INTRODUCTION

Background of the Study

The Internal Audit (IA), as a vital function of a business, has been evolving since

its initial application by Greeks and Romans before the birth of Christ (BC). From its

former sole purpose of detecting and correcting errors, its scope expanded beyond the

traditional audit of financial statements (IIA, 2015) to include the deterrence of problems

and identification of potential risks (Ahlawat & Lowe, 2004; Arel et al., 2012). Realization

came to the corporate world that IA is an indispensable element of business survival

(Danneels, 2002) which is highlighted by the establishment of Institute of Internal Auditors

(IIA) in 1941 (Ramamoorti, 2003).

IIA (2001) defined internal audit as “An independent, objective assurance and

consulting activity designed to add 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”. IA brings systematic and disciplined approach in evaluating and improving the

effectiveness of internal control, risk management, and governance processes (Sarens et

al., 2012).

The growing corporate awareness on the importance of IA in meeting corporate

goals and objectives cannot be overemphasized. The evident need for corporate monitoring

has been intensified by the break-out of large corporate scandals like that of Enron and

WorldCom (Schneider, 2003), which linked the ineffectiveness of the IA function to the
increased fraudulent activities (Diansyah et al., 2012; Umar, 2011; Wicaksono, 2009)

among business organizations.

The effectiveness of the IA function is “the degree (including quality) to which

established objectives are achieved” (IIA, 2010). It refers to the ability of the internal

auditor to achieve established audit objectives which are stated in clear terms, with the

means for achieving such objectives also being provided (Dittenhofer, 2001).

IA practice greatly influences the public confidence in financial reporting and

corporate governance of business entities (Belay, 2007; De Smet & Mention 2011). How

internal auditors affect public opinion is best explained by their actions concerning the

safeguarding of organizational resources, continuous monitoring of how these resources

are used, and assessing whether results of audit meet public objectives and expectations

(Adel, 2011).

Radu & Ramona (2013) indicated in their empirical study that for an IA to function

properly, there are four factors which need to be considered. Firstly, IA must be

strategically placed within an organization to allow it to achieve its audit objectives and

maintain its independence. This means that the role of IA in an organization must be clearly

defined and effectively communicated within a wider governance framework. Secondly,

IA must have a strong risk identification and planning methodology to deliver a high

quality service and use an appropriate technology to enhance the provision of IA services.

Thirdly, IA must be independent from all decision factors involved in corporate

governance. In this regard, activities being audited must be independent from everyday

internal processes. IA must be able to exercise its assignment on its own initiative in all

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departments, establishments, and functions of the organization. Finally, the IA function

must be adequately staffed with the right people to deliver its mission and objectives.

However, despite the emerging public knowledge and acceptance of IA and

increasing concerns regarding its ineffectiveness (Utami, 2016), there has been no

published research study investigating the practice of internal audit functions in electric

cooperatives in Western Visayas. Power (2003) stated that there has only been few research

conducted on the practice of the internal audit functions.

As Mihret (2012) pointed out, the practice of internal audit functions needs to be

studied further. Thus, this study will be conducted to assess the status and challenges of

internal audit practice in ten (10) electric cooperatives in Western Visayas according to

their internal auditors.

Statement of the Problem

This study aims to assess the status and challenges of internal audit practice in ten

(10) electric cooperatives in Western Visayas.

This study answers the following questions:

1. What is the status of internal audit practice in ten (10) electric cooperatives in

Western Visayas as to corporate support to internal audit, organizational

independence, internal audit charter, and internal audit competence as assessed by

the internal auditors?

2. What are the other challenges in the internal audit practice in ten (10) electric

cooperatives in Western Visayas as assessed by internal auditors?

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Significance of the Study

The findings and recommendations of this study are intended to benefit the electric

cooperatives in Western Visayas through contributing to the effort of raising the awareness

of management and board of directors on the status and challenges associated with internal

audit practice. This will eventually lead to more effective and efficient internal audit

function which will enable the achievement of corporate goals and objectives of the electric

cooperatives through the formulation, implementation, and maintenance of improved

internal controls. Ultimately, this will contribute to the body of knowledge on internal audit

practice as they particular apply to electric cooperatives within the Western Visayas

Region.

Scope and Limitation

A more profound research on internal audit practices would include examination of

audit working papers and reports from the current and previous files of the internal audit.

However, due to confidentiality reasons, the researcher will only use survey questionnaires

as basis for assessing the status and challenges of internal audit practice. The study will be

conducted in ten (10) different electric cooperatives in Western Visayas; namely the

Negros Occidental Electric Cooperative (NOCECO), Central Negros Electric Cooperative

(CENECO), Northern Negros Electric Cooperative (NONECO), Iloilo Electric

Cooperative I (ILECO I), Iloilo Electric Cooperative II (ILECO II), Iloilo Electric

Cooperative III (ILECO III), Guimaras Electric Cooperative (GUIMELCO), Capiz Electric

Cooperative (CAPELCO), Aklan Electric Cooperative (AKELCO), and Antique Electric

Cooperative (ANTECO).

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Definition of Terms

Internal Audit is a function which objectively examines, evaluates and reports on

the adequacy of internal control as a contribution to the proper, economic, efficient and

effective use of resources (Diamond, 2002). It is an appraisal system established within an

organization which helps the organization to achieve its objectives (Coyle, 2009).

Corporate support to internal audit operationally refers to the logical, financial,

and technical support provided by the management and board of directors to the internal

audit function to enable the IA to fulfil its purpose in the organization.

Organizational independence, as a concept, can be considered from the

perspective of autonomy in which internal auditors are said to be independent if they carry

out their work freely and objectively without fear or having to subject their judgment on

audit matters to the whims and biases of the management or others (Mary 2007).

Operationally refers to the level freedom in the organizational structure which allows the

IA function to fulfil its duty without partiality to any position or interest.

Internal audit charter is a formal document that defines the internal audit

activity's purpose, authority, and responsibility (Tsehay, 2016).

Internal audit competence refers to the professional qualification and experience

of the internal audit personnel (Kunkel, 2014).

Related Literature/Studies

The review of relevant literature on internal audit practices and other fundamental

theories of the topic under study includes areas such as definition of related concepts, key

features of effective internal audit function, challenges of internal audit practices,

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development of internal audit, duties and responsibilities of internal auditors, importance

of internal auditing and the like are covered. It encompasses auditing and auditing-related

practices then finally the summary of the review and screening of the gap in the existing

literature (Tsehay, 2016)

The demand internal auditing within an organization stems from necessity to have

an independent appraisal to reduce record-keeping errors, asset misappropriation, and

fraudulent activities within business and non-business organizations (Tsehay, 2016).

Accounting historian Richard Brown (1905), intuitively described the roots of auditing as

follows:

“The origin of auditing goes back to times scarcely less remote than that of

Accounting .Whenever the advance of civilization brought about the necessity

of one man being entrusted to some extent with the property of another, the

advisability of some kind of check upon the fidelity of the former would

become apparent.”

The added value delivered by internal audit has become more and more relevant,

which makes it quite necessary to identify the determinant factors in creating this added

value (Tsehay, 2016). In order to competitively assess the effectiveness of the IA function,

the factors to be considered are as follows:

Corporate support to IA. A study conducted by Mathose (2013) indicated that the

majority of employees perceived the internal audit department to have the support of senior

management, which is in line with the Standards for the Professional Practice of Internal

Auditing (SPPIA). The audit function requires support, both financial and technical, from

the senior management and board of directors to accomplish its day to day activities. This

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will provide for an appropriate stature for the function such as having unrestricted access

to staff, information and documentation (Sarens & De Beelde, 2006). The more resources

are allocated to assess strategic risk, the greater the value will be to the organization.

According to the study conducted by Abbot et al (2010) on the association between the

audit committee`s oversight of the internal audit function and the nature of their activities,

there is a strong positive relationship between the amount of internal audit budget allocated

and internal control-based activities. On the other hand, Dessalegn & Aderajew (2007)

have indicated in their Ethiopian higher education case study that management support to

IA is considered as one of the determinants of IA‘s attributes. They also indicate that audit

findings and recommendations would not serve much purpose unless management is

committed to implement.

Organizational Independence. The concept of independence is generally used to

mean the ability of the auditor to be fair and objective in his review and appraisal and not

to be under undue pressure from any party to the extent that this could bias his opinion

(Abu Azza). Independence is defined as the freedom from conditions that threaten the

ability of the internal audit activity to carry out internal audit responsibilities in an unbiased

manner (IIA, 2015). Lawrence (2013) found that the increased frequency of financial

reporting and external audit failures motivated the internal audit profession to seek greater

autonomy in the organization structure and in countries where the role of internal audit is

highly valued, functional reporting moved from senior officers in the organization to

specific committees set-up under the boards and that report to the board of directors. The

auditing services offered by internal auditors are achieved through internal auditor’s

independence and where internal auditors lack independence, they would normally fail to

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perform to the expectation of the organization (Kadondi, 2012). According to Ayele (2013)

there is need to be examine the independence of internal auditors to promote and protect

the interest of all stakeholders.

Internal Audit Charter. The Internal Audit Charter is a document that provides the

internal audit director with the authority to carry out the department’s mission. It should be

written by the internal audit department, approved by the top management, and authorized

by the board of directors and the audit committee, (Burnaby, et al ,1994; Peursem, 2004).

The internal audit charter establishes the internal audit activity's position within the

organization, including the nature of the chief audit executive’s functional reporting

relationship with the board; authorizes access to records, personnel, and physical properties

relevant to the performance of engagements; and defines the scope of internal audit

activities. The chief audit executive must periodically review the internal audit charter and

present it to senior management and the board for approval (IIA’s 2012).

Internal Audit Competence. The head of the audit function should be a qualified

and widely-experienced of manager (Tsehay, 2016). Moreover, as the chief audit

executive, he should be an articulate public spokesperson for the audit function and he must

be able to effectively recruit, retain, and manage highly skilled staff (IIA, 2006). As

Hepworth & Noel (2002) argued in their study that staffing professional employees

increase effectiveness of internal auditing, and that an internal auditor should pursue

continual professional development by seeking membership at professional associations,

in addition to recruiting competent and well-qualified staff to support internal auditing

activities.

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 Challenges. Mihret, Yismaw, & Belay (2007) stated in their study of Ethiopian

public universities that internal audit recommendations are not afforded enough

management attention and support which adversely affect the effectiveness of internal

audit. Moreover, the lack of mechanisms in place to follow up the implementation of

internal audit recommendations, absence of strategic plan and consistent documentation

styles for audit work, lack of resources, poor leadership of internal audit function (IAF),

absence of appropriate suitable framework for performance evaluation, and lack of

competent personnel are also some challenges of internal auditors.

Independence is also an important issue for internal auditors. However, because the

company they are auditing directly employs them, it is impossible for internal auditors to

be independent in the same manner as external auditors (Hock & Burch, 2011). Tsehay,

(2016) additionally affirmed that a crucial issue of organizational independence is for the

chief audit executives (CAE) to have a reporting line in the organization that will allow the

internal audit activities (IAA) to fulfill its tasks. To foster independence, Wobschall (2011)

on his Internal Audit Quality Assessment Framework paper similarly stated that internal

auditors sufficiently maintain independence and objectivity by not auditing operational

areas for which they have previously had executive or management responsibility within

the last year and not undertake subsequent audits of a system, which they have previously

been involved in consultancy on systems design.

Commonwealth of Australia (2007) states in its better practice guide that the charter

should define the scope of internal audit; that is, the programs, activities, processes,

systems and organizations that are subject to internal audit review. In addition it states that

the charter should also specify the requirement for an internal audit strategic business plan

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and annual work plan. In a similar manner, the internal audit charter should provide the

internal audit activity with a formal mandate to do its work (Hock & Burch, 2011).

The audit function also needs a professional staff that collectively has the necessary

qualifications and competence to conduct the full range of audits required by its mandate.

Auditors must comply with minimum continuing education requirements established by

their relevant professional organizations and standards (IIA, 2006). Mbogella (2011)

revealed in his study that audit staff skills have been a challenge for internal audit due to a

shortage of qualified internal auditors.

Hack (2013) also carried out a study on challenges facing internal auditors in 24

countries in Europe and found that the main challenges facing internal auditors were the

widening technical skills gap, corruption and lack of authority. The study also identified

other challenges that hinder the effective functioning of internal auditors which included

high costs of maintaining the function, reluctance to travel, cultural and language

differences, failure to adhere to quality standards and limited knowledge on acceptable

accounting standards, regulations and local laws. The study recommended that institution

should enhance internal audit competency.

Theoretical Framework

The institutional theory originates from the view that an organization is structured

and works to achieve social outcomes in the public (Schneider, 2014). Goodwin (2014)

theorized that the institution of internal audit functions are hard and complex to realize and

that the external picture of the organization may be weakly associated with the

organization’s internal operations. Institutional theory is of the view that the organization

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has structured operations to ensure social accountability. The real functioning of the

organization is complemented by an effective internal audit process (Millichap, 2012).

The internal auditor roles focus on improving corporate governance in an

institutionalized context which is the basis for the adoption of the institutional theory.

These then demand for greater scrutiny of the organization’s financial reporting to

safeguard the interest of the stakeholders. Evaluation of the internal auditor’s role cannot

be avoided particularly where the function is a key feature of organizational effectiveness

(Dalila, 2013).

Fundamentally, internal auditors’ roles have now became much more essential as a

control within organizations and a key to effective risk management. Internal auditors are

heavily involved in the organization in the continuous internal audit process and ultimately

share with the boards their recommendations which are expected to contribute to the

organization’s objectives (Jamal, 2011). Similarly while performing their roles, all

measures have to be taken to maintain their independence, authority and objectivity, as a

result of being too involved in the organizations operations (Cattryse, 2014). According to

the United Nations, the preferred qualities for good governance are effectiveness,

transparency, responsiveness and public accountability. The same line of thought was

emphasized on in an Internal Auditing Forum (IAF) which emphasized on the need to focus

on the four characteristic for a better performance and functioning of public sector.

Subsequently internal auditors’ roles are considered crucial in an organization’s financial

management strategies and increasingly uses a dependable way of enhancing its

performance (Mahmoud & Ehab, 2011).

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 Internal Audit Function

Organizational Independence Internal Audit Charter

Internal Audit Competence

Effective
Internal Audit
Practices
Corporate Support to
Internal Audit

Effective Internal
Controls
Management and BOD
Function

Figure 1. Schematic diagram of the framework of the study.

Methodology

This segment discusses the design, participants, measures, procedures of data

gathering, ethical consideration, and data analysis, and statistical treatment employed in

the study.

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 Research Design. The type of research design to be employed in this study is

descriptive research. This design was selected because it aims to describe the state of affairs

as it exists at present. Schwarzkopf (2008) defined descriptive research as a type of research

design derived from a broad class of non-experimental studies with the purpose of

describing characteristics of a phenomenon as it is occurring. This study will describe and

critically assess the status of, and the challenges in internal audit practice in electric

cooperatives in Western Visayas.

Participants. The participants of this study will be all of the internal audit

personnel of the ten (10) electric cooperatives in Western Visayas. The researcher decided

to conduct the study with the whole population instead of using sampling because of the

very limited number of personnel employed by the electric cooperatives. A pre-testing of

the research instrument will also be conducted on the internal audit personnel of electric

cooperatives in Negros Oriental so as not to deplete further the actual participants in this

study.

Measures. A researcher-made survey questionnaire will be used in collecting the

data on the status of, and challenges in the internal audit practice in electric cooperatives

in Western Visayas. The said questionnaire will assess the corporate support to internal

audit, organizational independence, internal audit charter, and internal audit competence

as assessed by the internal auditors. A total of 16 statements involving the status of internal

audit were prepared. 18 possible challenges in the internal audit practice were also

identified by the researcher. The questionnaire will be subjected to the validity and

reliability tests prior to actually distributing them to the participants.

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 Validity refers to the extent to which a measure accurately reflects the concept that

it is proposed to measure (Wilson, 2014). After the questions had been prepared, the

researcher will request five experts in internal auditing to validate the questionnaire. The

content validity of the instrument will be rated by using the Good and Scates Research

Instrument Evaluation Form.

After the refinement of the questionnaire, the researcher will prepare it for

reliability testing. Reliability refers to the extent to which the measurements when taken

with a particular instrument are repeatable (Hair et al, 2014). The researcher will ask

permission from the general managers of two (2) electric cooperatives in Negros Oriental

to conduct a pre-testing or pilot study with their internal audit personnel. Cronbach’s Alpha

will be used in determining the result of the reliability testing using the SPSS software.

Moreover, to improve the study and strengthen the findings, the researcher has

referred to both published and unpublished articles on the topic area. Proper detection by

an advisor and subject matter expert will also be sought to ensure the content validity of

the instruments.

Procedures

Data gathering. After the validity of the questionnaire is established, a written

request will be made to the general managers of the respective electric cooperative before

the survey to be officially conducted. The researcher will spend two weeks on personally

handing over the questionnaires to, and gathering it from the participants. The researcher

will instruct the participants to mark the option applicable to them in Part 1 of the

questionnaire corresponding to information about their gender, age, educational

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qualification, and length of work experience as an internal auditor. The researcher will also

emphasize that there is no need for them to indicate their names on the questionnaire. For

both Parts 2 and 3 of the questionnaire, the participants will be instructed to indicate their

answers to the statements with a mark. The researcher will personally answer all possible

concerns which might be raised by the participants regarding the questionnaire.

Ethical Consideration. Before the participants answer the questionnaire, the

researcher will explain the purpose of the study to them. The researcher will guide the

participants in completing the questionnaires. Honesty and sincerity will be observed by

the researcher in answering the questions raised by the participants regarding the

questionnaire. There will also be transparency in the conduct of the survey. After the

participants accomplish the questionnaire, the researcher will assure them that the

confidentiality of their answers and identity will be upheld and protected by the researcher.

Data analysis. The accomplished questionnaires will then be coded and tabulated.

The assistance of a statistician will be employed for the interpretation of the results. The

descriptive statistics and statistical tools such as mean, standard deviation, frequency count,

and percentages will be used to summarize the participants’ answers to assess the status of,

and challenges in internal audit practice in electric cooperatives in Western Visayas.

For problem 1, the mean and standard deviation will be determined for each

indicator of internal audit practice. The mean range and interpretation of the scales used

in response to the perceived rating of the participants is presented in Table 1.

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Table 1

Mean Range and Its Interpretation

Weights Mean Range Interpretation

5 4.21 - 5.00
4 3.41 - 4.20
3 2.61 - 3.40
2 1.81 - 2.60
1 1.00 - 1.80
Very Strong (The provisions or conditions are effectively
implemented and are functioning excellently.)
Strong (The provisions or conditions are implemented and
are functioning well.)
Moderate (The provisions or conditions are moderately
implemented and are functioning satisfactorily.)
Weak (The provisions or conditions are implemented to a
limited extent and are functioning minimally.)
Very Weak (The provisions or conditions are not
implemented and are not functioning.)

For problem 2, the frequency count of “yes” will signify the existence of the

challenges in the internal audit practice in electric cooperatives in Western Visayas. The

percentage of “yes” answers for each statement will also computed and used as basis for

determining the pervasiveness of the identified challenges. Recommendations which will

address the more pressing challenges will be presented and discussed on Chapter 3.

Statistical Treatment. The mean and standard deviations will be used to analyse

the results of the survey for problem 1 which assesses the status of internal audit practice

in electric cooperatives in Western Visayas because the level of measurement was an

ordinal data which cannot be measured numerically. On the other hand, the frequency count

and percentages will be employed in the analysis of the data gathered for problem 2 which

involves the challenges in internal audit practice in electric cooperatives in Western Visayas

since the level of measurement are ratio data which have a fixed zero point.

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