Impact of Political Instability on Financial Statement Accuracy: evidenced

from selected manufacturing firms in Amara region

1. Introduction
The accuracy of financial statements is fundamental to the effective functioning of businesses
and the economy. Financial statements provide essential information for decision-making by
various stakeholders, including management, investors, creditors, and regulatory bodies.
However, in regions experiencing political instability, the reliability of these financial statements
can be significantly compromised (Dănescu & Popa, 2019; Asmare, 2021). This study focuses on
manufacturing firms in Amhara region, a region in Ethiopia that has faced considerable political
unrest, to explore how such instability impacts the accuracy of financial reporting.
Amhara region has witnessed periods of political instability characterized by social unrest,
governmental changes, and conflicts. These events can disrupt business operations, leading to
uncertainties that complicate financial reporting. For manufacturing firms, which rely heavily on
stable supply chains, predictable market conditions, and regulatory clarity, political instability
can have dire consequences on their financial health and reporting practices.
Operational disruptions are a significant concern, as political instability often leads to
breakdowns in production processes, supply chain disruptions, and logistical challenges
(Mengistu, 2020). These operational challenges can cause delays, increased costs, and inventory
management issues, all of which must be accurately reflected in financial statements.
Additionally, political instability creates economic uncertainty, affecting currency valuation,
inflation rates, and interest rates, further complicating financial forecasting, asset valuation, and
financial planning (Tadesse, 2021; Teshome, 2021).

Inaccurate financial statements can mislead stakeholders, leading to poor decision-making,

financial losses, and decreased trust in the firm (Journal of Corporate Finance, 2019; Law and
Business Review of the Americas, 2020). Legal and regulatory repercussions may also arise if
inaccuracies are discovered, resulting in penalties and reputational damage. Furthermore,
management might make erroneous strategic decisions due to flawed financial insights,
impacting the firm’s long-term viability and growth prospects (Strategic Management Journal,
2020; World Development Report, 2020).

While the general impact of political instability on businesses has been studied, there is a lack of
detailed research specifically focusing on how such instability affects the accuracy of financial
statements in the manufacturing sector, particularly in regions like Amhara region. This study
aims to fill this gap by providing empirical evidence and detailed analysis of the specific
challenges and consequences faced by manufacturing firms. The primary objective of this study
is to investigate the impact of political instability on the accuracy of financial statements of
manufacturing firms in Amhara region. By identifying the specific challenges and inaccuracies
that arise during periods of political unrest, the study aims to provide actionable
recommendations for businesses, investors, and policymakers to improve financial reporting
practices and enhance economic resilience in politically unstable regions.

Objectives of the study

General Objectives
The primary objective of this study is to investigate the impact of political instability on the
accuracy of financial statements of manufacturing firms in Amhara region.
Specific Objectives
 To Assess the Extent of Political Instability in Amhara region
 To Examine the Impact of Political Instability on Business Operations
 To Evaluate the Accuracy of Financial Statements During Periods of Political Instability
 2. Literature Review

Importance of Accurate Financial Statements

Accurate financial statements are crucial for stakeholders, including investors, creditors,
regulators, and management, as they provide a true and fair view of a firm's financial position
and performance. These statements are essential for decision-making, resource allocation, and
maintaining market confidence. Misstatements or inaccuracies can lead to misinformed
decisions, financial losses, and regulatory penalties (Smith, 2020).
Financial reporting practices are particularly vulnerable to political instability, as firms may face
pressure to manipulate financial statements to present a favorable picture amidst economic
turmoil. Research by Leuz and Oberholzer-Gee (2006) suggests that firms in politically unstable
regions are more likely to engage in earnings management to mask their financial distress and
maintain investor confidence. Such practices compromise the reliability and accuracy of
financial statements, making it challenging for stakeholders to assess the true financial health of
the company.

Factors Affecting Financial Statement Accuracy

Several factors can influence the accuracy of financial statements, ranging from internal controls
and accounting practices to external environmental conditions such as political stability. Proper
internal controls and adherence to accounting standards are foundational to ensuring accuracy.
Conversely, weaknesses in these areas can lead to errors or fraudulent reporting (Jones, 2019)

Internal Controls and Accounting Standards

Strong internal controls and strict adherence to accounting standards are fundamental in ensuring
financial statement accuracy. Internal controls help prevent and detect errors or fraud, while
accounting standards provide guidelines for consistent and accurate financial reporting. Studies
have shown that firms with robust internal controls and compliance with international accounting
standards tend to produce more accurate financial statements (Adams, 2018).

Impact of Political Instability on Financial Reporting

Political instability can significantly impact the accuracy of financial statements. Unstable
political environments often lead to economic volatility, regulatory changes, and operational
disruptions, which complicate financial reporting. For example, frequent policy changes and
incidents of social unrest can disrupt business operations, making it challenging for firms to
maintain accurate financial records (Brown & Smith, 2021).

Research on Political Events and Financial Accuracy

Research indicates that political events such as elections, government changes, and policy shifts
can lead to uncertainty and economic instability, adversely affecting financial reporting
accuracy. Firms operating in politically unstable regions may face increased risks and challenges
in maintaining accurate financial statements due to the unpredictable business environment
(Miller, 2020).

Policy Changes and Financial Reporting

Frequent and unpredictable policy changes create a complex and uncertain business
environment, making it difficult for firms to plan and report their financial activities accurately.
Such changes can affect tax laws, trade regulations, and labor laws, which in turn impact
financial planning and reporting processes. Studies have found a negative correlation between
the frequency of policy changes and the accuracy of financial statements(Taylor, 2019).

Violence, Conflict, and Financial Reporting

Incidents of violence and conflict pose direct threats to business operations, leading to
disruptions that can hinder the accurate preparation of financial statements. These incidents can
result in asset damage, loss of inventory, and operational shutdowns, complicating the
accounting processes and increasing the likelihood of financial misreporting.(Clark, 2018).

Social Unrest and Its Effects on Financial Accuracy

Social unrest, including protests, strikes, and demonstrations, can disrupt supply chains,
workforce stability, and overall business operations. These disruptions can lead to inaccuracies in
financial reporting as firms struggle to maintain normal operations and record-keeping practices
during periods of unrest (Johnson, 2021).

Political Instability and Business Environment

Political instability disrupts the business environment, leading to economic uncertainty and
fluctuations in market conditions. This instability often results in inconsistent government
policies, frequent regulatory changes, and disruptions in supply chains, which can adversely
affect the accuracy of financial reporting. According to Aisen and Veiga (2013), political
instability significantly hampers economic growth by creating an uncertain environment that
discourages investment and increases transaction costs.

Specific Challenges in Manufacturing Firms

Manufacturing firms are especially susceptible to the adverse effects of political instability due
to their reliance on stable supply chains and predictable regulatory environments. Political
instability can lead to supply chain disruptions, fluctuating input costs, and changes in trade
policies, all of which complicate financial forecasting and reporting. A study by Brouthers,
Brouthers, and Werner (2002) highlights that manufacturing firms operating in politically
unstable environments face greater risks and uncertainties, leading to higher costs and
`inefficiencies that must be accounted for in financial statements .

Conceptual frame work

The conceptual framework for this study explores the relationship between political instability
and the accuracy of financial statements in manufacturing firms. It identifies the key variables
and their interactions to understand how political instability impacts financial reporting.

Independent variables
Dependent variable

Political instability

- Political Events Financial

- Policy Changes Statement
- Social Unrest Accuracy
- Violence and Conflict Incidents

Figure- 2.1-own research, 2024

 3. Methods
The research paradigm for this study is positivist, focusing on empirical data collection and
analysis to understand the impact of political instability on financial statement accuracy in
manufacturing firms. This paradigm relies on observable and measurable evidence to formulate
and test hypotheses, emphasizing objectivity and quantitative analysis.
The study adopts a quantitative research design with a cross-sectional approach. This design
involves collecting data at a single point in time from multiple manufacturing firms in Amhara
region to examine the relationship between political instability and financial statement accuracy.
The use of quantitative methods allows for statistical analysis and generalization of findings.
The target population for this study will be employee of manufacturing firms operating in
Amhara region. This includes medium and large-scale manufacturing enterprises across various
sub-sectors within the region.
The sample size will be determined based on the total number of manufacturing firms in Amhara
region, aiming for a statistically significant representation.
A stratified random sampling technique will be used to ensure that the sample accurately
represents the different sub-sectors within the manufacturing industry. The firms are first
grouped into strata based on their size and sub-sector, and then random samples are drawn from
each stratum proportionally.

To examine the relationship between political instability and the accuracy of financial
statements, a binary logistic regression model is used. This model is suitable because the
dependent variable, financial statement accuracy, is binary (accurate vs. inaccurate).

Let Y be the binary dependent variable representing financial statement accuracy:

 Y=1 if the financial statement is accurate

 Y=0 if the financial statement is inaccurate

The logistic regression model can be specified as follows:

logit(P(Y=1))=β0+β1X1+β2X2+β3X3+β4X4
Where:

 P(Y=1) is the probability that the financial statement is accurate.

 β0 is the intercept.
 β1, β2, β3, β4are the coefficients for the independent variables.
 X1,X2,X3,X4 are the independent variables:

The model will be estimated using Maximum Likelihood Estimation (MLE) to determine the
coefficients β0, β1, β2, β3, β4. The significance of each coefficient will be tested using the Wald
test, and overall model fit will be assessed using the likelihood ratio test and pseudo-R^2
statistics.

By applying this logistic regression model, the study aims to quantify the impact of political
instability on the accuracy of financial statements in manufacturing firms, providing actionable
insights for policymakers and business leaders.

This budget covers the primary expenses anticipated for the study, ensuring comprehensive data
collection, analysis, and reporting within the specify
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