CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Audit quality is one most significant topic in the auditing profession. Audit Quality is defined as the auditors being capable of detecting and reporting material Misstatements exist in the sample being investigated during the audit process (Vanstraelen, 2000; Mohamed, 2010). According to Pittman and Zhao (2017), the Primary role of financial statement audits is to increase the informational value of financial disclosures via independent verification. To fulfill this role, the auditor is Responsible for detecting and correcting all types of material misstatements in Magnitude, classification, presentation, and disclosure of financial reports. As the Auditor is able not only to detect but also to report on the existing material Misstatements, the audit process is considered as more effective and of a higher Quality.

Wallace (1980) defined audit quality in the form of the ability of an Independent auditor to decrease abnormalities of the reflected information in the financial statements and the increased in the accuracy of this information. On the Other hand, the conflict of interests of managers and owners, potentially affects the Quality of distributed information and the importance of auditing role in protecting the interests of capital suppliers of profit sectors. Directors, as they are responsible for preparing financial statements with the full knowledge of the financial situation of the Company and by having more knowledge than users of financial statements, In the world over, there have been concerns about audit quality in the present environment, where severe failures have come to light, for example; Enron scandal of 2001; Parma at in 2003; Cadbury Nigeria Plc. in 2006 and Afribank Nigeria Plc. in 2009 (Eighme, Cashell, (2002). It has been found that the perceived reliability of audited financial information has declined. In contrast, the perceived relevance of audited financial information has increased. With such recent financial scandals in the U.S. and other countries emphasize the importance of investors’ confidence in financial reporting quality and the need for a quality financial report to meet expectations of current and potential investors. Regulations have an important role, in that weak regulations could reduce the governance quality and financial reporting quality, resulting in poor market efficiency (Goodwin, 2001).

In the past, auditing had played a great role in ensuring that there is transparency in financial statements. Organizations requests for correcting non-conformities or findings are very common. Hence, correcting actions are taking to eliminate the causes of an existing nonconformity, defects, or other undesirable situations in order to prevent a recurrence. Organizations in the world like the World Bank, Central banks, Commercial banks, and micro finances have to demonstrate accountability in the use of government money as well as shareholders money and efficiency in the delivery of services. Organizations now demand great competence and professionalism from auditors and scarce resources must be employed to be more efficient to minimize and manage risks. Technological advancement has made it easier for organizations to track and analyze data continually with increasing speed. The transactions from merely ensuring compliance rules and to truly deliver adding value require more than just organizational changes. In most organizations staff is poorly paid and unmotivated, ethical standards are weak and governance practices are ineffective leading to assets mismanagement Ramamorti (2000), Ekaterina (2007) observed that auditing played an important role in serving the public interest in order to strengthen accountability and reinforce trust and confidence in the financial report. Otieno (2012) research the effects of corporate governance on the financial performance of commercial banks. He concluded that corporate governance plays an important role in banks stability, performance, and banks’ ability to provide liquidity in difficult market situations. Also, organizations like the European Investment Bank (EIB) have gone in for more accountability recently. There exist an audit committee that ensures the accuracy of financial reporting and the confirmation of financial reporting, and the confirmation of the effectiveness of the internal control processes and procedures and also boosts up the financial performance of the institution. The auditing firm ensuring reliability in its institutions financial statement is the KPMG firm. They are appointed and reported to the audit committee. Internal control to be strictly being monitored by managers and other people with authority in specific positions all in a bit to ensure that the financial performance of the Microfinance institutions is steady and improving. Also, as concerns auditing, the Islamic development bank (ISDB) has put in lead auditing activities to determine whether the risk management processes are adequately identified and managed. This role ensures compliance with Islamic Development Bank Group policies and procedures. The internal control systems are strictly implemented and properly evaluated to ensure accountability and functions are properly delegated to respective persons depending on the departments in which they are found. Due to this it has been considered as one of the fasted growing and expanding institutions. Hudgins and Rose (2013) claim that in recent years Microfinance institutions have experienced vibrant and extensive changes which have rapidly and revolutionize these sectors. These key trends include government deregulations, service proliferation, geographic expansion an increasing interest-sensitive mix of funds, and many others. One of the most enormous transformations in the field was the initiation of a new prototype for the sectors. The Islamic Bank has gained the attention of both Islamic and non-Islamic economies worldwide. All over the world, there is the realization that auditing has the potential to provide unparalleled to management in the contact of their duties. This potential has been turned into a challenge and embodied in the new definition of auditing. Microfinance institutions have come to the realization that auditing is essential in improving the management of assets in Microfinance institutions like the bank leading to improved financial performance (Basel Committee, 2012).The Impact of auditing has been found to mitigate risks of improper reporting by enhancing quality financial reporting, minimizing losses, and eventually improving financial performance (vafeas, 1999). Well managed   Microfinance institutions make better use of scarce funds by providing better financial services and reaching more poor clients. Auditing is an effective external mechanism because it signals to potential investors and donors whether the manager confirmed the accounting practices and did not misrepresent financial information. The quality of auditing reports matters as evidence suggests that it is usually driven by active shareholders (Ashbaugh and Warfield, 2003). In addition, there is evidence that Microfinance institutions that voluntarily adopt the international accounting standards or US General Acceptable Accounting practices (GAPP) have lower costs of debt (Leutze and Verrecchia, 2000). The degree of transparency of Microfinance institutions helps to impose market discipline because more transparent Microfinance institutions will attract more investors, creditors, and donors. Increased concerns regarding corporate accountability in various developed nations had been associated with the need for appropriate audits which involve internal control systems (Beekes and Brown, 2006). For an organization to gain a competitive advantage, Microfinance institutions in developing countries like Bamenda requires to improve corporate governance to promote governance and accountability for the purpose of attracting capital, gain sustainability, and curb vices such as corruption. An internal audit function could be viewed as the first-line defense against inadequate corporate governance and financial reporting. With appropriate support from the Board of Directors, audit committee, the internal audit staff is in the best position to gather intelligence on inappropriate Accounting practices, inadequate internal controls, and inefficient corporate governance (Vafeas, 1999).

In recent years in Bamenda, with the expansion of Microfinance institutions, there has been increasing in a large number of deposits into these institutions. These Microfinance institutions usually require fresh capital from outside investors and improved governance plus internal control. The need for accountability is inevitable. Hence, Microfinance institutions are putting in a lot of effort if not their best to ensure that the internal control is strictly respected, accountants and other personnel responsible for accounting and documentation of transactions are done following stated standards, internal audits to are not left out. They do the necessary checks to ensure compliance with the recording principle. External auditors who are independent of these institutions come in to ensure that these financial statements which have gone through the hands of the accountants, checked by the internal auditors show a true and fair view. With all these properly done as it should be, the financial performance of the company is one that encourages investors to come in their numbers. In Bamenda, like across the globe, the notion of fraud in the public or private sector is as old as the origin of man but as a notion i.e. Bamenda it dates some five decades from independence in 1960. In the public and private sectors of the economy like in the day-to-day affairs of life (social or business) fraud has become not just a practice by fraudsters but it is more of an industry where people of low conscience exhibit their talents in deceiving, misappropriating and carrying out money laundering for self-enrichment, Lala .C (1998), ACFE (2004), & FOGAPE (1988). Indeed fraud (financial or otherwise) committed in the public or private sectors of the economy is a testament to the fact that the science of conduct is swayed in large by human greed, ambition, and hunger for power, money, famine and glory currently, manipulations in financial reports are difficult to detect, generally, and by distorting the accounting records, for every transaction or misapplication of accounting principles will impact the accounting and financial information results and decisions thereafter, GAO (2003) & ISA (2004). The Basel Committee, along with banking supervisors throughout the world, has focused increasingly on the importance of sound audit controls. This increased interest in audit controls as result of significant losses incurred by several financial organizations. An analysis of the problems related to these losses indicates that they could probably have been avoided had the organization maintained effective internal control systems. Such systems would have prevented or enabled earlier detection of the problems that led to the losses, thereby limiting damage to the organization. A system of accounting and records keeping will not succeed in completely and accurately processing all transaction unless controls known as internal controls are built into the system (Opromolla&Maccarini, 2010). Internal controls are processes designed to provide reasonable assurance that management achieves effectiveness and efficiency of operations, reliability of financial reporting and compliance with applicable laws and regulations (Grant, Miller, &Alali, 2008). Studying the effects of audit quality on the financial performance of microfinance institutions in, Cameroon, Bamenda is a valuable area of research, given the pivotal role microfinance institutions Play in supporting economic inclusion and development. The effects of audit quality can influence the transparency, reliability, and integrity of financial reporting, thereby impacting the trust of Stakeholders and the overall performance of these institutions. Microfinance institutions in Bamenda serve as key entities in providing financial services to Underserved populations, offering essential access to credit and financial resources for small Businesses, entrepreneurs, and individuals in rural and urban areas. The study employed the theory of inspired confidence (Theory of rational expectations) by Limperg (1932). It addresses both the demand and the supply for audit services. The demand for audit services is the direct consequence of the participation of third parties (interested parties of a company) in the company. These parties demand accountability from the management, in return for their investments in the company. Accountability is realized through the issuance of periodic financial reports. However, since this information provided by the management may be biased, and outside parties have no direct means of monitoring, an audit is required to assure the reliability of this information. With regard to the supply of audit assurance, Limperg (1932) suggests that the auditor should always strive to meet the public expectations. The theory claims that the auditor is responsible for searching, discovering and preventing fraud. In the early 20th century this was certainly the case. However, more recently the main focus of auditors has been to provide reasonable assurance and verify the truth and fairness of the financial statements. The detection of fraud is, however, still a hot topic in the debate on the auditor’ s responsibilities, and typically after events where financial statement frauds have been revealed, the pressure increases on increasing the responsibilities of auditors in detecting fraud. Auditing is the process of assessment and ascertaining of financial, operational, and strategic goals and processes in organizations to determine whether they are in compliance with the stated principles in addition to them being in conformity with organizational and more importantly, regulatory requirements. Indeed, among the objectives of auditing as mentioned above, conformance with regulatory norms and rules and regulations is indeed one of the drivers behind auditing and historically and traditionally, has been the main reason why organizations get their financial statements, operational process, and strategic imperatives audited (Cosserat, G. W. (2009).

Audit quality can be defined in two dimensions: first, detecting misstatements and errors in financial statement and second, reporting these material misstatements and errors. Due to the fact that these characteristics are largely unobservable, different proxies have been used by researchers to measure audit quality like: audit size, audit hours, audit fees, reputation, litigation rate and discretionary accruals (Krishnan & Schauer, 2000). Audit quality is subject to many direct and indirect influences. In tandem with the stakeholder theory (Khan, 2006), perceptions of audit quality vary amongst stakeholders depending on their level of direct involvement in audits and on the perspective through which they assess audit quality. Audit quality may be perceived from any of three fundamental perspectives: inputs, outputs, and context factors. Inputs to audit quality, apart from auditing standards, include the auditor’s personal attributes such as auditor skill and experience, ethical values and mind-set (Dye, R. 2013).

Financial performance is the level of performance of a business over a specified period of time, expressed in terms of overall profits and losses during that time. Evaluating the financial performance of a business allows decision-makers to judge the results of business strategies and activities in objective monetary terms (Carcello, Hermanson, and Rghunaandan

2005). Audit makes a large contribution to the achievement of company goals, and the implementation of strategies for their achievement (Ljubisavlj evió & Jovanovi, 2011). In addition, the audit function is responsible for reinforcing management and audit committee (Hutchinson &Zain, 2009). Likewise, audit quality determines the reliability, reality, and integrity of financial and operational information that comes from different organizational units, on which appropriate business decisions at all levels of management are based. Successful implementation of audit tasks means that it must be independent, i.e., company management should in no way influenced by its work, information, conclusions, and evaluations. In this way the internal audit report becomes a means of communication between internal audit and management, and an important guideline for the successful management of the company (Ljubisavljeviá & Jovanovi, 2011).

1.2 Statement of the Problem

The demand for audit in the present economic environment exist in the communication of financial information to the various interested stakeholders. The auditors’ major concern is risk management since any risk is capable of adversely affecting a firm has the potentials to impact the results reported in the financial statements, audit planning and conduct (Knechel, Salterio & Ballou, 2007). There is widespread criticism of the work done by auditors mainly due to the failure to perform the expected responsibilities or to execute them to the anticipated standards. Auditors have been accused of conducting poor quality audits due to lack of professional competence and independence, failure to dedicate enough time to the audit process and to comply with applicable standards and regulations. Many reports have emerged on loss of confidence in the work done by auditors which results in a decline of society’s confidence in the audit profession in its entirety and by implication the functions of audit (Porter& Gowhorpe, 2004). These negative views have resulted from a discrepancy between the expectations the society have about audit work and what it perceives they deliver otherwise referred to as the “audit expectation-performance gap” (porter, Baskerville & Hogartaigh, 2012). The collapse of eminent companies such as Enron, Parmalat, Xerox, Cable and Wireless, and WorldCom that were enjoying healthy financial performance throughout the 1990s led to a growing apprehension about the quality of work (BPP Learning Media , 2015) In 2001, it was revealed that the Management of WordCom and Enron colluded with their auditors to engage in “creative “ financial reporting and in using questions able accounting practices and they manipulated their financial statements to allude growth and profitability. Most of the Microfinance institutions have functional internal audit departments with well qualified staff charged with responsibilities of re-assuring that internal control systems are adequate and quality processes and systems are in place (Olando, Jagongo and Mbewa,2013). Despite the existence of such Audit departments, there is continued poor performance, incidences of fraud, incidences of budgets not being followed and cases of non-conformance to rules and regulations on usage of finance. This has put member savings at risk despite investing in the internal audit department (Ministry of finance planning and economic development, 2016). With all the above anomalies, it raises questions on the quality of audits done in Microfinance institutions which has negatively affected the financial performance of these institutions. This research study therefore sought to examine the relationship between audit quality and the performance of Microfinance institutions.

1.3 Research Questions

1.3.1 Main Research Questions

What are the effects of audit quality on the financial performance of microfinance institutions in Bamenda?

1.3.2 Specific Research Questions.

1. What is the effect of competence of the auditor on the financial performance of Microfinance institutions in Bamenda?
2. What are the effects of independence of the auditor on the financial performance of microfinance institutions in Bamenda?

• What is the effect of integrity of the auditor on the financial performance of microfinance institutions in Bamenda?

1.4 Research Objectives.

1.4.1 Main Research Objectives.

The general objective of the study was to find out the effects of audit quality on the financial Performance of Microfinance institutions in Bamenda.

1.4.2 Specific Research Objectives.

1. To establish the effect of competence of the auditor on the financial performance of Microfinance institutions in Bamenda.
2. To determine the effects of independence of the auditor on the financial performance of Microfinance institutions in Bamenda.

• To determine the effect of integrity of the auditor on the financial performance of Microfinance institutions in Bamenda.

By pursuing these research objectives, this study aims to provide a holistic understanding of the effects of audit quality on the financial performance of microfinance institutions in Bamenda. The findings are expected to contribute to the development of actionable recommendations for strengthening audit practices and enhancing the overall financial performance and stability of MFIs in the region.