WOLAITA SODO UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACOUNTING AND FINANCE

ASSESSMENT OF FACTORS AFFECTING FINANCIAL REPORT QUALITY PUBLIC

ENTERPRISE IN WOLAITA SODO HEALTH OFFICE.

A RESEARCH PROPOSAL SUBMITTED TO THE DEPARTMENT OF ACCOUNTING

AND FINANACE IN PARTIAL FULFILLMENT OF BACHELOR OF ARTS DEGREE
IN ACCOUNTING AND FINANACE.

BY

NAME; PAWLOSE TORU

ID;- ACC/WE/145/12

ADVISOR; - ABEBAYEHU

MARCH, 2024

WOLAITA SODO, ETHIOPIA

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 Abstract
This study examined the factors influencing quality of financial reporting in the public sector
entities in Wolaita Sodo health office. A key prerequisite for quality in financial reporting
according to IPSASB is the adherence to the objective and qualitative characteristics of
financial reporting information. This study aimed at investigating the factors that influence the
quality of financial reporting in the public sector entities based on the following; internal
control measures, adoption of International Public Sector Accounting Standards and existence
of an audit committee in an entity. The study was conducted on public entities in the wolaiata
zone health office focusing on management staff as respondents and who also formed the unit of
analysis. The study used primary data collected through questionnaire as the main data
collection instrument.

Key Words: Quality Financial Reporting, Public Sector Entities, Internal Controls, Audit
Committee.

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Table of Contents
Page
Abstract...........................................................................................................................................................i
CHAPTER ONE............................................................................................................................................1
1. INTRODUCTION.....................................................................................................................................1
1.1. Background to the Study.....................................................................................................................1
1.2 Statement of the Problem.....................................................................................................................3
1.3 Objectives of the Study........................................................................................................................4
1.3.1. Specific objectives......................................................................................................................4
1.4 Research Questions..............................................................................................................................4
1.5 Scope of the Study...............................................................................................................................4
1.6 Significance of the Study.....................................................................................................................5
CHAPTER TWO...........................................................................................................................................6
2. LITERATURE REVIEW..........................................................................................................................6
2.0 Introduction..........................................................................................................................................6
2.1 Theoretical Review..............................................................................................................................6
2.1.1 Agency Theory............................................................................................................................6
2.1.2 Stakeholders’ Theory..................................................................................................................7
2.1.3 Institutional Theory....................................................................................................................8
2.1.4 Stewardship Theory....................................................................................................................9
2.2 Empirical Review...............................................................................................................................10
2.2.1 Internal Control and Financial Reporting.............................................................................10
2.2.2 Audit Committees and Financial Reporting..........................................................................11
2.2.3 Adoption of IPSAS and Financial Reporting.........................................................................14
2.2.4 Government Laws and Regulations and Financial Reporting....................................................14

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 CHAPTER ONE

1. INTRODUCTION
1.1. Background to the Study
The financial reporting practices in public sector have been challenged in many forums both
internationally and nationally because of the inadequacy of financial information used in the
preparation of the financial reports. The inadequacy of financial information affects public policy
decisions and contribute to unreliable reports (Yamada,2007).The primary objective of financial
reporting is to provide sufficient financial information concerning economic existence of an
entity and relevant information useful for decision makings (Omoro,Aduda & Okiro,2015).

According to International Accounting Standard Board (IASB, 2009), financial reporting is to

provide information about the financial position of an entity that is useful to various users in
making economic decisions. The Public sector has undergone numerous reforms aimed at
enhancing effectiveness and efficiency of delivery of public accounting and reporting system
mostly prompted by economic globalization (Nistor, 2012; Andre, 2014).

In recent years most of Organization for Economic Cooperation and Development (OECD)
countries adopted reforms in the public accounting and reporting system following the New
Public Management (NPM) perspectives and principles. The main objectives of the reforms were
to improve public service management and to increase the transparency and accountability of
governments (Caperchoine, 2006, Chan and Xiaoyue, 2002).

The reforms in the public management , series of corporate failures and financial scandals of
world renown companies prompted the demand of transparency and accountability of finance all
over the world (Opanyi,2016).During the sovereign debt crises in the European Union in 2010
2012 the main problems witnessed were lack of transparency and accountability of governments,
poor public finance management and public sector financial reporting, and many countries had
deficiency of institutions for fiscal management (IFAC 2012).

There were no incentives for governments to manage their finances in a way that protects the
public interest and investors. Financial reporting was found to improve the credibility and

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integrity of the public finances thus contributing to effective management of public resources
(Caba &Lopez, 2009).
Citizens have a right to know how funds are used as the funding of public entities is through
taxation of the citizens (Ellwood &Newbury, 2006).Citizens demand for accountability as the
managers of the resources are regarded as stewards and financial information produced by them
should show whether they are accountable or not. Quality financial information of public entity
is useful in decision making as well as fulfilling the public “right to know” how resources have
been spent according to Governmental Accounting Standards Board (GASB 2008, p5).

Although the sovereign debt crisis prompted the governments to embark on financial reforms,
many have not embraced the reforms as a priority that leads to financial reporting that lack
public trust and confidence from citizens and business sector. In case of systemic fraud and
corruption that goes unchecked, the public entities have difficulty in attracting more funds from
the governments and donors (Whiteman, 2016).

Accountancy profession regularly calls upon the governments around the world to adopt accrual
accounting and strong public financial management to enhance public service that supports
economic growth and tackle poverty. Certified Institute Public Finance and Accountants
(CIPFA, 2008) financial management model had set out robust model that ensured there was
strong stewardship, good governance and improved performance to the public.

According to( IFAC ,2012) all governments around the world must have institutional
arrangements that protect the public as well as the investors by creating trust through proving
accurate and complete financial information to the public. The objective of financial reporting by
public sector entities is to provide information about an entity's financial statements that is useful
to the users for accountability and making economic decisions (FASB, 2010; IASB, 2008;
IPSASB 2014).

Public sector entities raise resources from taxpayers, donors and lenders for provision of services
to citizens; hence they therefore need to be accountable for those resources bestowed to them.
Users of public sector financial reports can be categorized as internal and external where internal
users are the managers of the resources and employees of the entities while external users are the
public who receive services from the public entities, government and its agencies, suppliers,

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potential investors and customers who have various reasons in using the financial
reports(Miller,2002).
Public resource wastages by the public sector made the GoK experienced inadequacy in
funding levels of most essential services (Njeru,2010).It was also found that lack of quality
financial reporting created room for fraud and corruption practices that affected the credibility of
corporate governance of entities (Madawaki and Amran, 2016).

1.2 Statement of the Problem

Despite the public entities relying on the Government of Ethiopia for their budgetary allocations,
the level of accountability has been low coupled with numerous audit queries from the Office of
Auditor General (OAG). According to Macharia (2014), the resources allocated to these entities
are not put into proper use as the Auditor General reports for 2010/11 to 2014/15 financial years
showed a big gap between finances injected and financial reports on utilization. Weak controls
and poor financial reports have made the public entities provide financial information to the
users which are insufficient to hold their management accountable for the public resources (Kiilu
and Ngugi, 2014).

Quality financial reporting is of great importance to the users both directly and indirectly as it
affects their economic decision making. Many governments world over have seen the need of
good financial accountability and transparency to ensure there is public trust on the service
delivery. A study by PwC (2013), Global Survey on Accounting and Financial Reporting noted
that many developing countries were using either modified cash accounting or modified accrual
based accounting which did not reflect, timeliness, credibility, relevancy and accuracy of the
financial reports. According to Hamisi (2012) the government financial management systems are
not providing timely and reliable financial information for reporting and decision making.

Difference in accounting method has contributed to non-uniformity, unreliable and not credible
reporting. Strong and transparent financial reporting help in decision making and make
governments to be more accountable to the public (Izedomni et al, 2013).In the study of
accountability challenges in Nigeria by (Nkwagu,Uguru and Nkwede,2016) it was stated that
financial malpractices and other fraudulent practices were more common in institutions where no
proper accounting reporting was done.

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Despite the importance of public sector quality financial reporting requirement by PFM Act
(2012) there is limited research on the factors influencing quality of financial reporting in
Ethiopia public sector. The majority of the studies done earlier had focused on financial
reporting and financial regulations in the private sector entities hence creating a knowledge gap.
Therefore this study seeks to assess the factors influencing the quality of financial reporting in
the public sector entities in the health office of Wolaita Sodo.

1.3 Objectives of the Study

The general objective of this study is to determine the factors that influence quality financial
reporting in public sector entities in wolaita sodo health office.

1.3.1. Specific objectives

 To determine the influence of internal control system on quality financial reporting in public
sector entities in the health office of Wolaita Sodo.
 To assess the influence of International Public Sector Accounting Standards on quality
financial reporting in the public sector entities in the health office of Wolaita Sodo.
 To determine the influence of the existence of audit committee on the quality financial
reporting in the public sector entities, in the health office of Wolaita Sodo.

1.4 Research Questions

In order to determine the above objectives, the study will be guided by the following questions

 What is the influence of internal control systems on quality financial reporting in the public
sector entities in the health office of Wolaita Sodo?
 What is the influence of the adoption of International Public Accounting Standards on quality
financial reporting in the public sector entities of in the health office of Wolaita Sodo?
 What is the influence of audit committee existence on quality financial reporting in the public
sector entities, Ministry of Environment and Natural Resources?

1.5 Scope of the Study

The study will be determine the factors influencing the quality financial reporting of public
sector entities in the health office of Wolaita Sodo. The targeted respondents will be considered
appropriate because they possessed the information needed by the study based on their day to
day duties regarding financial management of their institutions.

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1.6 Significance of the Study
The study will be to contribute knowledge to Financial reporting in the public sector has not been
exhaustively studied. The findings of this study are valuable to future researchers and
academicians by acting as an empirical source besides suggesting areas for further research. This
study has suggested areas for further research where they can extend knowledge on.

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 CHAPTER TWO

2. LITERATURE REVIEW
2.0 Introduction
This chapter presents an assessment of literature review on what has been covered
by other researchers and analysts. The review aims to capture their views on the
subject matter being discussed and is aligned to the theme and objectives of the
study. The areas covered underpin both the theoretical and empirical aspects of the
study.
2.1 Theoretical Review
In this section, four major theories underpinning various aspects of financial
reporting are presented.
2.1.1 Agency Theory
The central idea behind the Principal-Agent model is that the Principal is too busy
to do a given job and so hires the Agent, but being not in the management the
Principal cannot monitor the Agent perfectly (Jensen and Meckling 1976). This
theory is basically a framework for analyzing the conflict of interest between key
stake holders in an organization and the mechanism of resolving such conflicts. In
connection with corporate governance, agency theory is relevant in every situation
where one party (the principal) delegates tasks to a manager (the agent) who
carries out the task.

The agency theory description is basically behavioral because corporations‟ don‟t

generally adhere to the maximization principle mainly due to conflicting interests
of major governing parties. The objective of this theory is to determine optimal
contract between the provider of resources and the manager. The agent maybe
overcome by self-interest, opportunistic behavior and fails to act as per the
principal’s expectations for the separation of ownership and control. The theory
therefore portrays the agent as individualistic and self-interested hence being
driven by bounded rationality where rewards and punishment take priority. It
prescribes that a good governance structure must exist to hold managers
accountable in their tasks and responsibility (Bowrin, 2008).

The problem arising from the principal-agent relationship may be extended by

hiding of information and unexplainable costs (Okungu, 2012).
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 Jensen and Meckling (1976) argued that agency problems bring forth to extra
agency costs that are designed to bring separation of ownership and control.
Agency cost is the sum of monitoring expenditures incurred by the principal to
monitor the performance of the agent. Agency theory has emerged as a dominant
model in the financial economics literature which widely discusses the financial
reporting and management practices in the public institutions. Owners and agents
have various means to invest in information systems and control devices to reduce
agency costs associated with information asymmetry.

These control devices might offer Pareto optimality (maximum gains for all
parties) since the agent would otherwise bear agency costs that occur when
principals discount the value of the firm, based on the likelihood of adverse
selection, and moral hazard. Management may use various means to indicate to
others the quality of the financial information they are providing is accurate and
credible. Demands for monitoring may result in external audits, strong internal
control system, the use of outside directors and audit committees (Agarwal, Goel
and Vashishtha.2014).
2.1.2 Stakeholders’ Theory
According to Ansoff (1965) the objective of an organization is to attain ability to
balance the conflicting demands of the various stakeholders in the organization.
Stakeholders of public sector entities financial reporting include citizens,
governments and its agencies, donors, lenders, creditors, employees, civil societies,
researchers and political bodies. The stakeholders‟ theory tends to explain the
structure, procedures and operations of public sector in preparation of financial
reports to meets the needs of various stakeholders (Monari, 2014).

Freeman (2008) describes the stakeholder theory as addressing the morals and
values that manages an entity. In the public sector stakeholders‟ theory provides
the basis for identifying the main groups and parties which constitute the external
users of the entity‟s services whether in private or public. The theory is a contrast
of Friedman (1962) work which stated that the only group that can have a moral
claim on the corporation is the people who own shares in the entity.

Marcoux (2000) also criticized the theory by stating that the obligations to non-
owners will constrain the of owners‟ interests. The argument was that so long as
the managers serve the interests of owners by making good contracts, obeying the
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existing laws of the land and adhering to ordinary moral expectations, there is no
harm in ignoring the non-owners. Stakeholders‟ theory has been praised for
overcoming the narrow view in the business world that the business is to maximize
economic value of the owners only (Freeman, 2008b).

When the management has stakeholders in mind their financial reporting will take
into consideration all areas that may be required by the stakeholders‟ to enhance
the awareness and justification why the organization exists (Argandona, 2011).

The public sector institutions have a duty to build confidence with its stakeholders
(the general public, the national government, employees, donors, civil societies,
and the researchers) through assurance of transparency and accountability of
quality financial reporting (Monari,2014). According to Smallman (2004), the
problem of the theory is to identify the genuine stakeholders of an organization.
Yet meeting stakeholders‟ needs may lead to mismanagement of the resources
which may affect the wealth of the shareholders.
2.1.3 Institutional Theory
An organization is designed and functions to meet social expectations in so far as
its operations are visible to the public (Scott, 2004). Therefore organizational
internal operations, which are often complex and difficult to identify, may take
second place to the issue of external legitimacy (Goodwin, 2004). It is suggested
that the external image of the organization may be “loosely coupled” with its
operating processes (Sterck and Bouckaert, 2006).

Institutional theory, suggests that organizational structures in such an environment

become symbolic displays of conformity and social accountability (Meyer, 2002).
Simultaneously, the real work of the organization is accomplished by internal
operating processes loosely coupled from the observable structures. Organizations
with the appropriate structures in place avoid in-depth investigations of their
operating core by external parties as the users develop confidence in their
management (Meyer, 2002).

This theoretical perspective has been applied to a wide set of social phenomena,
including choice of accounting methods (Meyer and Rowan 2006) the use of
accounting practices by public sector organizations and the adoption of effective
means of reporting (King et al., 1994).

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 The expectations from users that have crystallized about corporate governance
indicate the existence of an institutionalized environment that serves as the
threshold for the application of institutional theory asserting that the contribution
of institutional theory is in the insight that the actual accomplishments of an
organization and what its structure suggests it should accomplish are often
different. The organization operates with internal processes that are not normally
visible to external users, while other structures maintained for outsiders do not
significantly add to output.

According to Zamzulaila, Zarina and Dalila (2007) the scrutiny by outsiders can be
avoided if the right structures are adopted by organizations. The theory is
applicable to this study as the public entities are government institutions that are
expected to practice good governance and accountability to meet the expectations
of the external parties.
2.1.4 Stewardship Theory
The stewardship theory is traced back to the school of Sociology and Psychology
as an improvement from the works of the earlier researchers. It focuses on the
management as stewards in the organization contrary to the views adopted by the
Agency theory (Mallin, 2004).

It looks at the manager as an individual who provides protection to the resources

bestowed upon him by the owner which he does it through performance
(Cornforth, 2003). Performance of the business is actualized through profit which
is a motivating factor in the sense that the success of the organization in the
opinion of the manager is also an indication of his own success. This is because in
the view of the theory, he or she is part of the business. As a result, the stewardship
theory eliminates agency costs such as monitoring and control which comes about
because of management and the owner frictions (Daly et al. 2003).

Unlike the Agency theory, Stewardship theory is anchored on the value of trust.
Whereas the theory does not advocate for controls, there is need for accounting
structures to assist the manager oversee the proper utilization of resources under
his care. The steward works through people who will need systems, procedures and
tools to produce effective results pertaining to the owners resources.

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These procedures include all the controls put in place such as internal controls,
audit committees and adoption of accounting standards to enable the business
perform well (Mackenzie, 2007).

Stewardship theory also advocates for appointment of insiders as directors from

whose good knowledge of the organization helps improve the quality of decisions.
Prior researchers argue that it is more profitable to an organization when it has
more of the insider directors than outsider directors because of their knowledge
and skills which help the organization improve on performance which is lacking
from outside directors.
2.2 Empirical Review
In this section the study presents a review of studies done by others on the subject
and their findings on the various factors influencing quality financial reporting.
2.2.1 Internal Control and Financial Reporting
Internal control is defined in different ways by various authors, according to
AICPA(2015) defines internal control as a plan and other coordinated means and
ways by an organization to keep safe its assets ,check covertness and reliability of
data to increase its effectiveness and to ensure the settled management politics.
Chabugwen and Kwasira (2014)defines internal control as an executive process of
board of directors, management and employees to achieve purposes in efficiency
and effectiveness of operations, reliability of financial accountability and
observing laws and regulations of the government.

According to Afiah and Azwari (2015) internal controls have significant influence
in the achievement of the organization goals and financial performance. Financial
statements may be seen to be unreliable when there is a problem with internal
controls. According to (Spitzer: 2005) the development and maintenance of the
organization internal control help in ensuring accountability and accurate financial
reporting. Lack of proper internal control will result in unreliable records resulting
in low quality of financial reporting. An organization may lose most of its
resources when the internal control systems cannot properly show the reliable
records of its transactions (Chabungwen and Kwarisa, 2014).

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 Various studies (Chabungwen and Kwarisa, 2014; Afiah and Azwari, 2015)
established that internal controls influence the quality of corporate financial
reporting. Wattayapoom (2012), Premuroso (2012) found strong relationship
between internal controls and financial statements and finally affect the reliability
of financial reporting. Elbannam (2007) states that good implementation of internal
control significantly increase the capacity to meet the financial statements and the
quality of financial information they produce.

Altamoro and Beatty (2010) found that through continuous monitoring and internal
check there is improvement of financial reporting in the banking industry.
Mahmud (2007) also found out that in order to produce reliable financial reports
for local governments, the quality of internal control must be very high. Whereas
internal controls play an important role in defining order, direction and consistency
of organizations, their application is dynamic and must be frequently reviewed to
make them more effective otherwise they may not bring the desired results for the
organization.

2.2.2 Audit Committees and Financial Reporting

Private sector was the first to establish audit committee to strengthen oversight of
the financial and ethical integrity of public companies. In the last two decades
audit committees were noted as key mechanism in strengthen corporate
governance globally. At the beginning audit committees were non-mandatory by
the companies but in recent years professional and regulatory institutions all over
the world have recommended the universal adoption and the expansion of their
roles (ICPAK 2015).Audit committee was first introduced in Kenya in 2000
through National Treasury circular No.AG/3/080/6/(61) of 8th August
2000,establishing Ministries Audit Committees. The performance of the ministerial
audit committees could not be felt due to lack of independence and objectivity
(ICPAK 2015).s The GoK circulars of 2005 mandated the Audit committees to
perform the following functions;(a) assist the accounting officer in enhancing
internal controls in order to improve efficiency, transparency and accountability (b)

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review audit issues raised by both internal and external auditors (c) resolve
unsettled and unimplemented Public Accounts and Investment committees (d)
enhancing communication between management, internal and external audit and
fostering effective internal audit function.

Audit committee expertise is where the committee members have different level
of accounting, financial management expertise and relevant knowledge in the
related field. DeFond, Ham, and Hu, (2005) in their investigation noted that market
reacted positively with the appointment of members in the committee having
accounting and financial background. During the appointment stage the board
should consider the members with appropriate qualifications, knowledge, skills and
experience to enhance professionalism in performing their duties ICPAK (2015).

The members should be financially literate for proper understanding and

interpretation of financial statement and risk management mechanisms.
Accounting and financial management related as qualifications and comprehensive
accounting and auditing standards, public sector understandings would be
appropriate. Carcello, Hollingsworth, Klein, and Neal (2006) in their study on the
association between financial expertise and earning management proxy abnormal
accruals found that accounting and financial expertise are consistently associated
with less earnings management. Dhaliwal, Naiker, and Navissi (2010) in their
investigation on the association between accrual quality and the characteristics
accounting experts found that there was positive relationship between accounting
and financial expertise in audit committees and financial reporting quality.
Madawaki and Amran (2013), when studying how audit committees affect
financial reporting in Nigerian companies the researchers found significant positive
relationship between audit committees with members having accounting and
financial expertise and improved financial reporting quality. Audit committees
whose members have financial expertise was found to interact frequently with
internal auditors of the firms that help in reducing internal control problems
(Raghunandan, Read,and Rama,2001).

Their understanding on financial matters help them in supporting external auditors

in their reports and implementation of the areas noted in the audit reports. On the

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other hand, Yang and Krishnan (2005) and Lin et al. (2006) could not get any
significant association between financial expertise and financial reporting quality
measured as the level of earnings management.

On the other hand the scope of reports generated by audit committee form the
basis of the committee‟s effectiveness when it communicates to the board,
management and stakeholders. IIA Standard 2060 states that audit committee must
report periodically to senior management and the board on its activity‟s purpose,
authority, responsibility, and performance relative to its plan IIA (2014). The IIA
explains that audit committees can greatly strengthen the independence, integrity,
and effectiveness of government audit activities through independent oversight of
both internal and external audit work plans and results EU (2014).

Reporting must include significant risk exposures, control measures, governance

issues, fraud risks and other matters requested by the management and the board.
The IIA (2014) states that audit committees play pivotal role in strengthening the
independence, integrity, and effectiveness of government audit activities by
providing oversight of internal and external audit work plans and result reports to
the board of management. The committee ensures that all audit reports presented
are acted upon, any recommended improvements or corrective actions are
addressed and resolved promptly.

Therefore it is imperative to note that effective audit committee characteristics

such as number of members with accountancy and financial management expertise,
and periodic reports are critical in determining the quality in the financial reporting
(Ball et al.2000; La Porta et. 2000; Leuz et al.2003).
2.2.3 Adoption of IPSAS and Financial Reporting
According to the International Federation of Accountants, IFAC (2009), IPSAS are
high quality financial reporting standards applicable in the public sector reporting
that takes care of public interest in presentation and disclosure of financial
transactions that enhances the accountability and management of public resources.
IPSAS was born out of the far reaching effects of global financial crisis where
many governments‟ accountability and transparency in the reporting of assets and
liabilities were put under question.

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Therefore IPSAS was adopted in order to help improve on the processes and to
avoid future crises. Bergmann (2011) argues that the 2008 financial crisis was an
eye opener from the fact that financial reporting systems of many governments
were unable to anticipate the problem in good time which reduced the level of
accountability in the public sector. Therefore IPSAS was considered the best
solution because of its comprehensive reporting framework that regulates the
recognition, measurement, presentation and disclosure requirements in the
financial statements (Ernst & Young, 2012).

2.2.4 Government Laws and Regulations and Financial Reporting

Government and its agencies will constantly influence the preparation of financial
statements by issuing regulations, policies, circulars and relevant guidelines to
public entities in directing how public resources are managed and accounted for.
Through the adoption of a new financial requirement, government authorities issue
laws and regulations guiding the auditors, accountants and the management of the
entities on financial statements and audit reports (Nkwagu, Uguru, and Nkwede,
2016).

According to Okafor (2012) relevant laws, regulations, policies and circulars guide
the public sector accounting in Nigeria by ensuring that prudent management of
public funds and the auditing the same funds. Financial regulations act as a
monitoring tool for the government where the institutions must implement to
maintain the integrity of the financial system. The regulations from the government
play important role in the Institution financial system only if the internal controls
are strong and the oversight role is done effectively by audit committee (Kimathi
2010).

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