Fighting Corruption by Means of Effective Internal Audit Function ...

International Journal of Auditing

doi: 10.1111/ijau.12082

Int. J. Audit. 21: 82–99 (2017)

Fighting Corruption by Means of Effective Internal Audit Function: Evidence from the Ghanaian Public Sector Kofi Fred Asiedu and Eric Worlanyo Deffor Ghana Institute of Management and Public Administration (GIMPA) Achimota, Accra, Ghana

Using structural equation modelling (SEM) we analysed the link between corruption and effective internal audit function (EIAF) in Ghana through a survey of directors and managers of selected public sector organizations. A decade after the promulgation of the Internal Audit Agency Act (IAAA), 2003 (Act 658) as an instrument to fight administrative corruption in Ghana, there is little empirical evidence to show its impact on corruption, though anecdotal evidence suggests it has played a critical role in maintaining financial discipline and public sector accountability and transparency. We established that full implementation of Act 658, size of the internal audit department and independence of the audit department significantly affect the effectiveness of the internal audit function which negatively impact on corruption. We conclude that strict adherence to and the implementation of regulations and laws as well as independence of the internal audit function will help fight administrative corruption in Ghana. Key words: Corruption, Ghana, internal audit, structural equation modelling, public sector

1. INTRODUCTION A complex socio-economic phenomenon that is difficult to quantify but has drawn much attention in recent years is corruption. Corruption is often defined as the abuse or misuse of public office for private gains (World Bank, 1997, 2004). Other authors have expanded this conventional definition to include any form of dishonest or unethical conduct by a person entrusted with a position of authority, often to acquire personal benefit (see Kaufmann & Vicente, 2005; Svensson, 2005). According to the literature, corruption harms the economic development and social stability of nations since it is rooted in the existence of privileges and incomplete market mechanisms. It is bad for development because it leads governments to intervene where they need not, thus undermining their ability to enact and implement policies in areas in which its intervention is clearly needed: environmental regulation, health and safety regulation, social safety nets, macroeconomic stabilization and contract enforcement (World Bank, 2005a; Liu & Lin, 2012). Corruption is seen as a primary impediment to growth (Kaufmann & Kraay, 2002), with serious consequences for the economies of developing countries (Hamilton & Hudson, 2014). While the phenomenon of corruption is multifaceted and difficult to measure, and can be encountered in all sectors of an economy (see, e.g., World Bank, 1997, 2005a, 2013; Campos & Syquia, 2005; Senior, 2006; Znoj, 2009), two perspectives emerge in the current financial literature and official pronouncements: bribery and extortion.1 Bribery entails malfeasance, fraud and embezzlement by a public official (Myint, 2000; Enu-Kwesi, 2014), whereas extortion refers to the use of public office or the use of official position, rank or status by an office holder to extort money or favours for the individualˈs own personal benefit (see Kaufmann, 2005; World Bank, 2005a; Heyneman, Anderson & Nuraliyeva, 2008; Enu-Kwesi, 2014). Other writers challenge the conventional definition of corruption by making a distinction between legal and illegal forms of corruption (see Campante & Ferreira, 2004; Correspondence to: Kofi Fred Asiedu, Ghana Institute of Management and Public Administration (GIMPA) Achimota, Accra, Ghana. Email: [email protected]

© 2017 John Wiley & Sons Ltd

Kaufmann & Vicente, 2005). They discuss legal corruption to involve collusion between parties both from the public and private sectors, working together for a common goal such as legal lobbying by the private sector in exchange for passage of particular legislation or allocation of procurement contracts that make use of publicly invested power at the expense of broader public welfare (Campante & Ferreira, 2004; Kaufmann & Vicente, 2005). Illegal corruption, according to the authors, focuses on bribery or other illegal forms of activities as abuse of public office for private gains. Illegal corruption is therefore a symptom of system and institutional failure, contributing to misallocation of resources, poverty, inequality, fiscal indiscipline, and erosion of the trust of the state (see Johnson, Kaufmann & Shleifer, 1997; Campos, Lien & Pradhan, 1999; Campante & Ferreira, 2004; World Bank, 2005a). In sub-Saharan Africa, corruption has been substantially documented in the financial literature as one of the drivers inhibiting development and fuelling poverty (see, e.g., World Bank, 1997, 2005a; Van Gansberghe, 2005; Znoj, 2009; Hamilton, 2013; Hamilton & Hudson, 2014; Pring, 2015). One important aspect of corruption in sub-Saharan Africa is administrative corruption (Campos & Syquia, 2005; Hamilton & Hudson, 2014). The literature defines administrative corruption as ‘mis-implementation of a law or a regulation to accommodate bribes or extract money’ (Campos & Syquia, 2005, p. 15). According to the authors, administrative corruption ranges from ‘petty bribes to government officials overlooking the violation of the law all the way to grand-scale corruption in the awarding of contracts for huge infrastructure projects’. The consequence of this is that it creates distortions in government programmes and retards investment, growth and poverty reduction (see World Bank, 1997, 2005a, 2013, 2014; Kaufmann 2003, 2005; Campos & Syquia, 2005; Pring, 2015). In Ghana, corruption is reported to have contributed to the erosion of trust in various state institutions, which in turn has weakened the stateˈs ability to fight other maladministration in the economy (Fosu & Aryeetey, 2008). According to the authors, it is unsurprising to note that corruption provided rent-seeking opportunities for various officials in government, and indeed Ghana is replete with ISSN 1090-6738

Fighting Corruption by Means of Effective Internal Audit Function

cases of corruption in all regimes, both civilian and military (Fosu & Aryeetey, 2008). As economic incentives, these rent-seeking opportunities contributed to the prevalence of elite political instability in Ghana in the late 1970s (Fosu & Aryeetey, 2008). To reverse the trend, several reforms and anti-corruption laws have been put in place. They include the Public Procurement Act, 2003 (Act 663); the Financial Administration Act, 2003 (Act 654) as amended; the Internal Audit Agency Act, 2003 (Act 658); the Anti-Money Laundering Act, 2008 (Act 749); and the Whistle Blowers Act, 2006 (Act 720). Taking the Ghanaian institutional setting into consideration, this paper examines the Internal Audit Agency Act, 2003 (Act 658) as an instrument to fight administrative fraud and corruption in Ghana. After a decade of promulgation, there is little empirical evidence as to its impact on corruption, though anecdotal evidence suggests that the Act has played a critical role in maintaining financial discipline and public sector accountability and transparency (see, e.g., AuditorGeneralˈs Report, 2011, 2012, 2013, 2014). Using data from a survey of directors and managers and staff of selected public organizations in Ghana, we examine the effects of laws and regulations, specifically, the Internal Audit Agency Act, 2003 (Act 658) in fighting administrative corruption in Ghana. We hypothesize that full implementation of the Act is negatively related to administrative corruption. Our hypothesis is built on the intuition that fighting corruption in an institution is contingent on effective internal audit function (EIAF). The more effective the internal audit function, the lower the level of corruption in various institutions. Institutions are supposed to help stem corruption, thus the lack of quality and effective institutions,2 such as internal audit functions, is often cited as the cause for these system failures. To provide implications for theory and practice, we also examine the factors influencing EIAF in Ghana since, all things being equal, an EIAF will help unearth loopholes and system failures, which in turn will help stem corruption. Thus, we present empirical evidence of the link between EIAF and administrative corruption in Ghana. Three hundred directors, managers and staff of various institutions participated in this research, and they were asked to answer various questions relating to the internal audit function and corruption in the Ghanaian public sector. As hypothesized, the findings show that EIAF is negatively related to administrative corruption. We can conclude that the enactment of Act 658 has helped the government to tackle administrative corruption in the public sector. This study contributes to the literature by first, empirically establishing the link between Internal Audit Agency, an element of Act 658, and administrative corruption in the public sector of Ghana. Second, unlike other studies on corruption which pay critical attention to external auditors to detect fraud and corruption, especially the annual government auditing of metropolitan, municipal and district assemblies (MMDAs) by staff of the audit services, this study provides evidence of the role of internal regulations and law, such as the internal audit function, in addressing administrative corruption in institutions.

2. LITERATURE REVIEW Corruption and internal audit function There is a growing literature on fraud and corruption and the internal audit function in developed and © 2017 John Wiley & Sons Ltd

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developing economies (see Brierley, El-Nafabi & Gwilliam, 2001; DˈOnza et al., 2015; Halbouni, 2015). Most researchers argue that internal audit functions are a valueadding process which is critical for uncovering and preventing fraud in institutions (Richards, 2002; Burnaby, Howe & Muehlmann, 2009; IIA, 2010; Abbott, Parker & Peter, 2012). Though most researchers (e.g., Thomas & Clements, 2002; Halbouni, 2015) believe that it is not the primary objective of internal auditors to oversee fraud prevention programmes, it is logical that internal auditors help in the identification of fraud risks in institutions. For example, in the course of their work, when they discover certain risk factors for fraudulent financial reporting in income, questionable bonus plans and restrictive debt covenants (Church, McMillan & Schneider, 2001), it behoves internal auditors to report. In an ACFE survey in 2008, cited in Halbouni (2015), the survey found that internal auditors were able to initially detect fraudulent activity in over 19 per cent of fraud cases in their work (ACFE, 2008). According to ACFE, this 19 per cent represented a drastic increase compared with the 9 per cent of fraud cases that were revealed by external auditors (Halbouni, 2015) in the same work. According to Halbouni (2015), despite these relatively low percentages, ACFE (2008, 2010) concluded that internal audit departments were the most important entities for detecting and limiting asset misappropriations and corruption schemes. The IIA (1210.A2, p. 6) requires internal auditors to have sufficient knowledge to evaluate not only the risk of fraud but also the manner in which organizations manage that risk. Despite this, the standard does not mandate internal auditors to have the same degree of experience as those mandated to detect and investigate fraud (Halbouni, 2015). Most theoretical studies on corruption focus on the micro-models of the phenomenon by studying individual acts of corruption, while the empirical papers typically study corruption at the country level (see RoseAckermann, 1978; Kaufmann & Kraay, 2002; Kaufmann & Vicente, 2005; Vicente, 2005; de Graaf, 2007). In all these studies, three necessary conditions are established to point to the existence of corruption: discretionary power, economic rents and weak institutions (see Adit, 2003; Liu & Lin, 2012). According to Liu and Lin (2012), while the arbitrary nature of power makes rent-seeking possible, the lack of strong institutions make ‘public officers with authority fearless’ in extracting and creating rent because they would be difficult to catch and prosecute. Corruption is said to be a huge problem that concerns many economies as it distorts production (Mauro, 1998; Wu & Yao, 2008), causes redistribution of income, and makes non-beneficiaries worse off, thus increasing the gap between the rich and the poor (Chen & Li, 2010). Most researchers of corruption believe that the phenomenon distorts the function of government and market mechanism by making it difficult to build economic order, ensure economic development, consequently damaging social stability (Wu & Yao, 2008; Liu & Lin, 2012; Hamilton & Hudson, 2014; Pring, 2015). Since corruption results from systems failure, strong institutions or institutional reform is a strong counter-strategy to combat the phenomenon. Strong institutions mean making systems and structures more effective, including human resource capacity building in these institutions. Internal audit function, as part of institutional governance, is an independent, objective assurance and consulting activity designed to add value and improve an organizationˈs operations (see Goodwin & Teck, 2001). Int. J. Audit. 21: 82–99 (2017)

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Thus, internal audit is a management-oriented discipline that addresses the entire range of operating activities involving a variety of assurance and consulting services (see, e.g., Spraakman, 1997; IIA, 2002b; Dubois, Dumontier & Frésard, 2010; Alzeban & Gwilliam, 2014). To the IIA, the internal audit function 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 (see also Stern, 1994; Sawyer & Dittenhofer, 1996; Nagy & Cenker, 2002; Goodwin, 2004). In most developed economies, the internal audit function is underpinned by mandatory requirements. In Singapore, for example, Goodwin and Teck (2001) report that listed companies are mandated to have their own internal audit function. In the early 1990s, there was a strong global trend towards outsourcing internal audit activities to public accounting firms and other providers (Ritternberg, Moore & Covaleski, 1999). However, by the late 1990s, the IIA had expressed its preference for in-house internal auditing (IIA, 1999; Martin & Lavine, 2000). According to Goodwin and Teck (2001), the Institute argued that an effective internal audit department is an integral part of corporate governance and plays an important role in helping management and the Board of Directors (BoD) to achieve their objectives (see also Ritternberg et al., 1999; Ridley, 2001). The importance of internal auditing has also been recently underpinned by the decision of the New York Stock Exchange (NYSE) to amend its listing requirements to mandate that all listed companies in the United States have an audit committee (NYSE, 2003) to liaise among internal auditors, external auditors and management to ensure the independence of the audit function. Three monitoring mechanisms (external auditing, internal auditing and presence of board of directors) have been identified in the corporate governance literature as critical to the success of institutions (see Anderson, Francis & Stokes, 1993; Blue Ribbon Committee, 1999). The Institute of Internal Auditors (IIA) introduced another perspective that explicitly included a fourth cornerstone of corporate governance: the audit committee (IIA, 2003a, 2003b). The IIA sees the objective of internal auditing as both supporting and strengthening the organizationˈs governance mechanisms and evaluating and improving the effectiveness of risk management and control (IIA, 1999). Despite the increasing importance of internal audit, studies on the value added of having an internal audit function in an institution, especially in the public sector of most developing countries, are limited due to the political and economic environment of most public sectors and recent developments in the area (see Schyf, 2000; Brierley et al., 2001; Gwilliam & El-Nafabi, 2002; Mihret & Yismaw, 2007; Alzeban & Gwilliam, 2014).

Effective internal audit function In the transition economies, studies provide evidence that firms with good corporate governance structures and systems, such as the presence of a board of directors, are more likely to have an internal audit function (see Goodwin & Kent, 2004). A limitation of such studies is that they simply attempt to predict the existence of an internal audit unit and do not examine the number of staff, budget, qualifications, strategic focus and its independence – likely predictors of audit quality or internal audit effectiveness (Carey, Craswell & Simnett, 2000; Carcello, Hermanson & Raghunandan, 2005; Böhm © 2017 John Wiley & Sons Ltd

K. F. Asiedu and E. W. Deffor

et al., 2013). In explaining the importance of internal audit in institutions, for example, Van Gansberghe (2005) stated that internal audit effectiveness is measured by the extent to which it contributes to effective and efficient service delivery, as this drives the demand for improved internal audit services. In the literature, two main approaches are used to describe internal audit effectiveness (IAE). The first approach, as advanced by White (1976), explains that IAE is determined by the fit between the audit and some set of universal standards extrapolated from the characteristics of the internal audit function. Further to Whiteˈs (1976) position, Sawyer (1988) advanced five standards for internal auditing – interdependence; professional proficiency; the scope of work; the performance of the audit; and management of the internal audit department – as the key characteristics of an effective internal audit. Arena and Azzone (2009) added to Sawyerˈs position by stating that internal audit effectiveness should be based on several measures such as the implementation of internal audit recommendation; compliance with the IIAˈs International Professional Practice Framework (IPPF); the nature of internal audit charter and mission; applicable laws and regulations; and audit strategies and plans in place of the department (see also Sutton, 1993; Spraakman, 1997; Dubois et al., 2010). Other authors have noted that the effectiveness of internal auditing is not a computable reality, but rather is determined by the subjective evaluations assigned to this function by management and other stakeholders (see Ransan, 1955; Schneider, 1984; Albrecht et al., 1988; Dittenhofer, 2001). Empirical studies such as Al-Twaijry, Brierley and Gwilliam (2003) and Arena, Arnaboldi and Azzone (2006) have used institutional theory framework to identify factors driving the existence of internal audit effectiveness. For instance, a study involving 364 Italian companies established that company peer pressures have a significant impact on the companiesˈ support of internal auditing. Their findings confirmed that the adoption and development of internal audit were impacted by the coercive, mimetic and normative pressures (Arena & Azzone, 2007). Internal audit effectiveness is necessary because it brings perfection to organizational activities (Ahmad et al., 2009; Unegbu & Kida, 2011; Ussahawanitchakit & Intakhan, 2011). A synthesis of the literature on internal audit effectiveness shows that the role of internal audit in corporate governance is analysed using the following categories: external auditorsˈ evaluation of the quality of a clientˈs internal audit function (IAF); determinants of the IAF reliance decision; extent and nature of the IAF work relied on by the external auditors; and other aspects of the external audit affected by the IAF ˈs involvement (Gramling et al., 2004). Thus, effective internal auditing is how well auditors detect or prevent actual errors within an organization and how best they propose remedial measures to safeguard the resources of the organization (see Goodwin & Teck, 2001; Goodwin, 2004). In the IIAˈs Global Internal Audit Survey, titled ‘Imperative for Change’, internal auditors are tasked to sharpen their focus and risk management and governance processes, since these issues are projected to become the cornerstone of the internal audit profession (IIA, 2011). In the series, written purposely for chief audit executives (CAEs), issues of risk management and governance, key stakeholder priorities, internal audit resources, and the leveraging of audit technology and tool were identified as key imperatives for change for the effectiveness of the internal audit function (for full discussion of these imperatives, see IIA, 2011). Int. J. Audit. 21: 82–99 (2017)


In recent literature, the presence and composition of the audit committee play a critical role in the IAE. The audit committee charter, the governance structure and the composition of the audit committee are equally important, as the responsibilities of audit committee may include the review of the qualifications, organization, strategic focus and resourcing of internal audit as well as the addressing of the effectiveness of the companyˈs internal control system (Böhm et al., 2013). Internal auditors are seen as central forces in uncovering or limiting misappropriation of assets and corruption schemes (Halbouni, 2015). They are supposed to be at the forefront of detecting and preventing fraud in institutions (see Richard, 2002; Burnaby et al., 2009; Abbott et al., 2012).

Country background Ghana promulgated the Internal Audit Agency Act, 2003 (Act 658) more than a decade ago, but there is little empirical evidence on the effectiveness of the Act. Act 658 established an Internal Audit Agency as a central agency to coordinate, facilitate, monitor and supervise internal audit activities within ministries, departments and agencies (MDAs) and MMDAs in order to secure quality assurance of internal audit within these state institutions. Management, by law, is mandated to ensure the establishment of internal audit departments (IADs) and to give it the needed support to perform its work. Given the nature and extent of administrative corruption in the country, it is important that we examine the effectiveness of this law, as Ghana has had a U-shaped history with corruption and embezzlement of public funds. In the late 1970s, corruption was rife and cited among the factors contributing to failed policies in Ghana. After major reforms in the 1980s to reduce corruption by instituting severe punishment for offenders, there was a general consensus among Ghanaians that corruption among policy-makers and senior government officials had diminished considerably (Aryeetey & Kanpur, 2008). According to the authors, there were hardly any allegations in public about government officials demanding and taking bribes on government contracts. This was partly due to the harsh methods that the government instituted (see Gyimah-Boadi & Jeffries, 2000). In the 1990s, corruption was said to have reappeared. Allegations at all levels of public life began to increase. The majority of Ghanaians saw corruption as a major problem in the country. Many Ghanaians considered corruption to be widespread and commonest in the police service and among customs officials. Many regarded politicians also to be relatively corrupt (Ayee, 2002). The Internal Audit Agency Act, 2003 (Act 658) was enacted to check the abuse of public resources, control spending, disbursement and procurement of goods and services. However, evidence abounds in various bulletins, with the 2011 Auditor-Generalˈs report stating that the government lost over US$60 million due to violations of procurement laws, irregularities in contract administration and management lapses, all pointing to corruption. The report further stated that in 2010, the value of reported irregularities in contract administration was significantly higher as a result of contract management lapses that occurred particularly at the Ministries of Health, Defence, Roads and Transport, Education, Employment and Social Welfare (Auditor-Generalˈs Report, 2011). The 2012 Auditor-Generalˈs report on the financial operations of MDAs also revealed unhealthy cash management © 2017 John Wiley & Sons Ltd

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practices, which resulted in the failure of these institutions to pay revenues collected into the Consolidated Fund. The practice of tax irregularities and unauthorized payments, as well as non-availability of adequate records was most prevalent. According to the report, such irregularities and indifference of MDAs in general cost the nation $246,744.24 in 2011 (see Auditor-Generalˈs Report, 2012). In recent times, corruption has been described as systemic and grand as exemplified by the recent revelation of corruption involving the public sector, legislature and the judiciary of Ghana (IAR, 2014). In the annual review of the Auditor-Generalˈs reports by the Public Accounts Committee (PAC) of Ghanaˈs Parliament in 2014, many instances of administrative corruption were established, specifically regarding public spending by MMDAs and other para-statals. In 2015, for instance, the Afrobarometer and Transparency International report cited Ghana as the second most corrupt nation in Africa (Pring, 2015). According to all these reports, the negative consequences of these corrupt acts by government officials and MMDAs find expression in huge budget deficits, high transaction costs of doing business, low standard of living and poor economic performance (see CDD, 2000; IAR, 2014). With the Internal Audit Agency Act, 2003 (Act 658) in place, many hope that administrative corruption will reduce as the number and magnitude of irregularities and errors requiring adjustment by the external auditor have been found to be substantially lower for entities with an internal audit department (see Wallace & Kreutzfeldt, 1991). Thus, after a decade of the promulgation of the Internal Audit Agency Act, 2003 (Act 658) as an instrument to fight administrative corruption in Ghana, there is little empirical evidence as to its impact on corruption, though anecdotal evidence suggests that the Act has played a critical role in maintaining financial discipline and public sector accountability and transparency. The present paper intends to apply structural equation modelling to provide evidence of the role of EIAF in fighting corruption in a developing economy.

3. STRUCTURAL EQUATION MODEL (SEM) Conceptual model We examine corruption and effective internal audit function (EIAF) after a decade of the promulgation of the Internal Audit Agency Act, 2003 (Act 658) using structural equation modelling (SEM). Corruption (Corrpt) and EIAF are represented by a function as: Corrpt ¼ f ðEIAFÞ

(1)

We postulate that EIAF will help fight corruption in institutions. Following Alzeban and Gwilliam (2014), we assume that the internal audit function can be represented by a composite internal audit effectiveness function in the form: EIAFi ¼ EIAFðZi Þ

(2)

where EIAFi denotes effective internal audit function, which is a function of a vector of factors Zi such as the relationship between internal and external auditors (REL), resource and size of the department (SoD), extent of implementation of Act 568 (LAW), certification and years in practice (YRPT), competency of internal auditors (COMP) and independence of internal audit (INDP). The Int. J. Audit. 21: 82–99 (2017)


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relationships between these variables are presented in the conceptual model presented in Figure 1. From Figure 1, we derive three composite functions as presented in equations (3), (4) and (5) respectively. This is basically our internal audit effectiveness – independencecompetency model (see Figure 1). EIAFi ¼ EIAF YRPT; SoD; LAW; COMP; INDPi

(3)

INDPi ¼ INDPðLAW; RELÞ

(4)

COMPi ¼ COMPðLAW; SoD; YRPT; RELÞ

(5)

In the conceptual model of Figure 1, there are three latent constructs: effective internal audit function (EIAF), relationship between internal auditors and external auditor (REL) and competency of internal auditors (COMP). A latent variable or theoretical construct refers to a phenomenon that is supposed to exist but cannot be directly observed. Examples are intelligence, socio-economic status, welfare competence, job satisfaction, awareness, etc. However, a latent variable is given empirical meaning (measured) by means of corresponding statements that relate it to a set of observed variables (indicators). For instance, intelligence is measured by intelligence tests and welfare by indicators such as income, environmental quality, health care, safety, etc. Diamantopoulos, Reifler and Roth (2008), however, explained that given the nature of the relationships to the indicators, latent variables can be classified into two main categories, namely reflective and formative latent variables. They explained that for a latent variable to be reflective, its causality flows from the latent variable to its indicators. Hence a change in the indicators reflects the change of the latent construct. Conversely, a latent variable is formative if the causality is from the indicator to the construct. This distinction is important because, according to Diamantopoulos et al. (2008) and Coltman et al. (2008), the nature of the latent construct determines the specification and the reliability of the measurement model, a a misspecification of the measurement model leads to biased estimators and poor model fit.

Endogenous variables Corruption Corruption, a symptom of system and institutional failures, has been identified as one of the drivers inhibiting development and fuelling poverty in sub-Saharan Africa (Van Gansberghe, 2005; Znoj, 2009; Hamilton, 2013; Hamilton & Hudson, 2014; Pring, 2015). The phenomenon is considered a bad omen for development as it keeps development in a perpetual reverse gear because governments are forced to intervene where they need not, thus undermining their ability to enact and implement policies in other areas in which its intervention is clearly needed: environmental regulation, health and safety regulation, social safety nets, macroeconomic stabilization and contract enforcement (World Bank, 2014). We expect corruption to decrease when an effective internal audit function or internal audit effectiveness improves: an inverse relationship.

Competency of internal auditors According to the literature, when an internal audit function is effective, it becomes an important element in helping an organization achieve its objectives (MacRae & Van Gils, 2014). These authors conclude that organizations with internal audit activities are better able to identify business risks and systems inefficiency, take appropriate corrective action and ultimately support continuous improvement. In Ghana, the establishment of Act 568 was supposed to give the mandate to the public services to establish internal audit departments with a charter and mission to ensure efficiency in the service. The competency of a department actually depends on the charter and mission as well as the education and skills of the staff. Skilful staff with sufficient resources enhance the competence of an internal audit department and its effectiveness. We expect a positive correlation with EIAF as, all things being equal, such auditors will be able to unearth corrupt practices; thus in the long run reducing corruption.

Independence of IAD The financial literature identifies independence and objectivity as key elements in ensuring effectiveness of

Figure 1: The conceptual model. © 2017 John Wiley & Sons Ltd

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IAD within public sector organizations (CIPFA, 2003). The Chairman of the American Institute of Certified Public Accountants (AICPA) had earlier stated independence as one of the most precious assets and the main cornerstone of the accounting profession (Mednick, 1997). Alzeban and Gwilliam (2014) also confirm that increasing weight is now being placed on the need for internal auditors to be independent and objective, even though they are normally employees of organizations. They stated lack of independence as the main obstacle to satisfactory internal audit performance in a number of developing countries (Alzeban & Gwilliam, 2014). An example includes the case of the South African public sector, where Schyf (2000) noted a lack of independence of internal audit as a concern facing the internal audit activities in that country. The above evidence therefore suggests the importance of independence of IAD in ensuring its effectiveness within public sector organizations. To ensure independence and thus objectivity of IAD, it is now being recommended that the IAD should hierarchically not be positioned under parts of the organization that are themselves subject to internal audit scrutiny. It is suggested that IAD should have a reporting line that makes it independent of management in order to achieve independence (see Schyf, 2000). In Ghana, the internal audit units/departments within the MDAs are required to submit reports on their activities to the audit committee of the board of directors. The independence of the internal auditor is therefore influenced by Act 658 (LAW) and the relationship of internal auditors with external auditors. We therefore hypothesize that the independence of IAD would have a positive relationship with EIAF.

Effective internal audit function The term effectiveness describes ‘the degree (including quality) to which established objectives are achieved’. For every internal audit system to be effective, the process should have established performance metrics with related measurement criteria appropriate to its environment/ organization (White, 1976). We employ a measure based on the quality of the audit function (see also Alzeban & Gwilliam, 2014), as a result of the implementation of the Internal Audit Act, IAA (Act 658) of Ghana as perceived by internal auditors and managers of selected public sector organizations. We measure EIAF by aggregating responses from directors and managers of institutions on a basis of survey questions on aspects of Act 658 and other department-specific questions such as resources, certification and education (qualifications), charter and mission of department and relationship with external auditors. We assume that a competent internal audit department will be effective. We therefore hypothesize that the effectiveness of the audit function (EIAF), among others, will depend on the availability of laws and regulations; clear and well-presented reports, i.e. the extent of rigour and accuracy of internal audit reports; extent of implementation of laws and regulations; size of the department; staff experience; and relationship with external auditors.

Exogenous variables Relationship between internal and external auditors For a good relationship to exist between internal auditors and external auditors, the independence of the internal audit department is critical. More often than © 2017 John Wiley & Sons Ltd

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not, external auditors rely on the work of internal auditors to do their job. The scope of work and materiality of systems and structures depend on the efficiency and effectiveness of the internal audit function. For instance, a poorly deployed internal auditing system can lead to increased, non-value-added costs, many hours of wasted resources and eventual breakdown of the assurance system of the institution. According to the literature, internal auditing, when effectively implemented, becomes an important gauge as to the level of risk in the company or institution (Strauss, 2009). The primary function of IAD through the continuous monitoring of the institutionˈs quality assurance system is a good feedback to external auditors in the task and scope of audit engagement. We expect the relationship between internal and external auditors to correlate positively with internal audit effectiveness.

Resources and size of IAD The number of internal auditing staff is a critical issue in EIAF. Studies have established that the quality of internal audit work is likely to be higher when the department is well resourced and sufficient number of staff is involved in audit work (Ali et al., 2007; Alzeban & Gwilliam, 2014). The link between a sufficient number of staff and ability of an IAD to perform its duties is well documented (see Brierley et al., 2001, 2003; Mulugeta, 2008; Obeid, 2010; Alzeban & Gwilliam, 2014). Since the number of staff in an IAD most often correlates with the size of the agency or institution, we expect large institutions to have a sizeable number of internal audit staff to engage in internal assurance. The number of staff affects the scope of work and resources and time allocation. Thus, we hypothesize that larger internal audit departments will demonstrate higher EIAF compared with a smaller department.

Charter and mission: extent of implementation of the Internal Audit Agency Act 2003 (Act 658) Laws and regulations are important in setting the mandate and legitimacy of a department. A formal mandate in the form of an Act gives a department the power and authority to execute its mandate. Thus, a good governance process that ensures establishing and preserving values, setting goals, monitoring activities and performance, and defining the measure of accountability is paramount in reducing organizational inefficiencies. The enactment of the IAA Act, 2003 (Act 658) was good for Ghana. The extent of implementation of various tenets and provisions of the Act is another question and depends on several factors such as the presence of an audit committee, independence of the department and management support. A welldefined charter and mission of the internal audit department will correlate positively with internal audit effectiveness.

Certification and years with the IAD The qualification of the IA staff, especially those that are certified internal auditors, is also important. Certified and experienced staff members can have very good knowledge of the operations and systems of the institutions, thus helping to reduce risk and to set proper audit scope of activities. The role of an internal auditor in an institution is to ensure that the organization adheres to all financial, personnel, lending, data processing, and other administrative policies and Int. J. Audit. 21: 82–99 (2017)


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procedures as well as economy, efficiency and effectiveness with which resources are used (see IIA, 2002a). We hypothesize that qualification based on certification and years in an enterprise, being a proxy for experience and skill, will affect EIAF positively. Experienced and certified auditors will understand the system better, apply the necessary technology and databased analysis, including all administrative policies and procedures, and will therefore save the institution a lot of man-hours and resources.

Structural equation model The conceptual model presented in Figure 1 contains latent variables (relationship, effectiveness and competency) and observed variables [Act 658 (law), resources and department size, certification and years with department and relationship with external auditors]. Latent variables or theoretical constructs in this paper refers to those phenomena that are presumed to exist but cannot be directly observed (Oud & Folmer, 2008). Typically, SEM allows the handling of latent and observed variables in their relationships within an integrated framework (Jöreskog & Sörbom, 2001). An SEM, as introduced by Jöreskog (1977), consists of two submodels: a measurement model and a structural model. The measurement model specifies the relationships between the latent variables and the observed indicators, while the structural model represents the relationships between the latent exogenous variables and latent endogenous variables as well as the relationships among the latent endogenous variables. The following equations

present the measurement models for the endogenous and exogenous variables, respectively. y ¼ Λy η þ ε

(6)

x ¼ Λx ξ þ δ

(7)

where y is a p × 1 vector of endogenous observed variables, x is a q × 1 vector of exogenous observed variables, η is an m × 1 vector of latent endogenous variables, and ξ is an n × 1 vector of exogenous variables. Λy and Λx are p × m and q × n matrices of coefficients (or loadings). Finally, ε and δ are p × 1 and q × 1 vectors of measurement errors of y and x, respectively. The structural model reads as follows: η ¼ Βη þ Γξ þ ζ

(8)

where η and ξ are defined in equations (6) and (7), B is an m × m matrix with βij representing the effect of the jth endogenous latent variables on the ith endogenous latent variable. Γ is an m × n matrix with γij representing the effect of the jth exogenous latent variables on the ith endogenous latent variable and ζ is an m × m vector of disturbances. Estimation of the model was performed using the SEM package in Stata 13.1, though other software packages such as LISREL, OpenMx (in R) and Amos can be equally used (for details, see Jöreskog & Sörbom, 2001). Maximum likelihood (ML) estimation was used. Table 1 presents the various a priori expectations for each of the variables used in the study.

Table 1: Hypothesized relationships Independent variable

Resource and size of department Competency Effectiveness of internal audit function Relationship between internal and external auditors Extent of implementation of Internal Audit Act Qualifications of staff

Independence Corruption


Measurement

Number of people and tools of the IA Department Measured by a five-item scale using a five-point Likert scale Measured by six item scale using a five Likert scale Measured by a four item scale using a five point Likert scale Measured by the extent of implementing sections of the ACT 658 Certification and average number of years working in the field of Auditing Measured by a four-item scale using a five-point Likert scale Measured by a four-item scale using a five-point Likert scale

Variable names

Hypothesized influence on: Effectiveness (EIAF)

Competency (COMP)

SoD

+

+/

COMP

+

Independence Corruption (INDP) (CORRPT)

EIAF REL

+

+

+

LAW

+/

+/

+/

YRPT

+

+/

INDP

+

+

CORRPT

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The conceptual model in terms of equations is as follows: Measurement model 2

3

2 CORRPT1 λ1;1 6 CORRPT2 7 6 7 6 6 7 6 λ2;1 6 CORRPT3 7 6 6 7 6λ 6 7 6 3;1 6 7 6 6 7 6 6 EIAF1 7 6 6 7 6 6 7 60 6: 7 6 6 7 6: 6 7 6 : 6 7 6 6 7 6: 6 EIAF6 7 6 6 7 60 6 7 6 6 7 6 6 7 6 6 COMP1 7 ¼ 6 6 7 6 6 7 60 6: 7 6 6 7 6: 6 7 6 6: 7 6 6 7 6 6 COMP5 7 6 : 6 7 60 6 7 6 6 7 6 6 7 60 6 INDP1 7 6 6 7 6 6 7 6: 6: 7 6 6 7 6: 6 7 4 4: 5 0 INDP7

0

0

3

0

7 0 7 7 0 0 7 7 7 7 7 7 0 0 7 2 3 7 ε1 7 : : 6 7 7 ε 6 2 7 7 7 7 2 : : 3 6 6 ε3 7 7 CORRPT 6 7 7 0 0 7 6 7 7 6 7 6 EIAF : 7 7 6 6 7 7x6 þ 7 7 4 COMP 5 6 : 7 6 7 7 λ10;3 0 7 6 7 6: 7 7 INDP 6 7 7 : : 6 7 7 4: 5 7 7 : : 7 ε21 λ14;3 0 7 7 7 0 λ15;4 7 7 7 7 : : 7 7 : : 5 0 λ21;4

0

0

0 λ4;2 : : λ9;2 0 : : 0 0 : : 0

(9) 2

R1

6R 6 2 6 6 R3 6 6 6 R4 6 6 LAW 6 6 4 SOD

3

2

λ11 0 0 0

7 6λ 0 7 6 21 7 6 7 6 λ31 0 7 6 7 6 7 ¼ 6 λ41 0 7 6 7 60 1 7 6 7 6 5 40 0

YRPT

2

3

δ1

3

6δ 7 0 07 6 27 7 2 3 REL 6 7 7 6 δ3 7 7 0 07 6 6 7 7 6 7 7 6 LAW 7 0 0 7x6 7 þ 6 δ4 7 6 7 7 4 SOD 5 60 7 0 07 6 7 7 YoP 6 7 7 40 5 1 05

(10)

0

0 0 0 1

Structural model 2

CORRPT

6 6 EIAF 6 6 6 COMP 4 INDP

3

2

0

0

0

0

0

0

3

2 3 6 7 CORRPT 6 7 7 6 β21 0 0 0 7 6 7 7 6 7 76 7 6 6 EIAF 7 7 7 ¼ 6 0 β32 0 0 7 6 7 7 6 76 COMP 7 5 6 4 5 7 4 0 β42 β43 0 5 INDP 2

0

6 6 γ21 6 þ6 6γ 4 31 γ41

0

3 2

REL

3

2

ζ1

3

γ32 γ33

7 6 7 6 7 6 7 6 7 γ24 7 7 6 LAW 7 6 ζ 2 7 7x 6 7þ6 7 6 7 6 7 γ34 7 5 4 SOD 5 4 ζ 3 5

γ42

0

γ22 γ23

0

YRPT

ζ4

(11)

4. EMPIRICAL ANAYSIS AND RESULTS The survey The study was carried out in the Greater Accra Region of Ghana, which is the economic and administrative region of the country. A two-stage sampling frame was used to identify and select the sample for the study. In the first stage, purposive sampling was used to select some public sector organizations, followed by the selection of the respondents from the departments using a simple random sampling technique. The data instrument collected data on the socio-demographic information of the respondents and their perceptions relating to the various factors influencing internal audit effectiveness using structured selfadministered questionnaires.

Data type and sampling The data is obtained from workers of selected public organizations in Ghana. We examined the effects of laws and regulations, specifically, the Internal Audit Act (Act 658) in fighting administrative corruption in Ghana. We sampled 300 workers consisting of heads of department (director), managers of various units and staff of the internal audit departments of public organizations that have functioning internal audit departments. Purposive sampling was employed to select the organizations. Thereafter, a simple random sampling technique was used to draw the sample for the study. Hence, a total of 300 respondents was drawn. The structured questionnaires were self-administered to the sampled respondents in the selected organizations that met the criteria above. Each organization received a total of 30 questionnaires, one each for the head of the department and the unit head and the rest for staff of the internal audit department. To facilitate the data collection process, a key person was tasked within each of the departments to follow up on the distributed instrument. After collection and data cleaning, incomplete and implausible answered questionnaires were removed from the final dataset. A total of 287 questionnaires were used for the data analyses, representing a response rate of 96 per cent of the entire sample. The response rate for each category of respondents is presented in Table 2 as follows: heads of departments (directors, managers/heads of unit) (100%) and staff of internal audit unit (92%). The designed questionnaire dealt with the effectiveness of the internal auditing processes, corruption and other independent variables (see Appendix). Specifically, the study employed several measures of effective internal audit function (EIAF). These include the departmentˈs perceived ability to plan; to improve the organizationˈs productivity; to assess the consistency of results with established objectives and goals; to implement internal audit recommendations; to evaluate and improve risk

Table 2: Sample distribution and actual response rate Type of respondents Department heads/managers Other staff of units/departments Total


Number per unit

Number of units/departments

Total sample

Actual

Response rate

2 28

10 10

20 280 300

20 267 287

100% 92% 96%

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management; to evaluate internal control systems; and to provide recommendations for improvement. Furthermore, we explored the perceptions of stakeholders (staff of internal audit departments) on EIAF using measures of competence of auditors; size of internal audit department; and relationship between internal and external auditors. Other variables measured include independence of internal audit; number of years with the internal audit department; and extent of implementation of Act 658. From Table 3, the respective measures for each variable are presented. These factors were adapted for this study from Alzeban and Gwilliam (2014) and from review of existing work from

Africa (Wolderupheal, 1998; Ali et al., 2007; Mihret & Yismaw, 2007; Adetoso, Oladejo & Akesinro, 2013).

Descriptive statistics The scores for the six indicators used to measure the effectiveness of the internal audit function (EIAF) is presented in Table 4. The results show that about 84 per cent of the respondents either agree or strongly agree (score of 4 to 5) with the indicator (EIAF1) while 11.8 per cent of the respondents neither agreed nor disagreed with the indicator (EIAF1). In addition, close to 4 per cent of the respondents

Table 3: Measure questions for each variable Statements Effective internal audit function The activities of internal audit meet the expectations I have from the internal audit department. Internal audit is aware of to the organizationˈs needs and operates accordingly. The evaluation of internal audit reports made by the external auditors is positive. Internal audit reports are clear and well presented. Internal audit reports are professional. The managementˈs decision-making process is strongly affected by the reports and findings of the Internal audit function. Independence Internal audit staff members are sufficiently allowed by management to perform their professional obligations and duties. The head of the internal audit reports to a level within the organization that allows the internal audit to fulfil its responsibilities. The internal audit has direct contact to the Board of the organization. Conflict of interest are rarely present in the work of internal auditors. The board approves the appointment and replacement of the head of the internal audit department. The internal audit department has direct contact with senior management other than the finance director. Internal audit staff have free access to all departments and employees in the organization. Corruption Internal Audit Agency Act 2003 (Act 658) had made a difference in the fight against corruption. The internal audit department, as part of corporate governance of your institution, has helped in the fight against corruption. Given the nature of the internal job, it is difficult for one to avoid encountering incidents of corruption in the course of work. Competency The internal audit unit has sufficient skilled internal auditors. Most of them have certification in auditing. The internal audit staff number and their skill matches the scope of officeˈs/sectorˈs internal operations. The internal audit staff are able to use modern technology (use computerized data tools and specific IA software). The audit procedures and evidence collections are completed on time, since enough and skilled internal auditors are available or employed. It is possible to audit and review each activity on time, and cover the planned scope of auditing activities. Relationship External auditors are friendly and supportive. External auditors have good attitude towards internal auditors. External auditors are willing to give internal auditors an opportunity to explain their concerns. External and internal auditors consult on the timing of work in which they have mutual interest. Adapted from Alzeban and Gwilliam (2014) Table 4: Frequency distribution of the scores of the indicators of Effectiveness and Corruption Indicators

EIAF1 EIAF2 EIAF3 EIAF4 EIAF5 EIAF6 CORRPT1 CORRPT2 CORRPT3

Statements

The activities of internal audit meet the expectations I have from the internal audit department Internal audit is aware of to the organizationˈs needs and operates accordingly. The evaluation of internal audit reports made by the external auditors is positive Internal audit reports are clear and well presented Internal audit reports are professional The managementˈs decision making process is strongly affected by the reports and findings of the internal audit department Internal Audit Agency Act 2003 (Act 658) had made a difference in the fight against corruption The internal audit department, as part of corporate governance of your institution, has helped in the fight against corruption Given the nature of the internal job, it is difficult for one to avoid encountering incidents of corruption in the course of work


Score 1

2

3

4

5

0.0

3.8

11.8

59.6

24.7

0.3 0.3 0.3 0.3 0.0

3.1 2.4 2.1 1.4 1.0

13.6 17.5 17.4 16.1 14.6

60.8 57.0 58.5 56.6 55.7

22.0 22.7 21.6 25.5 28.6

0.4

24.7

24.0

42.0

8.8

47.1

25.7

24.6

2.5

16.6

26.7

44.0

12.6

Int. J. Audit. 21: 82–99 (2017)


scored the indicator (EIAF1) from 1 to 2 (‘Strongly disagree’ and ‘Disagree’). A lot more of the respondents scored the effectiveness indicator (EIAF2) from 4 to 5, representing 82.8 per cent of the respondents followed by 13.6 per cent of the respondents who scored the indicator 3 (‘Uncertain’). The results also show that majority of the respondents (79.7 per cent) scored the third indicator for effectiveness (EIAF3) at 4 or higher with a small percentage (2.7 per cent) scoring lower (2 or lower). The findings suggest that despite a minority having a different view of internal audit effectiveness, most of the respondents agree that these indicators measure the effectiveness of the internal audit department. These percentages are based on a total of 287 respondents used in the analysis. This put the response rate at 96 per cent. To measure the construct ‘corruption’, three statements adapted from the Transparency International questionnaire for assessing corruption perception were used. Using a five-point Likert scale, respondents were required to

91

indicate their level of agreement or disagreement with the statements. The results are presented in Table 4. The findings show that 42 per cent of the respondents agree that the internal audit law has made a difference in the fight against corruption, although some 24 per cent of the respondents neither agree nor disagreed with the indicator CORRPT1. The second indicator CORRPT2 shows that 47.1 per cent of the respondents disagreed that the level of corruption had improved over the past five years. See Table 4 for details. The respondentsˈ subjective assessment of the construct competence was tested using five indicators as presented in Table 5. For each indicator, a five-point Likert scale was used. From the table, a total of 12.9 per cent of the respondents scored the first indicator (COMP1) 4 with about 3 per cent of the respondents scoring it 5, indicating their strong agreement with the indicator COMP1. However, about 58 per cent of the respondents disagree with the indicator COMP1, with some 16 per cent of the

Table 5: Frequency distribution of the scores of the indicators for Competency Indicator Statements

Score 1

COMP1 COMP2 COMP3 COMP4 COMP5

The internal audit unit has sufficient skilled internal auditors. Most of them have certification in auditing The internal audit staff number and their skill matches the scope of officeˈs/sectorˈs internal operations. The internal audit staff are able to use modern technology (use computerized data tools and specific IA software) The audit procedures and evidence collections are completed on time, since enough and skilled internal auditors are available or employed. It is possible to audit and review each activity on time, and cover the planned scope of auditing activities.

2

3

4

5

10.8 57.5 16.0 12.9 2.8 16.0 52.6 16.0 12.9 2.4 14.6 61.3 14.3

9.1 0.7

16.4 57.1 15.3 10.5 0.7 13.9 59.9 16.4

8.7 1.0

Table 6: Frequency distribution of the scores of the indicators for Independence Indicator

INDP1 INDP2 INDP3 INDP4 INDP5 INDP6 INDP7

Statements

Internal audit staff members are sufficiently allowed by management to perform their professional obligations and duties The head of the internal audit reports to a level within the organization that allows the internal audit to fulfil its responsibilities The internal audit has direct contact to the Board of the organization Conflict of interest are rarely present in the work of internal auditors The board approves the appointment and replacement of the head of the internal audit department The internal audit department has direct contact with senior management other than the finance director Internal audit staff have free access to all departments and employees in the organization

Score 1

2

3

4

5

3.8

38.3

38.0

18.5

1.4

3.8

34.8

33.1

26.5

1.7

5.6 3.1 3.8

39.4 26.8 31.0

35.2 32.1 27.9

17.8 35.9 35.2

2.1 2.1 2.1

3.8

30.0

28.9

34.8

2.4

3.8

32.1

36.2

25.4

2.4

Table 7: Frequency distribution of the scores of the indicators of Relationship between External and Internal Auditors Indicators

REL1 REL2 REL3 REL4

Statements

External auditors are friendly and supportive External auditors have good attitude towards internal auditors External auditors are willing to give internal auditors an opportunity to explain their concerns External and internal auditors consult on the timing of work in which they have mutual interest


Score 1

2

3

4

5

8.7 2.4 12.2

41.5 23.7 42.2

23.7 24.4 26.1

24.7 45.6 16.0

1.4 3.8 3.5

8.4

42.9

20.2

26.5

2.1

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Responses pertaining to the independence of the internal audit department were measured by seven different indicators on a five-point Likert scale (Table 6). The results presented in Table 6 show that 19.9 per cent of the respondents agreed with the indicator INDP1. The results show that 42.1 per cent of the respondents scored it between 1 and 2 (‘Strongly disagree’ or ‘Disagree’). Quite an appreciable percentage of the respondents were uncertain (neither agree nor disagree). In terms of the second indicator, 26.5 per cent of the respondents scored it 4 (‘Agree’) on the Likert scale. A small percentage of the respondents (1.5 per cent) also scored it 5 (‘Strongly agree’). The third indicator (INDP3) measures the internal audit contact with the board. Here, the results show that 39.4 per cent of the respondents scored the indicator 2 (‘Disagree’), whereas 17.8 per cent and 2.1 per cent of the respondents scored it between 4 and 5 (‘Strongly agree’ or ‘Agree’) respectively, with about 35.2 per cent of them being uncertain (score of 3). See Table 6. Another construct measured in this study relates to the level of relationship the internal audit departments has with external auditors. A total of four indicators were used to measure this construct on a five-point Likert scale, where 1 represented ‘Strongly disagree’ and 5 ‘Strongly agree’. The results are presented in Table 7. The findings show that about half of the respondents (50.2 per cent) scored the first indicator (REL1) between 1 and 2. This means that 50.2 per cent of the respondents either strongly disagree or disagree that external auditors are friendly and supportive. On the other hand, a cumulative percentage of the respondents (26.1 per cent) scored it between 4 and 5. On the second indicator (REL2), however, about 26.1 per cent of the respondents scored it between 1 and 2 (‘Strongly disagree’ and ‘Disagree’), whereas 45.6 per cent and 3.8 per cent of the respondents scored it 4 and 5 respectively.

respondents neither agreeing nor disagreeing with the indicator COMP1. In terms of the second indicator (COMP2), 12.9 per cent and 2.4 per cent of the respondents scored it 4 and 5 (‘Agree’ and ‘Strongly agree’) respectively. Cumulatively, 68.6 per cent of the respondents disagreed or strongly disagreed with the indicator COMP2. Further details are presented in Table 5.

Table 8: Overall goodness of fit measures Fit index

Values

Chi-square with 95 degree of freedom Root mean square error of approximation (RMSEA) Standardized root mean square residual (SRMR) Comparative fit index (CFI) Tucker-Lewis index (TLI) Coefficient of determination (CD)

705.09 0.063 0.118 0.921 0.912 0.886

Table 9: Measurement model Latent variable

Indicator

Coefficient

Standard error

R2

Corruption

CORRPT1 CORRPT2 CORRPT3 INDP1 INDP2 INDP3 INDP4 INDP5 INDP6 INDP7 REL1 REL2 REL3 REL4 COMP1 COMP2 COMP3 COMP4 COMP5 EIAF1 EIAF2 EIAF3 EIAF4 EIAF5 EIAF6

0.49 0.78 0.51 0.66 0.85 0.73 0.78 0.82 0.85 0.66 0.73 0.77 0.73 0.70 0.77 0.86 0.89 0.86 0.85 0.80 0.80 0.92 0.94 0.81 0.74

0.07 0.09 0.07 0.04 0.02 0.03 0.03 0.02 0.02 0.04 0.04 0.03 0.04 0.04 0.03 0.02 0.02 0.02 0.02 0.02 0.02 0.01 0.01 0.02 0.28

0.24 0.61 0.26 0.44 0.73 0.54 0.61 0.68 0.72 0.43 0.53 0.59 0.52 0.49 0.60 0.75 0.81 0.76 0.73 0.64 0.76 0.85 0.88 0.66 0.55

Independence

Relationship

Comp

Effectiveness (EIAF)

The Estimated SEM Before presenting and discussing the results of the measurement and structural models, the goodness of fit of the SEM results is presented. To establish the goodness of fit for the SEM model, various measures can be used. These include the (χ 2) goodness of fit index (GFI), adjusted goodness of fit index (AGFI), comparative fit index (CFI), normed fit index (NFI) and the root mean squared error of approximation (RMSEA). Others include Akaikeˈs information criterion (AIC), Bayesian information criterion (BIC) and coefficient of

Table 10: The final structural model (standardized coefficients)

Effective internal audit function (EIAF) Independence of IA (INDP) Competency of IA (COMP) Relationship with internal and external auditors (REL) Qualification/Certification (YRPT) Extent of implementation of IA Act (LAW) Size of IAD (SOD) R2

EIAF

COMP

0.140** (0.702) 0.034 (0.053) 0.042 (0.059) 0.0034 (0.0119) 0.316*** (0.054) 0.0852*** (0.057) 0.27

0.248*** (0.074)

INDP

CORRPT 0.0098 (0.079)

0.314*** (0.059) 0.0345** (0.0156) 0.023 (0.067) 0.112*** (0.027) 0.22

0.314*** (0.059) 0.233*** (0.055) 0.23

9.5e5 2

Note: Standard errors are in parentheses, * 10%, ** 5%, *** 1% significance levels. © 2017 John Wiley & Sons Ltd

Int. J. Audit. 21: 82–99 (2017)


The measurement model

Note: Standard errors are in parentheses, * 10%, ** 5%, *** 1% significance levels.

CORRPT EIAF 0.0098 (0.079) INDP 0.248** (0.074) 0.140** (0.702) COMP 0.034 (0.053) SOD 0.112*** (0.027) 0.0852*** (0.022) REL 0.314*** (0.059) 0.354*** (0.072) 0.042 (0.059) LAW 0.233*** (0.055) 0.023 (0.067) 0.316*** (0.054) YRPT 0.0345** (0.0156) 0.0034 (0.0119)

CORRPT EIAF COMP INDP

Direct effect Variables

Table 11: Direct, indirect and total standardized effects (final model)

The structural model


EIAF INDP

COMP

Indirect effect

CORRPT

INDP

Table 9 presents the results of the measurement model and the factor loadings as well as their respective standard error estimates for each of the final measurement equations. The results show that except the observed variable corruption (CORRPT1), which had a low reliability score of 0.24, all the other observed variables for each of the latent variables had acceptable levels of reliability scores. This indicates that corruption is not only explained by an effective internal audit function. The R2 or the reliability gives an indication of the percentage of the variance of the indicator explained by the underlying latent variable. For effectiveness, the results show that the most reliable indicator was EIAF4 with an R2 of 0.88 and the least reliable was EIAF6 with an R2 of 0.55. This therefore suggests the effectiveness of the internal audit department is better measured by EIAF4 than EIAF6. With respect to competence, the reliability indicator for COMP3 was 0.81 with COMP1 recording the lowest value. This result indicates that COMP3 gives a better measure of competence of the internal audit department. The results presented in Table 9 show that the coefficients of each indicator are significant and have satisfactory reliability scores.

The estimated coefficients, standard errors and R2s of the final structural model are presented in Table 10. Per the conceptual model presented in Section 3, we expected a negative relationship between effective internal audit function (EIAF) and corruption (CORRPT). Although the a priori expectation was met, the coefficient was not statistically significant. This finding is supported by the literature, such as the Institute of Internal Auditors (IIA) International Standards for the Professional Practice of Internal Auditing, which does not ‘mandate internal auditors to have the same degree of experience as a person whose primary responsibility is detecting and investigating fraud’ (see Halbouni, 2015, p. 119). However, according to the author, the IIA, 1220.A1, 2120.A2 and 2210.A2 ‘require internal auditors to exercise due professional care by evaluating the probability of significant error, fraud or non-compliance and by indicating how organizational personnel manage these risks’ (Halbouni, 2015, p. 119). Independence of internal audit function (INDP), which is a factor of an effective internal audit function (EIAF), was positive and significant. This finding met the a priori expectation, being significant at the 5 per cent level. This points to the importance of the independence of the internal audit functions from direct management control. Thus, the more internal auditors and processes become

EIAF COMP

Total effect

CORRPT

determination (CD). From Hooper et al. (2008) there are no widely acceptable cutoff points for these goodnessof-fit estimates or indices for structural equation models. However, the most widely reported include the χ 2/DF (DF denoting degrees of freedom), the GFI, the AGFI, the standardized root mean square residual (SRMR) and the RMSEA (see Bentler & Bonett, 1980; Jöreskog & Sörbom, 2001; Tabachnick & Fidell, 2007; Byrne, 2013; Tang, Folmer & Xue, 2013; Li, Folmer & Xue, 2013, 2014). The results presented in Table 8 show that all the overall goodness-of-fit indices or estimates for the SEM final model meet their critical values, indicating that the model has satisfactory fit.

0.0098 (0.079) 0.0082*** (0.0029) 0.0014** (0.0006) 0.248*** (0.091) 0.015** (0.070) 0.0014** (0.00069) 0.00032 (0.0005) 0.033 (0.052) 0.00032 (0.0005) 0.0033 (0.0059) 0.00087 (0.0077) 0.098*** (0.027) 0.088*** (0.021) 0.00087 (0.0077) 0.075*** (0.029) 0.054** (0.0279) 0.0009 (0.0077) 0.302*** (0.058) 0.345** (0.071) 0.097* (0.052) 0.0009 (0.0070) 0.059*** (0.025) 0.034* (0.0178) 0.0034 (0.028) 0.236*** (0.055) 0.035** (0.067) 0.349*** (0.054) 0.0034 (0.027) 0.0011 (0.0018) 2.2 e-06 (0.00021) 0.033** (0.016) 0.0022 (0.011) 2.2e-06 (0.00021)

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independent, the more effective the function is. The construct competency (COMP) had a positive relationship with effective internal audit function; it was, however, not significant at any level. Size of the audit department had a positive and significant effect on the effectiveness of the IAD. It was statistically significant at the 1 per cent level. The findings suggest that resources and size of IAD are critical for the competency of auditors and effective internal audit function. From the findings we also establish that Act 658 had a positive and significant effect on effective internal audit function. The passage and subsequent implementation of Act 658 contributed to the overall effectiveness of the internal audit department of the institutions. The Act also has a positive and significant effect on the level of independence as well as the level of competency of the IAD.

Indirect and total effect The direct and indirect effects are presented in Table 11. Jöreskog and Sörbom (1996) explain that an indirect effect of a variable in SEM presents the effect of an endogenous variable through intervening endogenous variables. The total effect, on the other hand, is the sum of the direct and indirect effects. The indirect and total standardized effects of all the variables on the endogenous variables in the final model are presented in Table 11. The results show that Law (Act 658) had the largest positive total effect (0.34) on effective internal audit function, followed by independence of the internal audit department, with a total effect of 0.14. Corruption, as indicated in earlier sections, is a complex and difficult-to-measure phenomenon. With respect to corruption, the law had the largest total effect with a negative sign, implying that the more effective the implementation of the internal audit law within the public sector of Ghana, the better the fight against administrative corruption, all things being equal. We also note that the indirect and total effect of the variable INDP on corruption was significant at the 5 per cent level (see Tables 10 and 11). This finding gives an indication that the extent to which internal audit function in public organizations in Ghana is independent significantly influences the effort to fight corruption: independence of internal auditors in the public sector matters.

5. SUMMARY AND CONCLUSIONS The study examined the link between internal audit function and corruption by analysing how the promulgation of the Internal Audit Agency Act, 2003 (Act 658) has helped stem administrative corruption in Ghana. The Act established the internal audit function or department in all MMDAs. Using a SEM approach and a sample of directors, managers and staff of public sector institutions, our results establish a correlation between Act 658 and administrative corruption in Ghana. Specifically, our study finds a strong relationship between effective internal audit function and reduction in administrative corruption. This finding points to the greater importance of internal auditing and suggests that the passage of the Internal Audit Agency Act, 2003 has had two important effects. First, it has improved internal auditing practices in Ghana, making it possible for auditors to unearth practices that were hitherto not recognized. Second, it can be inferred that the increase in reported corruption cases are all due to how effective the © 2017 John Wiley & Sons Ltd


internal audit function has uncovered sleazy practices and helped external auditors to detect corruption in various institutions in Ghana. The study, therefore, has important implications for government and public sector bodies. It highlights the organizational significance of internal auditing practices (Arena & Sarens, 2015) and the importance of the internal audit function within MDAs in Ghana. In order to secure quality assurance of internal audit within these state institutions, Act 658 has provided the instrument for government to manage fraud and embezzlement by public officials by mandating all organizations to have an internal audit function or department. For public sector bodies, the results can be taken as strong evidence for them to establish internal audit functions or departments and for MDAs to employ competent audit officials (such as certified internal auditors). In terms of how the internal auditing practices are shaped in MDAs, allowing internal audit departments the independence to do their work and providing them with the necessary logistics are critical to effective departmental functioning. In addition, for quality control of audit process, it is important for government and audit managers to strengthen the supervision and monitoring of internal audit processes to meet the challenges of todayˈs business environment (see also IIA, 2011). Specifically, ensuring compliance with all tenets of the Institute of Internal Auditors requirements in Ghana (especially independence of the internal audit function and the establishment of audit committees on boards) are critical if we want to fight administrative corruption. The results also provide legitimacy for the internal audit function and offer policy makers the important data needed to strengthen the powers of government to enforce the establishment of internal audit function in all governmental organizations and also to internal audit practitioners in the public sector to demand proper training and appropriate remuneration to enable them do their work competently based on the IIAˈs Code of Ethics. Our findings show that internal auditing practices in the Ghanaian public sector are influenced by factors such as the level of independence of the internal auditors, the implementation of the Internal Audit Agency Act, 2003 (Act 658), competency of auditors, as well as the resources and size of the internal audit department: these factors are critical for internal auditing practices. In conclusion, though the main finding of this paper is that an effective internal audit function can help fight administrative corruption, our research does not provide a panacea to reducing corruption in Ghana. Other factors not captured by this study may well be important in fighting corruption. The study also used only Act 658 to study one aspect of corruption in Ghana: administrative corruption. It did not consider other forms of corruption and measures put in place to address them. Therefore, further research is needed to look into other legislation implemented to reduce corruption in Ghana, such as the Public Procurement Act 2003 (Act 663), Financial Administrative Act, 2003 (Act 654), the Whistle Blowers Act 2006 (Act 720) and the Anti-Money Laundering Act, 2008 (Act 749). Hence, for future research, a comprehensive approach, including all legislation and administrative directives, is needed if all factors contributing to corruption are to be unearthed, as each law is part of the whole corruption jigsaw puzzle. Int. J. Audit. 21: 82–99 (2017)


NOTES 1. Earlier research postulated similar perspectives (e.g., Borner, Brunetti & Weder, 1994; Mauro, 1995; Keefer & Knack, 1997; Wei, 1997). 2. Institutions here refer to the ‘agglomeration of rules, both formal and informal, that underpin the rule of law and the protection of property rights’, with laws and the mechanism for their enforcement, fiduciary care and due diligence among the most important of these institutions (see Campos & Syquia, 2005).

APPENDIX Questionnaire This questionnaire seeks to gather your views and opinions as staff of internal audit departments of this institution on how the implementation of the Internal Audit Act influences effectiveness of the audit process and the extent it has help in reducing corruption in public institutions. Responses provided are purely for academic process hence anonymity is highly assured. Questionnaire No.____________ Date of Interview_____________

Part A: Socio-demographic background Instructions: Please Tick the appropriate respondents to questions in this section Sex of respondent 1 = Male □ 2 = Female □ Age of Respondent (in years)___________ Number of years of education___________ Year of practice as an Auditor/Manager____________ How many year have you been with your department _______________ 6. What is the size of your audit department _______________ (no. of employees) 1. 2. 3. 4. 5.

Part B: Relevance of Internal Audit Act (Act 658) 1. Are you aware (heard or read) of the Internal Audit Act 2003 (Act 658)? 1 □ = Yes □ 2 = No 2. Have you been trained on the Act? 1 □ = Yes □ 2 = No 3. If yes, to what extent has this helped in your line of duty? 1 = Not at all □ 2 = A little □ 3 = Uncertain □ 4 = Much □ 5 = Very Much □ 4. To what extent has contents of Act 658 been implemented in your department? 1 = Not at all Extensive □ 2 = A little Extensive □ 3 = Uncertain □ 4 = Extensive □ 5 = Very Extensive 5. In your opinion has the implementation of the internal audit Act reduced the level of administrative corruption? 6. 1 = Not at all □ 2 = A little □ 3 = Uncertain □ 4 = Much □ 5 = Very Much □ Using response of your Disagree Agree.

the following scale, please Tick (√) the appropriate to each of the statements below showing the extent agreement or disagreement: Scale: 1 = Strongly 2 = Disagree 3 = Uncertain 4 = Agree 5 = Strongly


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Part C.

STATEMENTS

1

2

3

4

5

EFFECTIVENESS 1. The activities of Internal Audit meet the expectations I have from the internal audit department. 2. Internal audit is aware of to the organizationˈs needs and operates accordingly. 3. The evaluation of internal audit reports made by the external auditors is positive. 4. Internal audit reports are clear and well presented. 5. Internal audit reports are professional. 6. The managementˈs decision making process is strongly affected by the reports and findings of the internal audit department. COMPETENCY 1. The internal audit unit has sufficient skilled internal auditors. Most of them have certification in auditing. 2. The internal audit staff number and their skill matches the scope of officeˈs/sectorˈs internal operations. 3. The internal audit staff are able to use modern technology (use computerized data tools and specific IA software). 4. The audit procedures and evidence collections are completed on time, since enough and skilled internal auditors are available or employed. 5. It is possible to audit and review each activity on time, and cover the planned scope of auditing activities. INDEPENDENCE 1. Internal audit staff are sufficiently allowed by management to perform their professional obligations and duties. 2. The head of the internal audit reports to a level within the organization that allows the internal audit to fulfil its responsibilities. 3. The internal audit has direct contact to the Board of the organization. 4. Conflict of interest are rarely present in the work of internal auditors. 5. The board approves the appointment and replacement of the head of the internal audit department. 6. The internal audit department has direct contact with senior management other than the finance director.

(Continues) Int. J. Audit. 21: 82–99 (2017)


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REFERENCES STATEMENTS

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2

3

4

5

7. Internal audit staff have free access to all departments and employees in the organization. RELATIONSHIP 1. External auditors are friendly and supportive. 2. External auditors have good attitude towards internal auditors. 3. External auditors are willing to give internal auditors an opportunity to explain their concerns. 4. External and internal auditors consult on the timing of work in which they have mutual interest.

Part D. D1. Using the Likert scale of 1 to 5 where 1 strongly disagree and 5 strongly agree, please tell me whether you agree or disagree with the following statement:

Statements

1

2

3

4

5

Internal Audit Agency Act 2003 (Act 658) had made a difference in the fight against corruption The internal audit department, as part of corporate governance of your institution, has helped in the fight against corruption Given the nature of the internal job, it is difficult for one to avoid encountering incidents of corruption in the course of work

D2. What is the most effective thing that internal audit staff can do to help combat corruption in this country? Tick as many as you think apply. 1. Report corruption when you see or experience it 2. Institutions should have sufficient skilled internal auditors 3. If managementˈs decision making process is strongly affected by the reports and findings of internal audit department 4. Internal audit reports are professional and of high quality 5. Conflict of interest are rarely present in the work of internal audit staff 6. Internal auditors consult external auditors on the timing of work in which they have mutual interest 7. Internal audit staff number and their skill match the scope of officeˈs/sectorˈs internal operations 8. Participate in protest marches or demonstrations against corruption 9. Sign a petition asking for a stronger fight against corruption 10. Refuse to accept unprofessional conduct of staff in the course of their work © 2017 John Wiley & Sons Ltd

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Eric Worlanyo Deffor is a consultant with GIMPA Consultancy Services. He holds a BSc in Agriculture (Economics) and an MPhil in Agriculture (Admin) from the University of Ghana. His research interests include agricultural value chain analysis, adoption and impact studies, project M&E, consumer preference and satisfaction studies.

AUTHOR PROFILES Dr. Kofi Fred Asiedu is the managing consultant at GIMPA Consultancy Services with over 20 years management consulting experience. He holds a PhD in Social Sciences: Economics, from Wageningen University in the Netherlands. His research interest spans the spectrum of social sciences from policy analysis, finance and economics to management and leadership.


Int. J. Audit. 21: 82–99 (2017)