The Relationship Between Auditing and Quality of Financial Statements in Small Medium

MAKERERE UNIVERSITY

THE RELATIONSHIP BETWEEN AUDITING AND QUALITY OF FINANCIAL STATEMENTS IN SMALL MEDIUM ORGANISATIONS.

(A CASE STUDY OPPORTUNITY UGANDA (KAWEMPE BRANCH)

BY

OPILA MOSES

07/U/14575/EXT

ARESEARCH REPORT SUBMITTED TO FACULTY OF ECONOMICS AND MANAGEMENT IN PARTIAL FULFILLMENT FOR THE REQUIREMENT OF THE AWARD OF BACHELOR OF COMMERCE OF

MAKERERE UNIVERSITY.

MAY, 2011

Table of contents:

Declaration iv

Approval v

Dedication vi

Acknowledgement vii

List of tables and figures viii

List of abbreviations and acronyms ix

Abstract x

CHAPTER ONE: 1

1.0Introduction 1

1.1 Statement of the problem 3

1.2Purpose of the study 4

1.3Objectives of the study 4

1.4Research questions 4

1.5Scope of the study 4

1.6Significance of the study 5

CHAPTER TWO: 6

2.0Literature review 6

2.1 introduction 6

2.2 The concept of auditing 6

2.3 Financial statements 7

2.4 Constitutes of quality financial statements 8

2.5 Impact of auditing on financial statements 9

2.6 Impact of audit and quality of financial statements on a business entity’s success. 10

2.7 The relationship between auditing and quality of financial statements. 11

2.8 Conclusion. 13

CHAPTER THREE: 14

3.0RESEARCH METHODOLOGY 14

3.1 Introduction 14

3.2 Research design 14

3.3 research variables 14

3.4 Study population 14

3.5 Sampling procedure 14

3.6 Source of data 15

3.6.1 Secondary data 15

3.6.2 Primary data 15

3.7 Data collection 15

3.8 Research instruments 15

3.9 Data analysis 16

3.9.1 Qualitative data 16

3.9.2 Quantitative data 16

3.10 Limitations of the study/anticipated problems. 16

CHAPTER FOUR: 18

4.0PRESENTATION, ANALYSIS AND DISCUSSION OF FINDINGS. 18

4.1 Demographic characteristics of the respondents 18

4.1.1 Sex of the respondents 18

4.1.2 Employee category according to departments 19

4.1.3 Marital status of the respondents 20

4.1.4 Work experience of the respondents 21

4.2 The effectiveness of auditing as a tool for organizational success 22

4.2.1 The control measures in place 22

4.2.2 Presence of audit departments 23

4.2.3 Presence of audit department acting as a relationship between auditing and quality of financial statements 24

4.3Quality dimensions used to financial statements. 25

4.3.1The effectiveness of quality dimensions. 27

4.4The relationship between auditing and quality of financial statements. 28

4.4.1 Auditors help and guidance 28

4.4.2 The independence and objectivity of auditors. 29

CHAPTER FIVE: 31

5.0 SUMMARY, CONCLUSIONS AND RECOMMENDATIONS 31

5.1 Summary of the findings 31

5.1.1 Effectiveness of audit as a tool for organizational success 31

5.1.2 Quality dimensions used to financial statements 31

5.1.3 The relationship between auditing and quality of financial statements 32

5.2 conclusions 32

5.3 Recommendations 32

5.3.1 Recommendations in respect of effectiveness of an audit as a tool for organizational success 33

5.3.2 Recommendations in respect to quality dimensions used to financial statements 33

5.3.3 Recommendations in respect to relationship between auditing and quality of financial statements 33

5.4 Areas suggested for further studies 33

Key text: references. 34

Appendices

Introduction letter

Questionnaire

DECLARATION

I, Opila Moses do hereby declare that this is my original work and has not been submitted for award of a degree in any university/institution before or for publication.

SIGNED...... Date......

OPILA MOSES

07/U/14575/EXT

CANDIDATE.

APPROVAL

This research report has been submitted under my supervision as a university lecturer.

......

PASTOR YOEL SHALOM

SUPERVISER.

DEDICATION

This work is dedicated to my mother Mrs. AINO NOSIANTA and my brothers; Robert, James, and Francis. They have been supportive both morally to see me to this level in my academic struggle. I am very happy and I feel indebted to them.

ACKNOWLEDGEMENT

The journey has been long I thought I wouldn’t reach, but now I am there. I would like to extend my sincere gratitude to those who have made my dream come true.

My sincere gratitude in this regard therefore, goes to my supervisor pastor shalom yoel for his efforts, spiritual guidance, patience, parental love and all the support and advice he gave me during this exercise.

I would also like to recognize the assistance given to me by various staff at opportunity Uganda especially Mr. Kachau Richard who was always ready and willing to give me all the information I needed to make this project a success.

A special acknowledgement goes to my friend Ronah and to all my discussion group members who encouraged and stood with me in difficult times.

Above all, my praises go to the almighty God who has seen me through. Without his strength and spiritual direction, this work would be nothing and to him, I give the entire honor.

LIST OF TABLES AND FIGURES:

Table I: Gender composition of respondents.

Table ii: Employee category according to departments.

Table iii: Marital status of the respondents.

Table IV: Employees work experience.

Table v: The control measures in place.

Table VI: Presence of audit departments.

Table vii: Presence of audit department acting as a relationship.

Table viii: Quality dimensions used to financial statements.

Table ix: Effectiveness of quality dimensions used to financial statements.

Table x: Auditors help and guidance.

Table xi: Independence and objectivity of auditors.

Diagram 1: Gender composition of respondents

Diagram 2: Marital status of the respondents

Diagram 3: Employees work experience.

Diagram 4: The effectiveness of control measures in place.

Diagram 5: Presence of audit departments.

Diagram 6: Quality dimensions used to financial statements.

Diagram 7: Effectiveness of quality dimensions used to financial statements.

Diagram 8: Auditors help and guidance.

Diagram 9: Independence and objectivity of auditors.

LIST OF ABBREVATIONS AND ACRONYMS:

A-Agree.

D-Disagree.

N/S- Not sure.

SA- Strongly agree.

SD- Strongly disagree.

Ltd- Limited.

%- percentage.

ABSTRACT:

The study focused on audit and quality of financial statements. The research sought its basis from the fact that organizational fraud has continued to feature in mass media despite the presence of checks and balances and that there has been a deliberate tendency by some auditors to part with their professional ethics and statutory duty in the execution of the assignments.

The purpose of the study was to determine the need for quality financial statements for organizational success. The objectives were to evaluate the effectiveness of auditing as a tool for organizational success, to determine the adherence to quality dimensions used to financial statements, and to establish the relationship between auditing and quality of financial statements.

Data was collected using questionnaires. It was then edited, coded, tabulated, transformed into frequency and percentage and analyzed.

The study revealed from the findings that the effectiveness of control measures in place, presence of audit departments and presence of audit department acting as a relationship between auditing and quality of financial statements can enhance the effectiveness of an audit as a tool for organizational success.

The study also established that timeliness, compliance, objectivity, preparation of reports by the right persons and accuracy are quality dimensions critical to financial statements.

Lastly the research found out that, auditors help and guidance, presence of audit departments, and independence and objectivity of auditors are factors responsible for the relationship between auditing and quality of financial statements.

The research was also able to come up with the view that audit and quality of financial statements are strongly positively correlated.

The recommendations were made in respect of the findings and research objectives.

CHAPTER ONE:

• INTRODUCTION:

1.1 BACK GROUND:

Auditing has been performed for centuries but it has come to be recognized as modern profession only during the past approximately 50 years (Ratiff, Wallace, Loebeeke, Mc Farland, 1988).

This has been because of increased complexity in most organizations, companies, and government, especially in establishing the quality of financial statements.

Auditing, as defined by palm rose 1998, is a systematic process of objectively obtaining evidence regarding assertions, economic actions and events of an economic entity to ascertain the degree of assertions and establishes criteria and communicating feedback to users.

The demand for auditors arises from the auditors monitoring role in the principle agent relationship. According to Zimmerman 1986, financial statements audit is a monitoring mechanism that helps reduce information a symmetry and protect the interest of the principals, specifically stakeholders and potential ones by providing reasonable assurance that management’s financial statements are free from material misstatements. In the case of limited companies, financial statements are produced annually and take the form of statement of compressive income, statement of financial position, statement of cash flows, statement of changes in equity and notes comprising a summary of accounting policies and other explanatory notes.

The quality of auditing financial statements differs. Audit quality describes how well an audit detects and reports material misstatements of financial statements while high audit quality is associated with high information quality of financial statements.

This is because financial statements audited by high quality auditors are less likely to contain material misstatements. Angelo 1981 noted that the size of the audit firm is positively associated with audit quality of financial statements.

He further noted that when accounting firm size is used as the indicator of audit quality, higher audit quality is associated with less information asymmetry and higher information quality.

However, Murry 2002 argued that the quality of audit and auditor is strengthened by a system of compulsory rotation of audit firms, especially, after a specific period of time. This is according to Murry, is essential to maintaining confidence in audit quality and the quality of financial reporting which is critical in the efficient functioning of the World’s capital markets.

In addition, audit effectiveness i.e. accomplishes what it was designed to do depend upon the audit firms accumulated knowledge, and long-term experience with the clients operation and complex reporting issues. Compulsory rotation of auditor acts as a disincentive to the auditor to make investments that enhance quality, implying that the knowledge of the client relationship will be fixed and usually of rather short duration thereby his resources, attention and focus on the new client development.

Management seeks assurance that improves the quality of financial statements. If controls are not adequate and not operating properly, the organization may be in danger. So, management is responsible for the organization internal controls and increasingly utilizing auditors to monitor the performance of the organization control systems in order to produce quality financial statements.

1.2 Statement of the problem:

A number of Auditing issues are becoming subjects of anxious debate and controversy. The accounting press has many articles on these auditing issues which include increased accounting regulation of enterprise and the effect on auditors, increased regulation of auditors, the extent of auditors responsibilities for the detection and prevention of fraud, the gap between the public’s expectations of auditing and the legal position of auditors, audits independence and the whole future of auditing as professional activity.

The reliability of audited financial statements greatly depends on the auditors opinions, which are well known to be independent, honest and competent. Recent audit failures such as Enron, waste management, and WorldCom, have led to a negative perception on the quality of audited financial statements.

The companies Act requires that the audited financial statements must give a true and fair view of statement of affairs of the company which is based on auditor’s personal opinion. The users of these statements will know from his knowledge of the auditor whether or not to rely on the auditor’s opinion basing on so many factors.

1.3 Purpose of the study.

The study was intended to expand on the quality of financial statements and find out whether there was a relationship between auditing and quality of financial statements for the success of the firm.

1.4 Objectives of the study:

• To evaluate the effectiveness of auditing as a tool for organization success.
• To determine the adherence to quality dimensions which are critical to financial statements?
• To establish the relationship between auditing and quality of financial statements.

1.5 Research questions:

• How effective is auditing as a tool for organization success?
• What quality dimensions are used to financial statements?
• What is the relationship between auditing and quality of financial statements?

1.6 Scope of the study.

1.6.1 Geographical scope.

The geographical scope was opportunity Uganda Kawempe branch plus other

Departments and stakeholders.

1.6.2 Subject scope

This was based on auditing and quality of financial statements. It was an attempt to define what auditing is, what financial statements are and constitutes of quality and financial statements. The study also endeavored to find out the impact of auditing on financial statements and the impact of audited quality financial statements on company’s entity’s success.

1.6.3 Time scope.

The study covered time from financial year 2007/08 up to 2009/10.

1.7 Significance of the study.

This research can supplement numerous efforts readily put on ground by other

Researchers in availing proper information to guide on effective auditing and financial statements. The findings of the study may provide salient information to planners, relevant Ministries like ministry of finance and Economic Planning, to design appropriate policies concerning auditing and preparation of financial statements in organizations.

The results of the study will have implications for both researchers and accounting information users in that assessment of auditing through actual and perceived audit quality and observation will provide evidence in the quality of financial statements.

The academicians interested in auditing will learn from and expand upon the research.

REVIEW:

Future researchers are encouraged to research on internal audit and organisational performance, with the following research objectives.

• To examine the internal audit effectiveness.
• To examine the organisation performance.
• To determine the relationship between internal auditing and organisational performance.

2.0CHAPTER TWO:

LITERATURE REVIEW:

2.1Introduction: This chapter basically involves analyzing, examining, evaluating and assessing the existing body of knowledge about the topic. The researcher also tried to focus on the weakness while consolidating on the strength of the existing literature by various scholars.

The literature was reviewed on the concept of auditing as a variable to enhance the preparation of quality financial statements. The main issues discuss include auditing, financial statements, constitutes of quality of financial statements and impact of auditing and financial statements on a business entity success.

2.2 The concept of Auditing.

In ordinary sense, Auditing means official examination of accounts. ‘Audit’, is derived from the Greek word “Audire” meaning hear. This was so because in the ancient times the accountants of an estate, domain or manor were checked by having them called out by those who had compelled them to that authority (Woolf, 1994).

Spicer and pegler (1969), according to them, audit is such examination of the books of accounts and vouchers of business as will enable auditors to report whether he is satisfied that the statement of financial position is properly drawn up so as to give a true and fair view of the statement of affairs of the business and statement of comprehensive income gives a true and fair view of profit for the financial period, according to the best of information and explanations given.

Auditing in another sense is also said to be the systematic and independent examination of data, statements, records, operations and performance for a stated purpose

(Ramaswaamyi, 1981).

According to Woolf 1994, Auditing is a process carried out by qualified auditors whereby the accounts of business entities including limited companies, charities, trusts and professional firms, are subjected to scrutiny in such detail as will enable the auditors to form an opinion as to their accuracy, truth and fairness. This opinion is then embodied in an audit report, addressed to those interested parties who commissioned the audit, or to whom the auditors are responsible.

Auditing started in early days of man as people were employed to review the work tax collectors and estate managers. For example, landlords employed independent auditors to check returns from tenant farmers to ensure they accurately reflected revenue received from their estates.

Modern auditing started with the formation of limited companies where the business is separate from owners and the liability of owners is limited to the capital invested in the company. An audit of companies is therefore required to protect the:

• Business owners from unscrupulous managers.
• Business world and the public from owners taking advantage of the limited liability status.

Auditing is broadly divided into external Audit and internal audit. An external audit is an audit of financial statements by external auditors from outside the entity and its objective is to enable auditors to express an opinion whether the financial statements give true and fair view and are prepared in all material respects, in accordance with an applicable financial reporting framework and relevant laws applicable in a particular country.

According to (chamber, 1988) defines internal auditing as an independent appraisal activity, within an organization for the reviewing of operations as a service to management.

2.3 Financial statements.

These are Summaries of an organization’s day-to-day underlying transactions put in report form. They are basically developed from the basic records of an organization for example, Ledgers, receipts and vouchers. The financial statement usually take the form of statement of comprehensive income, statement of financial position, statement of changes in equity and statement of accounting policies and notes.

Audit work on financial statements is aimed at getting sufficient appropriate audit evidence to support the financial statement assertions. Financial statements assertions are the representation of the management, explicit or implicit, that are embodied in the financial statements.

The financial statements represent fair measurements of the economic events and business transactions that affect the organization during a certain period of time (Taylor, 1988).

The preparation of final accounts is the statutory responsibility of the directors who also prepare support schedules, which summarize the contents of accounts, and to relate the summaries to the detailed records from which the information has been drawn (Woolf,1994).

2.4 Constitutes of quality of financial statements.

Quality of financial statements is embedded in accuracy, relevancy and reliability, timely submission, objectivity, comparability, verifiability, neutrality and compliance.

Timely submission refers to beating the deadline or agreed upon for the final report to be handed over to the interested parties. Timeliness requires that accounting information be provided at a time when it may be considered in making a decision (Herman son, 1987).