CHAPTER ONE

INTRODUCTION
1.0 Introduction

This chapter will discuss, back ground of the study, statement of the problem, purpose of the
study, research objectives and questions guiding the study, significant and scope of the study, the
definitions of the key terms, and conceptual framework.

1.1 background of the study

For most of its history internal audit has served as a simple administrative procedure comprised
mainly of checking documents, counting assets, and reporting to Board of Directors,
Management or External Auditors. In recent times, however, a combination of different forces
has led to a quiet revolution of the profession. Organizations have to demonstrate accountability
in the use of shareholders money and efficiency in the delivery of services. Organizations now
demand great competency and professionalism from internal audit, and scarce resources must be
deployed more efficiently to minimize and manage risks. Technological advancement makes it
possible to track and analyze data with continually increasing speed thus making it essential for
organizations to be well advised by the internal audit department. Internal audit varies from one
organization to another, and making change to modern internal audit can be a substantial
undertaking. (ONDIEKI, 2013).

Globally, All over the world there is a realization that the Internal Audit activity has the
potential to provide hitherto unparalleled services to management in the conduct of their duties.
This potential has been turned into a challenge and embodied in the new definition of Internal
Auditing from the Institute of Internal Auditors (the IIA). Commercial banks have come to the
realization that internal audit is essential in improving management of assets in the banks leading
improved financial performance of banks (Committee, 2002).

The first agency for the internal auditors was established in the united states in 1947 that became
international after that and now it has 150 branches all over the globe and more than 100,000
members, this agency sets the standards of the internal auditing and defines clearly the morals of
this position. (AL-GHALAYINI, 2013).

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Most internal audit professionals argue that an effective internal audit function correlates with
improved financial performance. According to Beyanga (2011), an effective internal audit
service can, in particular, help reduce overhead, identify ways to improve efficiency and
maximize exposure to possible losses from inadequately safeguarded company assets all of
which can have a significant effect on the financial performance of an organization. He also
stated that internal audit is a ―invaluable tool of management for improving performance‖.
Fadzil et al (2005) also noted that internal auditors help run a company more efficiently and
effectively to increase shareholders value‖. Finally Herman son and Rittenberg (2005) argued
that the existence of an effective internal audit function is associated with superior organizational
performance (ONDIEKI, 2013).

Internal Auditing may be defined in several ways depending upon what purpose is to be served.
Pickett (1976) stated that internal audit is an independent, objective assurance and consulting
activity designed to add value and improve an organization’s operations. It helps an organization
accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve
the effectiveness of risk management, control, and governance processes. This definition actually
seeks to demonstrate the depth and breadth of the internal audit activity within an institution as
against the previous orientation of reviewing payment transactions over the years (JOSEPHINE,
2019).

This function has evolved a lot into the second half of the last century and changed the
perceptions of errors and deviations, as an effective tool in the management of the service where
the internal audit function to contribute to the design and development of the internal control
system. It also helps to strengthen the control of management at the bank or consolidate
(governance of the bank), as well as contributing to the risk assessment, management, protection,
suggesting the most effective ways to manage them, as well as to measure the efficiency of use
of available resources and evaluate the performance and effectiveness. Thus helping to achieve
maximum efficiency in the economic project management, which enhances the chances of these
projects in the optimal exploitation resources, and access to the overall quality and thus survive
in the face of global competition (Sabban, 2002).

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The independence of the auditor is a critical control standard so it must be the internal auditor
independent of its performance? In order to verify the effectiveness of the internal control, the
auditor should follow the upper levels of management, in order to be able to review and examine
other regulatory levels, and evaluation to ensure the implementation of the plans and policies set.
This requires the internal auditor to be away from the policies, procedures, preparation of records
or links mode, any other executive action in order to be natural to assume reviewed and
evaluated later. After having examined and audited the auditor presents the results of the work
and recommendations of the categories reporting to the Governing Council. Many companies
tend to formulate the Oversight Committee, which comprises of members of the Board of
Directors of the part-time, and the objective of the Commission is to oversee the internal
oversight function, thereby increasing independence from the administration because of the
Oversight Committee is responsible for hiring and rewarding department head (Nama, H., and
Hasan, A., 2008).

In Africa (Alaswad, 2016) investigated the relationship between the internal audit and
performance of financial companies in Libya. The latter study was conducted on twenty-six (26)
financial companies listed in Libya Stock Market. It focused on four (4) the internal audit
characteristics; the internal audit committee size, the audit committee independence, auditor's
qualification and auditor's experience. These variables are considered independent variables. As
for the dependent variable, it is represented in the return on assets (ROA) which was used to
measure the performance level of these financial companies. The latter study found that the
relationship between the size of the internal audit committee and performance is statistically
insignificant. It was also found that there is a statistically significant relationship between the
other variables and the performance of those companies.

Similar study was done in Uganda (Makerere University) and the main purpose was to find out
whether internal audit functions could influence financial performance of public universities and
the findings and recommendations showed that much needed to be done in terms of research to
fill the gap. Financial performance is variously defined and in this study, it is confined to how
financial resources are controlled and utilized through efficient budget management and
accountability to achieve organizational goals. However, most companies have continued to
experience incidences of budget deficits, unpaid utilities and NSSF and tax arrears, unaccounted

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for funds, non compliance with the policies and procedures and mismanagement of funds.
Companies have continued to register financial losses due to mismanagement even when there
are guidelines for the utilization of funds. Qualified audit staffs need to advise management on
issues of budget performance and financial accountability (Wanyama, 2018).

The audit has a high degree of importance, because it is not only significant to the accounting
system in general, and therefore we find, in recent times, a focus on this profession, to make it
more independent and professional than it is in present. There is an attempt to analyze a period of
previous works in an environment of traditional commerce, i.e. in a documented accounting
environment, but with technological advances. It has become binding on the auditing profession
to keep pace of this progress, since they affect and are affected by the surrounding environment,
and work under the e-commerce environment, i.e. in the accounting environment lacking in most
of the stages to be documented. (Qushi, 2011).

There are many aspects of the performance of commercial banks that can be analyzed. The
importance of bank profitability can be appraised at the micro and macro levels of the economy.
At the micro level, profit is the essential prerequisite of a competitive banking institution and the
cheapest source of funds. It is not merely a result, but also a necessity for successful banking in a
period of growing competition on financial markets. Hence the basic aim of every bank
management is to maximize profit, as an essential requirement for conducting business (Muga,
2012).

In Somalia, Somali remittance companies handles a lot of money and contributes the livelihood
of hundreds of thousands of families and develops the private sectors in a country where there is
no properly functioning government, therefore how an internal auditor is expected to be high
while the staff security has no guarantee. Somali remittance companies suffer loss of millions of
dollar due to lack of good quality control system in remittance companies and professional
internal auditors therefore most of Somali organizations do not have effective and independence
auditors (ABDI, 2015).

The internal audit standard significantly affects financial performance of commercial banks in
Mogadishu Somalia, there is a significant effect professional competency has on financial
performance of commercial banks in Mogadishu Somalia, this study proved a positive significant

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effect internal control has on financial performance of commercial banks in Mogadishu Somalia
(Ahmed, 2019).

Nevertheless, in our best awareness, the role of internal control system in Mogadishu
commercial banks looks to be unclear. So, this study will investigate the effect of internal audit
on financial performance in commercial banks in Mogadishu Somalia.

1.2 Problem statement

The problem that this research discusses will be the improvement of the internal auditing
function in the commercial banks in Mogadishu, the availability of clear goals that can be used
as a basis to audit the managerial and financial performance and that raise many questions in this
regard.
The main question of this research will be: does the internal auditing department in the
commercial banks in Mogadishu do its role to monitor the financial and managerial
performance?
From this general question we can draw sub-questions which should be:
1) In the commercial banks is there a separate department for the internal auditing and these
companies providing this department with the sufficient resources?
2) Can the internal auditor in the commercial banks do his / her duty in controlling the
administrative and financial performance according to the standards, and how much is that
important for the management, the auditing committee, the shareholders and the external
auditor?
3) Is there a sufficient degree of independency from the management that enables him / her to
achieve the work way from the pressure of the related parties?
4) Are the qualifications, knowledge and experience of the internal auditor sufficient enough to
let him / her work in the proper manner?

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1.3 Objectives of the study
1.3.1 Main Objective

The objective of this research will be to realize effect of internal audit on financial performance
of commercial banks in Mogadishu Somalia case study Dahabshiil bank.

1.3.2 Specific objectives:

1. To identify the role of internal audit on financial performance of commercial banks in

Mogadishu Somalia.
2. To establish the impact of monitoring and control activities of internal audit on financial
performance of commercial banks in Mogadishu Somalia.
3. To rise the accountability of internal audit on financial performance of commercial banks in
Mogadishu Somalia.

1.4 Research questions

1. What is role of internal audit on financial performance of commercial banks in Mogadishu

Somalia?
2. Does monitoring and control activities of internal audit effect the financial performance of
commercial banks in Mogadishu Somalia.
3. What is the accountability of internal audit on financial performance of commercial banks in
Mogadishu Somalia?

1.5 Scope of Study

This study will be concerned with “effect of internal audit on financial performance of
commercial banks in Mogadishu Somalia”. The study will conducted In Mogadishu, the capital
city of Somalia, using Dahabshiil bank (one of the commercial banks in Mogadishu) as a case
study.

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1.6 Significance of the Study

This study will help in increasing the role and image of internal audit in commercial banks to
make it more effective and professional. It will help the shareholders appreciate the role of the
internal audit as one of the most important managerial control systems in an organization
required to safeguard their interests. The management of banks will be able to look for ways of
making Internal Audit a completely independent function from the management thus making it
more effective. Implementing recommendations given on the internal audit reports management
will be able to enhance performance of the bank. For scholars it will help them to appreciate and
enhance their knowledge of internal audit so as to adhere to the professional ethics as required by
the IAS.

1.7 Operational definitions

Internal audit; Internal auditing is an independent, objective assurance and consulting activity
designed to add value and improve an organization's operations. It helps an organization
accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve
the effectiveness of risk management, control, and governance processes .
Performance; Performance is an act of staging or presenting a play, concert, or other form of
entertainment. It is also defined as the action or process of carrying out or accomplishing an
action, task, or function.
Commercial banks; The term commercial bank refers to a financial institution that accepts
deposits, offers checking account services, makes various loans, and offers basic financial
products like certificates of deposit (CDs) and savings accounts to individuals and small
businesses. A commercial bank is where most people do their banking. Commercial banks make
money by providing and earning interest from loans such as mortgages, auto loans, business
loans, and personal loans. Customer deposits provide banks with the capital to make these loans.

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1.8 Conceptual frame work
Independent variable (IV) Dependent variable (DV)

Effect of internal audit Performance of commercial

banks

The role of internal audit

The monitoring and control Dahabshiil bank

of internal audit

Accountability of internal
audit