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KENYA METHODIST UNIVERSITY

SCHOOL OF BUSINESS

D: RESEARCH METHODS

TOPIC: AN ANALYSIS OF FACTORS AFFECTING IMPLEMENTATION OF INTERNAL AUDIT REPORTS IN


KENYAN ORGANIZATIONS- A CASE STUDY OF K-Rep bank LIMITED

PRESENTED BY:

PRESENTED TO: On:

PREPARED IN PARTIAL FULFILMENT OF BACHELOR OF COMMERCE DEGREE OF KENYA METHODIST


UNIVERSITY TABLE OF
CONTENTS...........................................................................
...............................................Page CHAPTER
ONE................................................................................
..............................................................5
1.0
INTRODUCTION.......................................................................
..............................................................5 1.1 RESEARCH
BACKGROUND.........................................................................
....................................5 1.2 RESEARCH PROBLEM
STATEMENT..........................................................................
..................8 1.3 RESEARCH
OBJECTIVES.........................................................................
.......................................9 1.4 RESEARCH
QUESTIONS..........................................................................
........................................9 1.5 IMPORTANCE OF THE
STUDY..............................................................................
........................9 CHAPTER
TWO................................................................................
...........................................................11 2.0. LITERATURE
REVIEW.............................................................................
..........................................11 2.1 THE ORIGIN OF
AUDITING...........................................................................
...............................11 2.2. HISTORICAL
Development .......................................................................
.....................................13 2.3. Statement of
Responsibility.....................................................................
..........................................14 2.4. Definition of
Auditing...........................................................................
............................................15 2.5 DEFINITION OF OTHER
TERMS..............................................................................
...................18 2.6 Newly defined Internal Audit
function...........................................................................
...................19 2.7 Factors influencing Audit
Function ..........................................................................
.......................21 2.8 Independence of
Auditor:...........................................................................
........................................22 2.9 INTERNAL
AUDITING...........................................................................
.........................................23 2.10 Role of the Internal
Audit..............................................................................
..................................24 2.11 SCOPE AND OBJECTIVES OF INTERNAL
AUDITING...........................................................26 2.12.
Qualities of an Effective Internal Audit
department .....................................................................27
2.13 General Advantages of an
Audit..............................................................................
........................28 2.14 Types Of
Audits.............................................................................
....................................................29 2.15 General principles of
an
audit..............................................................................
............................30 2.16 Criticisms Of Internal Audit
Reports............................................................................
...................31 2.17 The Agency problem – need for
auditors...........................................................................
..............32 2.18 The Auditor and management of
corporations.......................................................................
........32 2.19 Audit
Demand.............................................................................
......................................................33 2.20. Nature Of Internal
Audit Reports In Kenyan
Organizations .......................................................34 Objective
of an
audit..............................................................................
...................................................36 3.0. Research
methodology .......................................................................
...................................................37 3.1 Description of Area of
study .............................................................................
.................................37 3.2 Research
design ............................................................................
.....................................................37 3.3 Target
population ........................................................................
......................................................38 3.4 Sample of the
study/sampling
design ............................................................................
....................38 3.5 Instruments for data
collection ........................................................................
.................................38 3.6 Pilot
study .............................................................................
..............................................................39 3.7 Procedure for
data
collection ........................................................................
....................................39 3.8 Data
Analysis ..........................................................................
...........................................................39
REFERENCES ........................................................................
....................................................................40 APPENDIX 1:
INTRODUCTORY
LETTER.............................................................................
..................42 Appendix 2:
Questionnaire .....................................................................
.....................................................43 APPENDIX 3: PROPOSED BUDGET
PLAN...............................................................................
.............49 APPENDIX 4: TIME SCHEDULE FOR THE RESEARCH: FEB - AUG
2007......................................49

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APPENDICES Appendix 1: Appendix 2: Appendix 3: Appendix 4: Introductory letter
Questionnaire Proposed budget Time Schedule

LIST OF TABLES Table1: categories of respondents ABBREVIATIONS AAA ICPA (K) IASC
IAS American Accounting Association Institute of Certified public accountants of
Kenya International Accounting Standards Committee International Accounting
Standards

AICPA American Institute of Certified public Accountants

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CICA IFA CPAs IIA SPSS ISA CEO IRS USA GAO GIAS

Canadian Institute of Certified accountants International Federation of accounts


Certified Public Accounts Institute of Internal Auditors Substantial Package for
Social Sciences International Standards of Auditing Chief Executive Officer
International Reporting Standard United States of America General Accounting Office
German International Accounting Standards

CHAPTER ONE 1.0 INTRODUCTION OVERVIEW This chapter on introduction covers the
following:  Research Background  Research Problem Statement  Research Objectives

 Research Questions  Importance of the study 1.1 RESEARCH BACKGROUND According to


the GIAS (2001) Internal Audit is an objective and independent appraisal service
within an organization on risk management, control and governance by measuring and
evaluating their effectiveness in achieving the organization’s agreed objectives.
In addition, internal audit’s findings are beneficial to the Board of Directors and
line management in the audited areas. The service applies the professional skills
of internal audit through systematic and disciplined evaluation of the policies,
procedures and operations that management put in place to ensure the achievement of
the organization’s objectives, and through recommendations for improvement.

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For most of its history internal auditing as 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 auditing, 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 auditing varies from one organization to another, and making
change to modern internal auditing can be a substantial undertaking. The transition
from merely ensuring compliance with rules and regulations to truly delivering
added value requires more than just organizational changes. In many organizations
staff is poorly paid and unmotivated, ethical standards are weak, and governance
practices are ineffective. Furthermore, many organizations lack support from senior
management and regulatory bodies, and in most cases the internal audit function is
often anything but independent. This research study will be based on K-Rep bank ltd
in general but its Internal Audit Department in specific. K-Rep was founded in 1984
as an intermediary organization to address the financial, management and technical
shortfall experienced by existing nongovernmental organizations (NGOs) involved in
small and micro-enterprise after a study conducted in 1983 to assess the
institutional needs of NGOs by USAID. At that time, USAID’s interest was to promote
micro-enterprise development globally as means of poverty alleviation. Starting as
a fiveyear project, the ‘Rural Private Enterprise’ project, a private voluntary
organization of the World Education Inc. based in Boston, with a strong focus on
the development of small micro-enterprises in the rural areas, KRep provided 100%
grants to other non-governmental organizations for onlending to small and micro-
enterprises.
K-Rep then entered into another five-year cooperative agreement with USAID in 1987
named ‘Private Enterprise Development’ (PED) project. With a well-founded support
from USAID, PED was registered as WEREP a Kenyan owned company limited by guarantee
and with no share capital. In 1992, WEREP changed its name to K-Rep, an
abbreviation for Kenya Rural Enterprise Programme. Change in Operations

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PED facilitated the growth of the K-Rep Group since it provided K-Rep with an
identity, authority and autonomy for making independent decisions with which KRep
instituted several changes in its operations. For example, K-Rep reduced its
involvement with non-governmental organizations; changed its approach of providing
100% grants to non governmental organizations to 30%; made the non governmental
organizations accountable for any funds given; adopted a minimalist approach by
eliminating all other technical support other than those related to credit
management; engaged in direct lending; developed in house training and indulged
more in research activities. Eventually, K-Rep ceased wholesale lending to other
non-governmental organizations and concentrated on retail and direct lending. K-Rep
Activities K-Rep activities were distinctly categorized into two divisions:
financial and non financial divisions.

(i) The financial division dealt with both retail and wholesale lending, through
the latter was ceased in 1994. K-Rep financial division generated some income
through interest rate earnings, which was ploughed back to the program. K-Rep’s
goal was not to maximize profits but to ensure sustainability. (ii) The research
and evaluation department monitored the performance of the credit program providing
recommendations and policies. Research was conducted to deeply understand the small
and micro-enterprises operations and results used to expand the program. Consulting
services on the other hand involved extending advisory services to other
organizations interested in designing, implementing and researching micro-
enterprise related development activities. The popularity and growth of consulting
services stemmed from the wealth experience that K-Rep had gathered over many
years. Today the financial division is now known as K-Rep Bank Limited, the first
microfinance bank in Kenya. The non-financial services division is now KRep
Development Agency, the research and development arm. K-Rep Advisory Services
Limited, the consulting and business development arm and K-Rep Fedha Services
Ltd,offers management services to Financial Services Associations .

T 1.2 RESEARCH PROBLEM STATEMENT Internal audit operations and recommendations do


not only have short-term effect on the running of an organization but is the
backbone of an organization and it dictates the prosperity or the down fall of the
particular organization. Its effectiveness and acceptability should be stressed at
all levels and especially the management to enhance its viability. However it seems
that laxity has crept in and it is in light of this view that we seek to analyze
the factors affecting implementation of internal audit reports in Kenyan
organizations and more specifically K-Rep bank ltd.

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1.3 RESEARCH OBJECTIVES 1. 2. 3. To identify the factors affecting implementation
of Internal Audit Reports To identify the role and functions of internal audit
department. To identify the effectiveness of the internal audit department, that
is, to examine to what extent the management and/or the external auditors implement
the internal audit’s reports and recommendations. 4. To establish ways and means of
strengthening the internal audit department.

1.4 RESEARCH QUESTIONS 1. 2. 3. 4. What are the factors affecting implementation of


internal auditors reports? What is the scope and purpose of the internal audit
department and how independent is it? To what extent are the audits reports
implemented or effected by the management or Board of Directors? What are the
challenges and weakness of the internal audit department?

1.5 IMPORTANCE OF THE STUDY This study will help in increasing the role and image
of internal auditing in K-Rep Ltd to make it more effective and professional This
study will help the shareholders appreciate the role of the internal audit
department as one of the most important managerial control systems in an
organization required to safeguard their interests To look for ways of making
Internal Audit department a completely independent group, completely separated from
the management thus making it more effective. For scholars it will help them to
appreciate and enhance their knowledge of internal auditing so as to adhere to the
professional ethics as required by the IAS. .

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CHAPTER TWO 2.0. LITERATURE REVIEW 2.1 THE ORIGIN OF AUDITING According to Walter
W.BIGG (1972), the origin of auditing had its origin in the necessity for the
institution of some system of check upon persons whose business it was to record
the receipt and disbursement of money on behalf of others. In the early stages of
civilization the methods of account were so crude, and the number of transactions
to be recorded so small, that each individual was no doubt able to check for
himself all his transactions, but as soon as the ancient States and Empires
acquired any coherent organizations, systems of check were applied to their public
accounts, as

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evidenced by exact records; the ancient Egyptians, the Greek and the Romans, all
utilized systems of check and counter-check as between the various financial
officials.

It was not until the fifteenth century that the great impetus given to trade and
commerce generally by the Renaissance in Italy led to the evolution of a system of
accounts which was capable of recording completely all kinds of mercantile
transactions, and the principles of double entry were first published in 1494 at
Venice by Luca Pacioli, although the system had been more or less utilized during
the preceding century. It thus became possible to record not only cash
transactions, but also all transactions involving matters of account, and the
duties of the auditor correspondingly increased. The increase in volume of trading
operations, necessitating the use of more capital than was the disposal of the
average trader, induced him to combine in partnership with others for the purpose
of obtaining the requisite funds, and this tendency was a potent factor in the
evolution of a more perfect system of accounts. In the same way, no doubt, it had a
material effect on the practice of auditing, but the audit of business accounts did
not become common until the Nineteenth century. The enormous increase in trade in
that period, which was fostered by the discovery of steam power and by mechanical
inventions generally, led to the formation of numerous joint stock companies, and
other corporate undertakings, involving the use of large sums of capital under the
management of a few individuals. Under these conditions the advantages to be
obtained from utilizing the services of auditors became apparent to the commercial
public generally, and a great increase in the practice of auditing resulted; at the
present day it forms the most important part of a professional accountant’s
practice. 2.2. HISTORICAL DEVELOPMENT According to Howard F.Stettler (1977),
internal auditing appeared on the business scene much later than auditing by public
accountants. The principle factor in its emergence was the extended span of control
faced by management in concerns employing thousands of people and conducting
operations from widespread locations. Defalcations and improperly maintained
accounting records were obvious problems under these circumstances, and the growth
in the volume of transactions presaged a substantial bill for public accounting
services for the businesses that endeavored to solve the problem by continuing the
traditional form of audit by the public accountant. The solution was, of course, to
provide the needed auditing service on an internal basis, particularly as the
magnitude of the problem made it possible for one or more persons to specialize in
such auditing

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services and devote their full time to needs of a single company. Other advantages
also resulted from an internal approach to the problem: internal auditors tended to
become better acquainted with the procedures and problems of the company, and the
auditing activity could be carried on continuously, rather than once a year when
outside auditing services were utilized. As a further inducement to the development
of internal auditing, public accountants were at about this same time finding an
increasing demand for independent audits leading to the expression of an opinion on
financial statements, and they recognized that they could seldom perform the older
type of detailed verification as effectively or efficiently as could the company’s
own specialist. Railroads were one of the first groups to employ internal auditors,
although as the practice developed at the turn of the century, the title
customarily used was `traveling auditors.’ The traveling auditor’s main function
was to visit the railroad’s ticket agents and determine that all tickets and cash
had been properly accounted for. The scope of internal auditing services that
developed from this elementary beginning is set forth in succeeding sections of
this chapter.

2.3. STATEMENT OF RESPONSIBILITY (Stettler, 1977) suggested of the relatively


recent origin and maturation of internal auditing was the fact that the first
extensive treatise on the subject was published in 1941, and that year also marked
the formation of a national organization of internal auditors- The Institute of
Internal Auditors. In the intervening years the institute has incorporated, has
become international in scope, and has developed a professional examination program
leading to the designation ‘Certified Internal Auditor.’ The institute,
understandably, held a relatively advanced concept of the internal auditor’s
function in business and the responsibilities associated with that function, and
the 1971 revision of the 1947 statement of the institute in this connection
represented a useful starting point for a discussion of internal auditing.

2.4. DEFINITION OF AUDITING According to Jach C. Roberston(1976),Auditing may be


defined in several ways depending upon what purpose is to be served. Four
definitions are given below, beginning with the most general one produced by a
committee of the American Accounting Association. The latter three definitions
exhibit three different purposes served by independent auditors, and governmental
auditors.

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Auditing is a systematic process of objectively obtaining and evaluating evidence
regarding assertions about economic actions and events to ascertain the degree of
correspondence between those assertions and established criteria and communicating
the results to interested users. (The AAA committee on basic auditing concepts
(1971)) The American Accounting Association definition discussed above is broad and
general enough to encompass all auditing activity. However, other definitions also
exist. Presented below are three definitions promulgated by organizations that have
direct professional responsibility for the practice of auditing. CONTROLLER GENERAL
OF THE UNITED STATES (GAO) The U.S. Comptroller General is the chief executive
officer of the U.S. General Accounting Office, which is an accounting, auditing and
investigative agency of the U.S. Congress. The first ‘basic premise’ given in the
1972 statement entitled Standards For Audit of Governmental Organizations,
Programs, Activities and Functions expresses a broad description of governmental
auditing. The term ‘audit may be used to describe not only work done by accountants
in examining financial reports but also work done in reviewing (a) compliance with
applicable laws and regulations, (b) efficiency and economy of operations, and (c)
effectiveness in achieving program results. The GAO considers auditing not as
restricted to financial reports alone, as is implied by the AICPA statements, but
extends audit interest to three elemental areas. The 1972 standards report defines
each of these elements as follows;  Financial and compliance-determines (a)
whether financial operations are properly conducted, (b) whether the financial
reports of an audited entity are presented fairly, and (c) whether the entity has
complied with applicable laws and regulations.  Economy and efficiency- determines
whether the entity is managing or utilizing its resources (personnel, property,
space and so forth) in an economical and efficient manner and the causes of any
inefficiencies or uneconomical practices including inadequacies in management
information systems, administrative procedures, or organizational structure. 
Program results-determine whether the desired results or benefits are being
achieved, whether the objectives established by the legislative or other
authorizing body are being met, and whether the agency has considered alternatives,
which might yield results at a lower cost.

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THE INSTITUTE OF INTERNAL AUDITORS (IIA) The institute of Internal Auditors has
officially adopted a statement of responsibilities of the internal auditor
(modified in 1947, 1957, and 1971). The definition of auditing offered therein is
as follows: Internal auditing is an independent appraisal activity within an
organization for the review of operations as a service to management. It is a
managerial control, which functions by measuring and evaluating the effectiveness
of other controls. Internal auditors view auditing as extremely broad, as does the
GAO reaching not only to accounting data but also to compliance, control
effectiveness, and performance quality. The internal auditors also add new
dimension-reports recommending operating improvements. The full statement of
responsibilities of the internal auditor contains a concise description of internal
auditing. Observation on Definitions In comparison to the GAO and Internal
Auditors, the AICPA’s definition appears to recognize only a small portion of audit
practice possibilities. Such an observation is literally accurate. However, the GAO
and IIA statements of definition and objective serve to define all professional
practice of governmental auditors and internal auditors. Likewise the AAA
definition is stated broadly to include a wide variety of auditing practice. In
contrast the AICPA definition pertains to only one part of the professional
practice of Certified Public Accountants. Many CPA firms perform the same tasks as
governmental auditors and internal auditors, but such engagements are either
performed as management advisory services or are audits in every sense of the
broadest definition except for the absence of the attestation report. Independent
CPA’s generally are reluctant to call an engagement an ‘audit’ unless its end
product is an attestation opinion, regardless of the substantive nature of the work
performed. The principal reasons for this reluctance have to do with legal
liability questions. 2.5 DEFINITION OF OTHER TERMS INTERNAL AUDITORS

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These are employees within an organization whose primary responsibility is to
determine whether organizational policies and procedures are being carried out
correctly and to safeguard organizational assets as well as assessing the
efficiency of internal control system. INTERNAL CONTROL SYSTEM Many accounting
institutions such as ICPAK, IASC and AICPA define internal control system as the
whole system of controls, financial and otherwise established by management in
order to carry on the business of the entity in an orderly and efficient manner,
ensure adherence to management policies, safeguard the assets secure as far as
possible the completeness and accuracy of the records, the individual components
are known as internal controls. According to ISA 315 internal control system is the
process designed and effected by those charged with governance, management and
other personnel to provide reasonable assurance about the achievement of the
entities objective with regard to financial reporting, effectiveness and efficiency
of operations and compliance with a appropriate laws and regulations. AUDIT
COMMITTEE This is a committee consisting primarily of non-executive Directors,
which is able to view a company’s affairs in a detached and independent way and
liaise effectiveness between the main board of directors and the external auditors.
AUDITNG PROCEDURES: AICPA (1963) Defines auditing procedures as the acts performed
by the auditor in the courser of attaining the objectives of the examination of
financial statements

2.6 NEWLY DEFINED INTERNAL AUDIT FUNCTION (Albert L. Nagy, William J. Cenker) in
their research, An assessment of the newly defined internal audit function,
presented some insight and opinions about the newly defined internal audit function
and related issues from several internal audit directors of large companies. As the
above responses reflect, the internal audit function varies significantly among
companies from a traditional assurance orientation to that of a value-added and
consulting orientation, with most companies landing somewhere in the middle.
Furthermore, the orientation or role of internal auditing appears to be

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determined primarily by management, and not from the profession, internal audit
professionals, or the audit committee. Some of the interviewed directors raise the
question of whether the internal audit function could and/or should be defined by
the profession in the first place. These directors believe that top management is
appropriately defining their organization’s internal audit function, and that the
profession should concentrate its efforts on providing guidance and support.
Despite this viewpoint, the directors’ responses suggest that most of their
internal audit departments have shifted toward a more value- added or operational
focus, which is consistent with the new definition. Therefore, the new audit
definition appears to better describe the current practice of internal auditing, at
least among the organizations included in this study, even if it may be a few years
late in coming. A concern expressed by several of the directors is whether the
internal audit department and the external auditor adequately coordinated their
efforts to address the recent shift in internal audit’s focus toward operations.
That is, because of limited resources most internal audit departments were forced
to reduce their level of traditional assurance services as a result of their shift
in orientation. Ideally, the external auditor would increase their level of
assurance testing in order to compensate for internal audit’s reduction in this
area. Unfortunately, most of the interviewed directors believe that this is not
occurring, especially in the area of reviewing the quarterly statements. We
encourage future research to address this area. All but one of the directors do not
feel threatened or feel an increased need to justify their services to top
management and believe that management respects and understands the value of the
services that internal audit provides. The directors support the new internal audit
definition’s suggestion that risk assessment is a key function of internal audit.
Interestingly, however, those directors from companies that have formal risk
assessment departments indicate that the level of coordination between internal
audit and the risk assessment department is minimal at best. The responses also
suggest that the internal audit department are capable and have an adequate level
of expertise to carry out proper risk assessment procedures. Given the wide variety
of risk assessment techniques employed by the sampled companies, the directors are
apparently still searching for the most effective risk assessment method. We
encourage future research to aid the internal auditing profession in identifying
and assessing effective risk assessment methods and techniques. 2.7 FACTORS
INFLUENCING AUDIT FUNCTION The auditor should consider several major factors
(discussed below) when performing the auditing function.

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I)

INTEGRITY OF MANAGEMENT

When one or a few individuals who lack integrity dominate management, the
likelihood of significantly misrepresented financial statements auditor’s function.
When management has an adequate level of integrity for the auditor to accept the
engagement (Willingham, 1971) but cannot be regarded as completely honest in all
dealings, auditors normally reduce acceptance audit risk and also increase inherent
risk. II) RESULTS OF PREVIOUS AUDITORS is greatly increased. The integrity of
management affects the

Misstatements found in the previous year’s audit have a high likelihood of


occurring again in the current year’s audit. This is because many types of
misstatements are systematic in nature and organizations are often slow in making
changes to eliminate them. Therefore, an auditor would be negligent if the results
of the preceding years audit were ignored during the development of the current
years audit program. MANAGEMENT STRUCTURE If a small number of individuals dominate
the management of a company without an effective oversight or board, there may be
an increased risk of error. III) CHANGES IN BUSINESS

When significant changes occur it may be more difficult to report accurate


financial information because of a lack of familiarity with new types of
transactions or a new line of business. IV) CLIENT’S CONCERNS ON INTERNAL CONTROL
STRUCTURE

Many companies establish a system for control so as to help in meeting its own
goals. The system consists of many specific policies and procedures designed to
provide management with reasonable assurance that the goals and objectives will be
met (Cecil, 1985). 2.8 INDEPENDENCE OF AUDITOR:

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According to the Institute of Internal Auditors (UK) in the book Standards For The
Professional Practice Of Internal Auditing (1979), internal auditors must be
independent of the activities they audit. Such independence permits internal
auditors to perform their work freely and objectively. Without independence, the
desired results of internal auditing cannot be realized. In setting these standards
the following developments were considered.  Boards of directors are being held
increasingly accountable for the adequacy and effectiveness of their organizations
systems of internal control and quality of performance.  Members of management are
demonstrating increased acceptance of internal auditing as a means of supplying
objective analysis, appraisals, recommendations, counsel and information on the
organizations control and performance.  External auditors are using the results of
internal audits to complement their own work where the internal auditors have
provided suitable evidence of the independence and adequate, professional audit
work. 2.9 INTERNAL AUDITING This has been defined by the institute of internal
auditors a a series of processes and techniques through which an organization’s own
employees ascertain for the management by means of first hand observation on the
job whether established management controls are adequate and are effectively
maintained, record and reports reflect actual operations accurately and promptly
and that each division, department or other unit is carrying out the plans,
policies and procedures for which it is responsible. According the Institute of
internal Auditors (ISA 610), internal auditing is defined as an independent,
objective, consulting and accurate activity designed to add value in an
organization; they improve the organization by reviewing the operational
effectiveness and efficiency of the internal control systems contribute to the
governance process and ensuring compliance with laws and regulations. 2.10 ROLE OF
THE INTERNAL AUDIT According to Cooper and Craig (1983): this was the first known
empirical study on the role of internal audit in the Asia Pacific region. This
seminal research on internal audit in Australia found a number of issues that were
of concern to the profession. It was found that there were a number of
misconceptions about what internal auditors were doing and what their chief
executive officers (CEO) perceived was being done and in fact there were
expectations by the CEO’s that internal audit could do more than the traditional
financial auditing work mainly being done at the time. There was nevertheless
strong support

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for internal audit by CEO’s and at the time it was seen as offering long-term
career prospects. However, the profession in Australia in the early 1980’s suffered
from an image problem, it did not have a strong professional body to represent its
interests as it has now, and there were no generally accepted professional
qualifications recognized as necessary to practice as an internal auditor. The
study was undertaken before the development of modern internal auditing, as we know
it now. It did, however, set the scene for a number of subsequent studies in
Australia, Hong Kong and Malaysia. According to Van Peursem (2004), a major study
has been undertaken in New Zealand on internal auditors role and authority. In this
study, internal auditors are asked to come to a view on whether functions they
perform in connection with audit engagements are essential, and to what degree they
feel they enjoy the authority over, and independence from, management that we might
expect of a professional. The research constituted a survey of New Zealand
auditors, all of whom were members of the New Zealand branch of the IIA. A very
high percent (73%) response rate was achieved over the original and follow-up
survey. The study found that characteristics of a ‘true’ profession exist but do
not dominate. Significantly, and as subgroups, Van Peursem (2004) also observed
that public practice and experienced auditors may enjoy greater influence over
management, and accountancy-trained auditors may enjoy greater status owing to the
‘mystique’ of the activities emanating from their membership of well-known
accountancy professional bodies. The research supports prior studies by Coopers and
Craig (1983), Cooper et al. (1966) and Myers and Gramling (1997), which all
expressed serious reservations about the effectiveness of the internal auditor’s
role. In a follow up study in New Zealand, Van Peursem (2005) examined the role of
the New Zealand internal auditor and conceptualizes on the auditor’s influence over
that role. The fundamental question is how an effective internal auditor can
overcome the tension of working with management to improve performance, while also
remaining sufficiently distant from management in order to report on their
performance. The research found that there are three concepts characteristic of
those who best balanced their role: the internal auditor’ external professional
status; the presence of a formal and an informal communication network; and the
internal auditor’s place in determining their own role. Informing these concepts is
the auditor’s ability to manage ambiguity. This was a qualitative study using a
multiple case-based approach in which the researcher made observations, examined
documents and interviewed senior internal auditors in six New Zealand
organizations. However, it is a very thorough study and offers insights arguably
not readily available in more traditional quantitative research. 2.11 SCOPE AND
OBJECTIVES OF INTERNAL AUDITING 1) Facilitate the integrity and reliability of the
financial statements by ensuring that:  The financial statements have been
prepared in compliance with IAS and IFRS

17

Safeguarding the company’s assets by ensuring that proper records are maintained to
proof their existence and periodic physical count to ensure the assets are in
existence and their conditions are okay. Ensure compliance with the relevant laws
and regulations and in the event of breaches the financial statements should
disclose such.

2) Review the operational effectiveness and efficiency and ensure economic


utilization of resources, targets of the economy are achieved and managers display
efficiency in discharging their duties. 3) Review the accounting system in use and
the related internal control system to ensure their design and effectiveness are
suitable, monitor their operations and recommend improvements thereto. 4) Assist in
the governance process. Governance process is the way the board of directors manage
the affairs of the company. Internal audit contributes by doing the following:  
Ensure adherence to the code of conduct and promote the ethical culture. Assist the
Board Of Directors to discharge their duties ethically by informing them of the
weaknesses and recommendations of the strategies employed.  Ensure the
recommendations of the external auditors are implemented within the
prescribed/reasonable time. Internal auditors are secretaries to the audit
committees and acts as a link person between external auditors and audit committees
2.12. QUALITIES OF AN EFFECTIVE INTERNAL AUDIT DEPARTMENT The institute of internal
Audits practice standard (1980) includes five categories of guidance that takes
into consideration financial and operational auditing, independence, professional
proficiency, scope of work, performance of audit and management of their internal
auditing department. 1. Independence: This is an essential element to the
effectiveness of the internal auditing function and requires internal auditor to
the independent of all the activities that they may be required to audit. 2.
Competent personnel: The proper functioning of any system depends on the competence
and integrity of those operating it. The staff employed should therefore be
competent and experienced in their files. If need be, staff should be continuously
updated through in house and /or off the job training. 3. 4. Professional
proficiency: internal audits should therefore be performed with proficiency and due
professional care Scope of work: The scope of work of the internal audit department
should encompass the examination and evaluation of the adequacy and effectiveness
of the organizations system of internal control and the quality of performance in
carrying out assigned responsibilities.

18
5.

Programmes for review:

The internal audit department should have comprehensive

programmes so as to ensure that no major aspect of operations is overlooked. The


department should avoid being involved in activities not falling within their audit
to function as this may prevent it from following their normal programme closely. •
• Collect, analyze, interpret and document information to support audit results.
Report 6. Report: Proper reports should be written after every audit and
communicated periodically to all interested parties within the organization.
Recommendations made on such reports should e clear and achievable. 2.13 GENERAL
ADVANTAGES OF AN AUDIT The institute of internal auditors-Standards For The
Professional Practice Of Internal Auditing (1979) gives a number of inherent
advantages in having accounts audited, even where there is no statutory provision
for this to be done.  Disputes between partners regarding the accounts may be
largely avoided, especially where complicated profit-sharing arrangements subsist.
 The admission of a new partner is facilitated if sets of audited historical
accounts are available for examination.  Any partnership change (i.e. death,
retirement or alteration of profit sharing) will require to be reflected in the
accounts, and it’s usual for the partnership assets, including goodwill to be
revalued at such a time. Since such revaluations directly affect the respective
shares of each partner, it’s advisable to have the post charge Accounts audited. 
Applications to banks and other outside parties for the purpose of raising funds
are greatly enhanced by the availability of audited Accounts.  Audited Accounts
(albeit adjusted) submitted to the Inland Revenue for tax assessment purposes carry
greater authority than accounts, which have not been audited.  The presence of a
qualified auditor is useful because o the variety of other capacities in which he
is able to assist. In addition, a number of partnerships and other agreements
incorporate a provision for the auditor to act as arbitrator in the event of
dispute on specified issues. 2.14 TYPES OF AUDITS According to Emile Woolf (1990),
audits are viewed as falling into three major types:

19
Audit of Financial Statements-this covers the balance sheet and the related
statements of income, retained earnings, and changes in financial position. The
goal is to determine whether these statements have been prepared in conformity with
GAAP’s. Firms of Certified Public Accountants normally perform financial statements
audits; the user groups include management, investors, bankers, creditors,
financial analysts and government agencies. Compliance Audits- This is dependent
upon the existent of verifiable data and of recognized criteria or standards,
established by an authoritative body. A familiar example is the audit of an income
tax return by an auditor of the Internal Revenue Service (IRS). Such audits seek to
determine whether a tax return is in compliance with tax and IRS regulations.
Operational Audits- This is a study of some specific unit of an organization for
the purpose of measuring its performance. The operations of the receiving
department of a manufacturing company, for example, may be evaluated in terms of
its effectiveness, i.e. its success in meeting its stated goals and
responsibilities. Performance is also judged in terms of efficiency i.e. success in
using to best advantage the resources available to the department. Because the
criteria for effectiveness and efficiency are not as clearly established, as are
Generally Accepted Accounting Principles, the operational audit tends to require
more subjective judgments than do audits of financial statements or compliance
audits. The end product of an operational audit is usually a report to management
containing recommendation for improvement in operations. 2.15 GENERAL PRINCIPLES OF
AN AUDIT The auditor should comply with the code of ethics for professional
Accountants issued by the International Federation of Accountant. Ethical
principles governing the auditors professional responsibilities are:• • • • • • •
Independence Integrity Objectivity Professional competence and due care
Confidentiality Professional behavior Technical standards

20
The auditor should plan and perform an audit with an attitude of professional
skepticism recognizing that circumstances may exist that cause the financial
statements to be materially misstated. An attitude of professional skepticism means
the auditor makes a critical assessment, with a questioning mind of the validity of
audit evidence obtained and is alert to audit evidence that contradicts or brings
into question the reliability of documents or management representations. 2.16
CRITICISMS OF INTERNAL AUDIT REPORTS Positive 1) 2) 3) 4) Negative 1) Audit reports
may not give the holistic view of what is actually happening hence giving room for
a material misstatement. 2) Auditor carrying out internal audit examination may be
biased not to make negative opinions on areas especially touching the top
management or fellow workmates in the organization. 2.17 THE AGENCY PROBLEM – NEED
FOR AUDITORS Berle and Means (1932) noted the consequences of separating ownership
and control when they cautioned against separating owners and managers of firms.
They established the basis for what became known as the agency theory that has
since seen the establishment of internal audit committees and corporate governance
policies in most organizations. For the agency problem to be solved there calls for
an independent evaluation of the firm’s effectiveness, thus the need of auditing to
ensure good governance, Taylor and Glezen (1985). Identify areas of weakness and
internal control system within a good time. Adds strength to the existing
mechanisms Audit reports prevent conflicts because they put into light possible
disagreements between management and employees Saves an organization from conflicts
of interest

2.18 THE AUDITOR AND MANAGEMENT OF CORPORATIONS Manasseh (2001) describes the
managerial functions that are effected through the office of the internal auditor.
By looking at the key managerial functions that determine a firm’s success, they
emphasize the relevance of the auditing office in making sure that there is (1) An
effective Organization plan (2) Proper record keeping (3) Segregation of duties to
enhance accountability (4) Authorization (5)

21
Supervision of work (6) Safe guarding of assets (7) Well organized internal audit
(8) competent staff are employed (9) proper accounting control Saleemi and Ajowi
(2000) observed that the auditor has two sets of objectives to accomplish. These
they group as; • • Primary objectives and Secondary objectives Primary objectives
of the Auditor In describing the audit objectives, Saleemi and Ajowi (2000)
explained that the auditor has statutory requirements to prove the true and fair
view or otherwise of the company’s state of affairs, to confirm that proper books
of accounts are kept and to communicate his findings to the shareholders for
effective decision making by the latter. Secondary objectives of the Auditor
Saleemi and Ajowi (2000) further explains that other than the primary objectives,
the auditors are required to perform the following; detect errors and fraud,
prevent occurrence of errors and fraud, assist their clients improve their
accounting systems and finding out whether there are proper systems of internal
control in the clients firm. 2.19 AUDIT DEMAND Taylor and Glezen (1985) explain the
demand for auditors as being aroused by the needs of the present and potential
investors, and the need for stewardship accounting. They observed that it is the
need of the auditor to provide the investors with unbiased expert opinion by
examining the operations of the company. Hubbard T. D. (1983) observed that there
exists conflict of interest between owners and managers, and that it is the
responsibility of the auditor as a corporate strategist to resolve this conflicts.
Taylor and Glezen (1985) describes the corporate functions of the auditor as to
include; (a) Auditing, (b) Tax advisory services, (c) Management advisory services,
and (d) Accounting services. 2.20. NATURE OF INTERNAL AUDIT REPORTS IN KENYAN
ORGANIZATIONS The Company’s Act CAP 486 states the following; Sec 156

22
(1)

The Profit and Loss account, and, so far as not incorporated in the Balance Sheet
or Profit and Loss account, any group accounts laid before the company in general
meeting shall be annexed to the balance sheet, and the auditors report shall be
attached thereto.

(2) (3)

The board of directors shall approve any accounts so annexed before the balance
sheet is signed on their behalf. If any copy of a balance sheet is issued,
circulated or published without having annexed thereto a copy of the profit and
loss account or any group accounts required by this section to be so annexed, or
without having attached there to a copy of the auditors report, the company and
every officer of the company who is in default shall be liable to a fine not
exceeding one thousand shillings.

Sec 162 (1) The auditors shall make a report to the members on the accounts
examined by them, and on every balance sheet, every profit and loss account and all
group accounts laid before the company in general meetings during their tenure of
office, and the report shall contain statements as to the matters mentioned in the
7th schedule. (2) (3) The auditor’s reports shall be read before the company in
general meeting and shall be open to inspection by any member. Every auditor of a
company shall have a right of access at all times to the books and accounts and
vouchers of the company, and shall be entitled to require from the officers of the
company such information and explanation as he thinks necessary for the performance
of the duties of the auditors. (4) The auditors of a company shall be entitled to
attend any general meeting of the company and to receive all notices of and other
communication relating to any general meeting which any member of the company is
entitled to receive and to be heard at any general meeting which they attend on any
part of the business of the meeting which concerns them as auditors. According to
the International Standards On Auditing (2005); NO. 86 Auditors report Basic
elements Title Addressee Opening paragraph Scope paragraph Opinion paragraph Date,
address and signature

23
No. 93 Other information The auditor should read the other information to identify
material inconsistencies with the audited financial statements. No. 94
communication The auditor should report on a timely basis, to those charged with
governance:   Potential effect of any significant risks and exposures. Audit
adjustments, whether recorded or not, that have or could have, a significant effect
on the entity financial statements.  Material uncertainties casting significant
doubts on the entity’s ability to continue as a going concern

No. 135 Auditors shall be appointed and their duties regulated in accordance with
section 159 to 162 of the Act.

The (ISA) IAASB HAND BOOK has the following; OBJECTIVE OF AN AUDIT The objective of
an audit of financial statements is to enable the auditor to express an opinion
whether the financial statements are prepared in all material respects, in
accordance with an identified financial reporting framework. The phase used to
express the auditor’s opinion is ‘give a true and fair view’ or ‘present fairly, in
all material respects’ which are equivalent terms. Although the auditor’s opinion
enhances the credibility of the financial statements, the user cannot assume that
the opinion is an assurance as to the future liability of the entity nor the
efficiency or effectively with which management has conducted the affairs of the
entity.

24
CHAPTER 3 3.0. RESEARCH METHODOLOGY 3.1 DESCRIPTION OF AREA OF STUDY The study will
be conducted in Nanyuki. This is because it is convinient to the researcher and the
targeted respondents are in great numbers here. This will thus enable/provide an
easy way of data collection, location of respondents. 3.2 RESEARCH DESIGN A case
study is to be developed on K-Rep bank Ltd. This is in line with Rist (1982) who
asserts that case studies give an in-depth analysis of superficial statistical
portrayal of populations. Hence case studies are commonly used in research. A
policy research is the process of conducting research on or analysis of fundamental
special problem in order to provide policy makers with action oriented
recommendations or alleviating the problem. Maychvzak (1987). Hence the case study
will enable the researcher to assess the internal audit procedures move critically
and above all/answer the research questions. 3.3 TARGET POPULATION The population
of interest in this study will consist of clients both coporate and retail that
benefit from the services of K-rep bank Ltd, management and employees of K-Rep bank
LTD at large and a selected number of auditors from the Institute of Internal
Auditors (IIA)

3.4 SAMPLE OF THE STUDY/SAMPLING DESIGN The sample of the study will comprise of
thirty-five respondents Table 1: categories of respondents categories sample size

25
managers employees IIA 3.5 INSTRUMENTS FOR DATA COLLECTION

5 25 10

Structured questionnaires will be used for data collection. They will have both
open and close-ended questions. 3.6 PILOT STUDY A brief pilot study to test the
validity and reliability of the questionnaire will be conducted using a small
sample of 10 respondents (28.6%) of the sample size. This will be through issue of
questionnaires to the various categories of respondents to pre determine the
response rate. 3.7 PROCEDURE FOR DATA COLLECTION The study will purely rely on
primary data. This will be collected by use of structured questionnaire. The
researcher will administer these, and this is to be made effective by availability
of the researcher to assist the respondents who will need classification on any
questions. 3.8 DATA ANALYSIS The data collected will be analyzed by descriptive
analysis. The data will then be presented in a tabular format to be generated by
use of SPPSS (statistical package for social sciences) computer programme. There
will be the use of mean, percentage and frequency. The mean will give the average
of respondents who agree or disagree. The frequency will show how many times a
certain factor appears and the parentage that agreed or disagrees on various
issues. Other forms of data presentation will be the use of graphs, charts. These
will assist/enable the researcher to come up with data that is easy to draw
conclusions from.

26
REFERENCES AAA (1973), A Statement of Basic Auditing Concepts, Sarasota, Florida.
AICPA, Statement on Auditing Procedure No. 33. Anderson R. J. (1984), The External
Audit, 2nd edition Toronto Clarke Pitman. Barefield R. M. (1975). The Impact of
audit frequency on the Quality of Internal Control AAA Brasseaux J. H. (1965)
Readings in Auditing 2nd edition, south western publishing company, Cincinnati,
Ohio. Burns W. H. and Waterhouse J. M. (1975) Budgetary Control and Organization
Structures, Journal of Internal Control, AAA, Sarasota. Cadmus et al (1955)
Internal Control Against fraud and Waste, Englewood Cliffs, Prentice hall, Inc.
Cashin et al (1958) Internal Auditing. The Ronald Press Company, New York. Cecil G.
(1985) Accounting systems, procedures and Methods, 3rd edition, Prentice Hall,
India. Cockburn D. J. (1994) CA Magazine, august. Cooper D. R. & Emory C. W.
(1995). Business Research Methods 5th edition Mcgraw Hill companies Inc. US. Gibson
J. L. et al (1976) Organizations Behaviour Structure process. Business Publication,
USA Harried A. and Imdieke F. (1988) Advanced Accounting, 4th edition. John Wiley
and Sons Inc. Canada. Haskins M. E. (1987), Client Control Environment: An
examination of Auditors Perception. The Accounting Review, July. . ICPAK (K), Kenya
Auditing Guidelines : Operational No. 6, Nairobi. IFA (2000), Technical
Pronouncements. Jensen D. L. et al (1980) Advanced Accounting 2nd edition Random
House, USA

27
Loebecke et al (1994), Auditing: An Integrated approach, Prentice hall, Canada.
Mautz R. K. (1964) Fundamental of Auditing 2nd edition New York, Wiley Meigs w. B.
et al (1988), Principles of Auditing, 5th edition, Richard D. Irwin Inc. USA
Millichamp (1996). Auditing: An Instructional Manual for Accounting Students, DP
Publications. Scheneider A. (1988), The Management Accounting Magazine, July, the
other side of Objectivity in operational auditing. Staffer H. f. (1980) Auditing
Principles, Prentice Hall India. Stetler (1974) Systems Based Independent Audit 2nd
edition Prentice hall inc. Englewood Cliffs. The Institute of I Internal Auditors
Practice standards (1980). Wallance W. A. (1991) Auditing, 2nd edition Boston PWS,
Kent Publishing Willingham J. J. (1971). Auditing concepts and Methods, New York,
Mc graw Hill companies Inc, USA.

APPENDIX 1: INTRODUCTORY LETTER C/O BACHELOR OF COMMERCE OFFICE SCHOOL OF BUSINESS


UNIVESITY OF NAIROBI P.O BOX 30197
NAIROBI----------------------------------------------------------------------------
--------------------------Dear Sir/ Madam RE: request for Research Data We are
undergraduate students at the University of Nairobi(UON) pursuing a course leading
to award of a Bachelor of Commerce Degree (BCOM). In partial fulfillment of the
requirements of this course, we are conducting a study on analysis of factors
affecting implementation of internal audit reports. The study will concentrate on
activities of internal auditors. Your firm has been selected to form part of this
study. We therefore kindly request you to assist by completing the attached
questionnaire to the best of your knowledge.

28
The information required is purely for academic purpose and will be treated with
strict confidentiality. A copy of the findings of this study will be made available
to you upon your request. Thank you for your co-operation Names of students: Mary
Kiarie Jane Mango Lincoln Gachuki Jesca Kochwa Faith Kibe APPENDIX 2: QUESTIONNAIRE
The questionnaire below is in two parts. Part A is aimed at giving a general
background of your organization. Part B is concerned with the operating procedures
in your department Part A 1. [ [ [ [ ] ] Ownership (Please tick the appropriate)
Foreign Partly local (….% ordinary shareholding) and partly foreign (….% Ordinary
shareholding) ] government owned ] local (including jointly owned with government)
Supervising Lecturer MR. Wainaina Gituro University of Nairobi P.O BOX 30197 NBI E-
MAIL:wainainagituro@yahoo.com

2. [ [ [ [ 3. [ [ [ [

What is the industry classification of your company? (please tick one) ]


Agricultural ] commercial and services ] finance and investment ] Industrial and
allied For how long has your firm been operating in Kenya? (Please tick one) ] 1- 5
years ] 6 – 10 years ] 11 – 15 years ] over 15 years

29
4. [ [

Do you have an internal audit department (please tick one) ] Yes ] No

Part B 5. 6. 7. 8. What is the title of the person in charge of the internal audit
department? ____________ To which position in the organization does the above in
charge report? …… what was the total number of internal audit employees as at
31.12.2006 What is the qualification of your audit staff in numbers? The column
shows academic

qualifications and rows shows the professional. If 10 employees are CPA (K) and
have a first degree. Then put 10 where the two intersect. qualifications CPA (K)
CPA 2 CPA 1 KATC others specify 9. [ [ [ [ O level a E I M Q A level b f j n r
First degree c g k o s second degree d h i p t

Does the position occupied by your department in the overall organizational


structure permit ] Yes ] No ] Yes ] No a………………………….. b………………………….. c…………………………..
d………………………….. e………………………….. f…………………………..

the department to accomplish its audit responsibilities? (please tick one)

10. Is the work performed checked by other people? (please tick one)

11. state the number of staff in your department falling within the following
experience categories 0 – 1 years Over 1 year below 2 years Over 2 years below 3
years Over 3 years below 4 years Over 4 years below 5 years Over 5 years

12. How would you rate on average the familiarity of your staff with the
professional code of conduct (Please tick one) [ [ [ ] very familiar ] Familiar ]
Some how familiar

30
[

] Not familiar

13. Which of the methods below do your staff use in communicating with each other
(Please tick one) [ [ [ ] mostly memos ] Memos and personal discussion ] Mostly
personal discussions

14. How frequently do your staff including yourself participate in CPE (continuous
professional education) (Please tick one) [ [ [ ] All CPE programmes ] Some ] None
of internal audit tests carried out in the firm by your

15. how would you rank the extent department (Please tick one) [ [ [ [ 16. ] Very
expensive ] expensive ] Somehow expensive ] Not expensive

How frequently do you and your staff attend seminars on auditing? (Please tick one)
[ [ [ ] Frequently ] Occasionally ] Infrequently

17.

Who in your firm performs the following functions (please tick in each category as
appropriate) Both internal auditor & dept. heads a. establishes control b. Reviews
control Verifies the e f g h the a external auditor only b Internal only c d
auditor Only dept heads

system of internal

system of internal c. the i j k l

31
reliability accuracy records d. accounts Ensures compliance

and of and m with n o p

policies, laws and procedures f. Determines what to audit g. Ensures economic use
of resources 18. Do you use audit programmes in performing your audits? Please tick
one [ [ 19. ] Yes ] No U Y v z w aa x bb

In what form is your work communicated to your boss? (please tick one) [ [ [ ]
Written report ] Verbally during meetings ] Both oral and written

20.

where you have made recommendations do management allow you to follow up to ensure
compliance (please tick one) [ [ ] Yes ] No

21.

How do your external auditors perform their audit work? (Please tick one) [ [ [ [ ]
They have their own approach ] they always take my word ] They take my word in some
cases only ] I do some work for them.

22.

do you review all aspects of the organization (Please tick one) [ [ ] Yes ] No

23.

If no state the areas that you do not audit

32
_________________________________________________________________
_________________________________________________________________
_________________________________________________________________ Thank you for
your co-operation.

APPENDIX 3: PROPOSED BUDGET PLAN 'ITEMS TRAVELLING COSTS DATA COLLECTIONS AND
ANALYSIS PRINTING, STATIONERY AND BINDING CONTIGENCIES 1000 TOTAL 9000 'COST (KSHS)
5000 2000 1500

APPENDIX 4: TIME SCHEDULE FOR THE RESEARCH:APRIL - AUG 2010 APRIL RESEARCH PROBLEM
FORMULATION MAY JUNE JUL AUG

33
LITERATURE REVIEW

PROPOSAL WRITING

DATA COLLECTION

DATA ANALYSIS

REPORT WRITING

34