) 200
Total 915

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