THE RELATIONSHIP BETWEEN RELEVANCE OF FINANCIAL

STATEMENTS AND THE PERFORMANCE OF SELECTED FINANCIAL

INSTITUTIONS IN MERU TOWN

ABSTRACT
The general purpose financial reporting is to provide financial information about the reporting
entity that is useful to existing and potential investors, lenders and other creditors in making
decisions about providing resources to the entity. To accomplish this objective, financial reports
should be useful to the users. The degree to which that financial information is useful depends on
its qualitative characteristics. Existing studies provide varying findings on the extent to which
each of the qualitative characteristics influence the quality of financial statements. The
importance of qualitative characteristics from viewpoint of users of financial information shows
that users give more emphasis on relevance of financial information than any other qualitative
characteristic. In contrast, users of financial information attach more emphasis on faithful
representation and verifiability. Consequently, there is a challenge in the art of balancing the
qualitative characteristics in order to meet the objectives of financial statements and make them
adequate for a particular environment. Constraints exist when it comes to providing timely
information versus reliability as well as balancing between benefits and costs of providing useful
information in the financial statements. The study sought to determine the relationship between
relevance of financial statements and performance of financial institutions. This study employed
both descriptive survey and Ex-post facto research designs. The target population was 50
financial institutions and 100 respondents. A sample size of 40 financial institutions was used
gathered from the various strata of the population to give a sample size of 80 respondents. The
study used a questionnaire as the data collection instrument. The study also recorded the
performance measured by profit before tax of the financial institutions for the year 2010. Data
collected was sorted, classified and coded then tabulated for ease of analysis. Both descriptive
and multiple linear regression analysis were used to analyze the data collected. The findings of
the study according chi-square test and multiple linear regression showed that relevance of
financial statements was related to and could predict performance of financial institutions.
Key words
Relevance, financial statement, performance, Meru town.
INTRODUCTION
The purpose financial reporting is to provide financial information about the reporting entity that
is useful to existing and potential investors, lenders and other creditors in making decisions about
providing resources to the entity. Moreover, it is directed at users who provide resources to a
reporting entity, but lack the ability to compel the entity to provide them with the information
they need to make decisions about their investments (IASB, 2010). To accomplish this objective,
financial reports should be useful to the users. The degree to which that financial information is
useful depends on its qualitative characteristics (Hennie, 2006).
Qualitative characteristics of financial statements have been a subject of debate since 1989 when
IASC Board approved the Framework for the Preparation and Presentation of Financial
Statements. There has been a move towards convergence between IASB and USA based FASB
on the qualitative characteristics to be included in the conceptual framework for the Preparation
and Presentation of Financial Statements among other issues. In September 2010 both IASB and
FASB agreed on two fundamental (relevance and faithful representation) qualities and four
enhancing (understandability, verifiability, timeliness and comparability) qualitative
characteristics of financial statements as the attributes which make the information provided in
such statements useful to users (IASB, 2010).
Providers of resources to an entity make decision on further investments based on the
information reflecting on financial statements. Therefore, management must explain its business
objectives clearly so that investors can be able to determine whether the company has achieved
its anticipated goals or not, because if management did not do it, there would be an occurrence of
‘reporting gap’ (Saleh, 2008). The performance of an entity shows how well it is utilizing its
resources to achieve the set goals and objectives. The art of communicating this information is
through qualitative characteristics of financial statements.

The managers of an entity are more concerned with the performance projected in the financial
performance and therefore they are likely to put more emphasis on reporting better performance.
Delivery of information regarding company activities and their results to shareholders is the most
important factor that ensures effectiveness of decisions taken by shareholders (Celik, 2006).

RESEARCH METHODOLOGY
Research Design
This study employed both descriptive survey and Ex-post facto research designs. Descriptive
research studies are those studies which are concerned with describing the characteristics of a
particular individual, a group or of a situation (Dhawan, 2010). The descriptive research design
was chosen in order to collect information from respondents on opinion on the influence of
qualitative characteristics of financial statements on performance of financial institutions. In ex
post facto research design, the cause-and-effect relationships are studied (Uma, 2006). The ex
post facto research design was used to determine the relationship between the dependent and
independent variables.

Target Population
The study focused on eighteen (18) commercial banks, eighteen (18) SACCOs and fourteen (14)
other financial institutions which include Micro Finance Institutions and insurance firms. The
commercial banks and other financial institutions were drawn from a list by Municipal Council
of Meru of licensed financial institutions operating in Meru town. The SACCOs in this study
were the active SACCOs operating in Imenti North District as provided by the District Co-
operative Officer, Imenti North District.
The population was stratified in three stratums. The first strata comprised of 18 commercial
banks, the second strata 18 SACCOs and the third strata 14 other financial institutions. The study
targeted senior managers in the financial institutions within Meru town. The accessible
population comprised of two (2) senior managers from each of the fifty (50) financial institutions
totaling 100 respondents. For the banks, the senior managers were the branch manager and
operations manager, in SACCOs the manager and chairman and in the other institutions the
manager and the assistant manager.

Sample Design & Size

The study used stratified random sampling for each of the stratum for the various categories of
institutions. The sample was based on a sample size to 80 respondents according to Krejcie and
Morgan (1970) table of sample size which shows that for a population of 100, the sample size
should be 80. A sample size of 40 financial institutions gathered from the various strata of the
population was used to give a sample size of 80 respondents.
Table: 3.2 Study Populations and Samples
Category Accessible % of Sample Sample % Sample
Population Sample representation Representation Representation
( financial of financial of respondents of respondents
institutions) institutions ( 2 from each
institution)
Commercial 18 80 % 14 28 35.0 %
Banks
SACCOs 18 80 % 14 28 35 %

Other 14 80 % 12 24 30 %
financial
Institutions
Total 50 80 % 40 80 100 %
Source: Author, (2011)

Data Collection
The study used both primary and secondary data. Primary data was obtained using questionnaires
while secondary data was accessed from the Government institutions, journals, and financial
statements. The study used a questionnaire as the data collection instrument. The questionnaire
was made up of both structured and unstructured questions so that quantitative data can be
collected for the study. Secondary data was obtained by analyzing the performance of the
financial institutions by comparing the profit before tax in the financial statements for the year
2010 since it was not possible to get the data for a five year period.

Data Analysis
Data collected was sorted, classified and coded then tabulated for ease of analysis. Both
descriptive and multiple linear regression analysis were used to analyze the data collected.
Descriptive data analysis involved use of frequencies, percentages and cross tabulation to
describe the collected data. Multiple linear regression analysis was used to determine the cause
and effect relationship between dependent and independent variables. The SPSS computer
software was used to aid the analysis.
Reliability of the Instruments
In order to ensure reliability, the questionnaire was composed of carefully constructed questions
to avoid ambiguity and in order to facilitate answers to all the research questions. The reliability
of the research instrument was tested by use of Cronbach’s Alpha with a 60% acceptance level.
The instrument was presented to experts (my supervisors) who ascertained its face validity.

Summary of findings
Response rate
The study reported a 68% response rate and 32% non-response rate according to table 4.2 below.

Table 4.2 Response rate and

characteristics of respondents
Responses Frequency Percent
Response rate Responded 54 68
Non responded 26 32
TOTAL 80 100
Gender Male 38 70.4
Female 16 29.6
TOTAL 54 100
Respondent years of service 0-5 31 57.4
6-10 15 27.8
11-15 4 7.4
16-20 3 5.6
Over 20 1 1.9
TOTAL 54 100
Age bracket of respondent ( years) Below 25 2 3.7
25-30 10 18.5
31-35 24 44.4
36-40 9 16.7
41-45 4 7.4
46-50 3 5.6
Over 50 2 3.7
 TOTAL 54 100

Performance of sampled financial institutions for the year 2010

A total of thirty seven (37) institutions provided their profit before tax for the year 2010. A
number of micro-finance institutions and Sacco’s were not able to provide their profit before tax
for any period due to confidentiality of the information given that many of them are branches in
Meru town with their headquarters in Nairobi. Since it was not possible to get the profit before
tax for the sampled institutions for the five year period as indicated in data collection procedures
in 3.7 above, the profit before tax for the year 2010 which was availed by most institutions was
used for this study.
Profit before tax in Billions Kshs Frequency Percentage
Less than 1 27 73.0
1-3 6 16.2
3-5 0 0
5-7 0 0
7-9 0 0
9-11 2 5.4
Over 11 2 5.4
TOTALS 37 100

The table 4.3 above shows that more than half (73%) of the institutions recorded profit before tax
of less than Kshs one billion in the year 2010. These included Sacco’s micro-finance institutions
and small banks. 16.2% of the institutions recorded profit before tax of between Kshs one and
three billion, while 4% recorded over Kshs nine billion in profit before tax for the same year.

The Chi-Square Test

The specific objective of this study was to determine if there was a relationship between
performance of financial institutions measured as the profit before tax and relevance of financial
statements. The variables were cross-tabulated and a Chi-square test done to determine the
association between the dependent and independent variables. The results obtained are shown in
table 4.3 below.

Table 4.3 Chi-Square test

Variable Chi-Square Value Significance

Relevance 30.289 0.017

Faithful representation 22.027 0.142

Understandability 37.000 0.002

Comparability 17.986 0.325

Verifiability 26.629 0.046

Timeliness 17.443 0.358

The relationship between relevance of financial statements and performance

of financial institutions.

The results obtained show evidence of association between relevance and performance of
financial institutions. The p value is 0.017 and therefore at 95% level of significance there is
statistically significant relationship between relevance and performance. The null hypothesis is
rejected since p<0.05 (0.017<0.05) thus there is a relationship between relevance of financial
statements and performance of financial institutions. In rejecting the null hypothesis, we accept
the alternative hypothesis: that there is a relationship between relevance and performance. This is
supported by the 81.5% respondents who said that there was a relationship between relevance
and performance.
Multiple linear regression analysis
In order to quantify the results of the chi-square test in table 4.3 above, multiple linear regression
analysis was done to determine the cause and effect relationship between the independent
variables and the dependent variable. The results are presented in table 4.4 below.
Table 4.4: Multiple linear regression analysis
Variable Standardized Coefficient P Value of Adjusted R2 Constant
Beta significance
Relevance 0.503 2960.936 0.025 0.032 1656.547
Faithful -0.167 -771.773 0.516
representation
Understandability 0.173 520.226 0.661
Comparability -0.330 -3271.291 0.256
Verifiability -0.345 -1785.791 0.298
Timeliness 0.344 2443.018 0.309

The results show that relevance significantly relates to performance of financial institutions at
0.05 level of significance (p value=0.025). Relevance is the ability of financial information to
make a difference to users when making a decision. This shows the immense effect of forward
looking information financial statements, extend to which business risks and opportunities are
disclosed and extend to which financial statements represent current value of assets. Performance
of a business is related to how it handles both risks and opportunities realized in the market
place.

Conclusion
There is indication that users value relevance of financial statements from the perspective of both
middle and top management in financial institutions. It is also noted that relevance of financial
institutions is held highly and if preparers of financial statements were to pick on one of the
qualitative characteristics to summarize the rest, then it appears that would be relevance. It is
noted that relevance is one of the fundamental characteristics of financial statements that shows
relationship with performance.
Recommendations
The study found out that there was a relationship between relevance of financial statements and
performance of financial institutions. Financial institutions are advised to identify qualitative
characteristics of financial statements highly that are regarded in the industry and ensure they
embrace them when preparing their financial statements. Accountants who prepare financial
statements and those who report the same to shareholders are advised to consider the emphasis of
relevance in the financial statements.

The subject of qualitative characteristics of financial statements is evolving with the interplay of
many factors such as technology, increase in accounting knowledge and the expectations of users
of financial information and therefore the accounting standards setting bodies need to be in
constant review of these qualitative characteristics of financial statements.

The Government through the various regulating authorities in the financial sector may need to
ensure that financial statements meet some minimum qualitative characteristics in order to be
useful to users of financial information.

ACKNOWLEDGEMENTS
I am grateful to both my supervisors Dr. B. Omboi and Mr. W. Muema who have been very
supportive and have generously given me dedicated and professional guidance and unlimited
access to their offices for consultations.
I would like to acknowledge a colleague and research assistant Mr. Jedidiah Maitai who
tirelessly assisted me in the research work.
I also appreciate the good response I received from sampled commercial banks, SACCO’s and
micro-finance institutions in Meru town.

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