1.1  Background to the Study

The concept of internal audit has been in existence for centuries, dating back to ancient    civilizations such as the Roman Empire and the Dutch East India Company. However, it was not until the late 19th century that the modern form of internal auditing began to emerge (Stuart and Stuart, 2008). Internal audit is      defined as an independent, objective   assurance and consulting activity designed to add value and           improve an organization’s     operations. It helps an organization to accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes (The Institute of Internal Auditors, 2019).

Internal auditing reviews and analyses the attributes of an organization, provides counsel and recommendation to the members of the organization to perform their duties effectively. It is an independent function which evaluates and appraises the functioning of the organization. Meckling (2000) identified auditing as one of the methods for monitoring and controlling the activities in the agency theory, where both the parties try to maximize their utilities. Raja (2002) argued that the increase of internal audit normally adds value and improves on an organization’s operation because of its objectivity and the consultative forums with other departments in the same Organization. Internal auditing is an independent, objective assurance and consulting activity designed to add value to and improve an organization operation. It helps the organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance processes (Wikipedia.org).

The function of internal audit extends beyond the books of accounts and it primarily concentrates on reviewing the operations of the organization and giving recommendations to improve the efficiency of the performance.  The main objective of internal auditing is to evaluate the systems, procedures and controls in the functional areas of the organization by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control and governance. Internal auditing achieves this by providing insight and recommendations based on analyses and assessments of data and business processes. Increase in the size of the organization and expansion of its operations require more control. Therefore, it is necessary to verify that the procedures are complied with correctness and inefficiency. This function can be done only by internal auditing.

The internal auditors are professionals who employed by the organizations to perform the internal auditing activity. The auditor is expected to guide the management on the best accounting practices and at the same time assist in the formulation and updating of policies (Anderson, V., 2003).  The internal auditor could be engaged either as a full time employee or on contract basis by the management of the company. These individuals are called upon to be independent both in fact and appearance. Internal audit services are deemed as a monitoring mechanism because of the potential conflicts of interest between employees as well as owners and managers and other different categories of stakeholders in an organization (De Angelo, 1981). According to Harrison Mwinzi 2015 “This monitoring role means that auditors are used as a mechanism to enhance credibility of the financial statements so that the public who are not involved in the day to day running of the organization can have some level of confidence in the reported financial position.  The willingness of internal auditors to report a discovered breach depends on a number of factors including; the level of independency accorded by the management”. Audit independence must be viewed within the totality of corporate governance and the accountability of organizations to their stakeholders (Raja, 2002). Auditor’s independence in an organization has been termed as the cornerstone of the auditing profession since the opinion of the auditor shades light to the management whether the financial statements for a given period depicts a fair and true position of the financial status of an organization (Caswell& Allen 2001). Harrison Mwinzi 2015 states “The management as the users of the financial statements usually rely on the internal audit reports for quality audits especially where independence was accorded to the auditors in the organization.  Independence permits internal auditors to render the impartial and unbiased judgments essential to the proper conduct of engagements”.  Over the years, several major instances of misstated earnings have been reported of Small and medium size enterprises. The definition of small and medium enterprises varies between one country and another.  However, generally small and medium enterprises (SMEs) are companies which deal with various industries in an economic sector with personnel numbers which fall below certain limits (Harrison Mwinzi 2015). Small and medium enterprises exceed large companies by a wide margin and also employ many more people and are involved in developing innovations and competition in different economic sectors (Bo, R.1992). Small and medium sized enterprises(SMEs), this is, companies with up to 250 employees, constitute the engine of most of the world’s economies. The OECD (organization for economic co-operation and development) estimates that SMEs account for 90% of firms and employ 63% of the workforce in the world.  In the enlarged Europe, some 23 million SMEs represent 99% of all enterprises and provides about 75 million jobs (EC 2008).

In Cameroon, like many other countries, the concept of internal audit has evolved over the years. Before 1974, public establishments in Cameroon were managed and controlled by the central government, and there was no specific focus on internal auditing (Fomum, 2015). However, with the enactment of Law No. 74/25 of 19 December 1974 and Law No. 93/32 of 19 April 1993, the public sector was reformed, and    public establishments were  established as autonomous bodies with administrative and financial   autonomy (Fomum, 2015). This change in the structure of public establishments gave rise to the need for  internal   audit to ensure effective and efficient utilization of resources and compliance with regulations and laws.

The evolution of internal audit in Cameroon can also be seen in the establishment of the   Institute of      Internal Auditors Cameroon (IIAC) in 2011. This professional association is  responsible for promoting the practice of internal audit in both the public and private sectors in the country. It provides training, certification, and networking opportunities for internal auditors, further emphasizing the importance of  internal audit in organizational management (IIA Cameroon, n.d.).

Furthermore, the enactment of Law No. 2016/017 of 14 December 2016 on the organization and functioning of internal audit in public establishments in Cameroon has further solidified the role of internal audit in the public sector (Fomum, 2015). This law provides guidelines for the establishment and functioning of internal audit units in public establishments,    highlighting the need for independence, objectivity, and  professionalism in carrying out internal audit activities.

The contextual background of the study shows that internal audit is becoming increasingly crucial in the management of public establishments in Cameroon. However, there are still challenges that need to be    addressed to ensure the effective implementation of internal     audit. According to Nfor and Fomum (2012), some of the challenges faced by internal auditors in Cameroon include a lack of independence,   inadequate resources, and political  interference.

Furthermore, studies have shown that the financial performance of public establishments in Cameroon is a cause for concern. For instance, a study by Njimanted and Ngege (2017) found that most public establishments under category five (which includes universities,  hospitals, and public corporations) in the South West region of Cameroon were facing      financial challenges, such as inadequate funding, poor financial management, and weak   internal controls. Problem Statement

The reporting quality of MFIs South West region is currently suffering due to the lack of effective internal audit mechanisms. The indicators of this issue are manifesting in various ways, painting a bleak picture of the financial health and accountability within these organizations.

One of the key indicators of the problem is the prevalence of financial irregularities and mismanagement within public establishments. Without robust internal audit processes in place, there is a higher risk of fraud, embezzlement, and misallocation of funds. This not only undermines the credibility and trust      worthiness of these institutions but also leads to significant financial losses that could have been otherwise prevented.

Another indicator is the lack of transparency and accountability in financial reporting. In the absence of thorough internal audits, there is a higher likelihood of errors or discrepancies in financial statements. This lack of accuracy and reliability in reporting hampers stakeholders’ ability to make informed decisions and assess the true financial health of these public establishments.

Furthermore, inadequate internal audit practices contribute to inefficiencies in resource    utilization.    Without regular audits to identify areas for improvement and optimization, public establishments may be wasting valuable resources on unnecessary expenses or failing to allocate funds effectively towards their core objectives. This inefficiency ultimately      hampers their overall financial performance and sustainability.

The impact of these issues on public establishments in MFIs in Cameroon’s South West region is profound. It not only jeopardizes their financial stability and operational    efficiency but also erodes public trust and confidence in these institutions. To address these challenges effectively and ensure the long-term viability of these organizations, there is an urgent need for comprehensive research into the role of internal audit in enhancing financial performance within public establishments.

By shedding light on the critical importance of internal audit practices and their direct     correlation with improved financial performance, this research aims to attract sympathy from potential sponsors who       recognize the significance of promoting transparency, accountability, and efficiency within public institutions. Through targeted funding support for this research endeavor, stakeholders can contribute towards finding sustainable solutions that will benefit not only MFIs in Cameroon’s South West region but also serve as a model for enhancing governance and financial  management       practices more broadly.

Research Questions

Main Research Question:

• How does the internal audit environment impact the reporting quality of microfinance institutions (MFIs)?

Specific Research Questions:

1. What are the key components of the internal audit environment in MFIs?
2. How does the effectiveness of internal audit functions influence financial reporting quality in MFIs?
3. What is the relationship between internal audit independence and reporting transparency in MFIs?
4. How do internal control mechanisms affect the accuracy and reliability of financial reports in MFIs?
5. To what extent does compliance with audit standards improve financial reporting quality in MFIs?

Research Objectives

Main Objective:

• To examine the impact of the internal audit environment on the reporting quality of microfinance institutions (MFIs) in Cameroon.

Specific Objectives:

1. To identify the key components of the internal audit environment in MFIs.
2. To assess the effect of internal audit functions on the financial reporting quality of MFIs.
3. To evaluate the relationship between internal audit independence and financial reporting transparency in MFIs.
4. To analyze the influence of internal control mechanisms on the accuracy and reliability of financial reports in MFIs.
5. To determine the extent to which compliance with audit standards improves financial reporting quality in MFIs.