FINANCIAL IMPLICATION OF INTERNAL CONTROL SYSTEM IN AN ORGANISATION

(A Case Study of Mercury Microfinance Bank)

ABSTRACT

Internal control systems is a topical issue following global fraudulent financial reporting and accounting scandals in both developed and developing countries.

This research work examine the implications of internal control system in an organization with reference to Mercury Micro Finance Bank. In today’s volatile business environment, banking sub-sector in Nigeria faces a wide array of complex business challenges. These challenges come in the form of regulatory compliance, litigation, competitive market pressure, changing technology, investors demand, corporate governance, business ethics and accountability.

The research examine the various types of internal control and the components of internal control. A questionnaire was designed and administered to the staff of Mercury Micro Finance Bank. The data gathered from the questionnaire were presented on table with the respective percentages. The formulated hypotheses were analysed with the used of Chi square statistical tool. From the analysis it was concluded that;

·        Effective internal control system make fraudulent practices and other incidences of irregularities very difficult to perpetrate.

·        Constant review of accounting and internal control system will reduce incidence of fraud and irregularities in Microfinance banks.

·        The internal control system currently in operation at Mercury Microfinance Bank is inline with the International Accounting Standard (IAS).

Conclusion was deduced from the result of the analysis and recommendations were made.

TABLE OF CONTENTS

CHAPTER ONE

INTRODUCTION

1.1     Background of the Study       

1.2     Statement of Problem

1.3     Aim and Objectives of Study

1.4     Research Question        

1.5     Statement of Hypothesis

1.6     Research Methodology

1.7     Significance of Study

1.8     Scope and Limitation of Study        

1.9     Definition of Terms

CHAPTER TWO

LITERATURE REVIEW

2.0     Introduction        

2.1     Definition of Internal Control 

2.2     Purposes of Internal Control System

2.3     Types of Internal Control

2.3.1  Directive or Entity Level Controls   

2.3.2  Preventive Internal Control

2.3.3  Detective / Corrective   

2.3.4  Compensating Control

2.4     Components of the Internal Control System

2.4.1  Definition of Responsibilities 

2.4.2  The In-House Dissemination of Relevant and

          Reliable Information     

2.4.3  A System for identifying and Analysing Risk

2.4.4  Control Activities

2.4.5  On-Going Monitoring of the Internal Control System  

2.5     internal Control Players

2.5.1  The Board of Directors or the Supervisory Board

          (“The Board”)     

2.5.2  Executive Management / The management Board

2.5.3  Internal Audit      

2.5.4  Company Staff    

2.6     Conceptual Framework

2.6.1  Control Environment    

2.6.2  Risk Assessment 

2.6.3  Control Activities

2.6.4  Application Controls    

2.6.5  Information and Communication     

2.6.6  Monitoring

2.7     Effective Internal Control

          References

CHAPTER THREE

RESEARCH METHODOLOGY

3.1     Introduction        

3.2     Sources of Data

3.3     Population and Sample Size   

3.4     Research Instrument Design   

3.5     Administration of Research Instrument

3.6     Analysis of Data

3.7     Methodology

CHAPTER FOUR

DATA PRESENTATION AND ANALYSIS

4.1     Introduction        

4.2     Personal Characteristics of the Respondent

4.3     Response of Respondents of the Problem Areas

4.4     Testing and Interpretation of the Hypothesis

4.4.1  Test of Hypothesis One

4.4.2  Test of Hypothesis Two         

4.4.3  test of Hypothesis Three        

CHAPTER FIVE

SUMMARY, CONCLUSION AND RECOMMENDATION

5.1     Introduction

5.2     Summary   

5.3     Conclusion

5.4     Recommendation

          References

          Appendix

CHAPTER ONE

INTRODUCTION

1.1     BACKGOUND OF THE STUDY

When companies suddenly collapse, the often resounding question is, “what went wrong?” Abreakdown in the internal control system is the usual cause. Internal control is a process that guides an organization towards achieving its objectives. These objectives include operational efficiency and effectiveness, reliability of financial reporting, and compliance with relevant laws and regulations (COSO 1992). Absence of these variables often results in organizational failure. The findings of the Treadway Commission Report of 1987 in the United States (USA) confirmed absence of, or weak, internal controls as the primary cause of many cases of fraudulent company financial reporting.

The widespread global corporate accounting scandals that assumes near epidemic proportionsin recent years inform this study. Cases of accounting scandals have been recordedInternational Research Journal of Finance and Economics - Issue 27 (2009) 125in JCI and Randgold and Exploration companies. In Nigeria, the Managing Director and ChiefFinancial Officer of Cadbury Nigeria plc were dismissed in 2006 for inflating the profits of thecompany for some years before the company’s foreign partner acquired controlling interest.

These scandals emphasize the need to evaluate, scrutinize, and formulate systems of checks andbalances to guide corporate executives in decision-making. These executives are legally and morallyobliged to produce honest, reliable, accurate and informative corporate financial reports periodically.

The banking industry is a very important subsector of the financial services of any economy. For effective operation and to beable to render a good stewardship to the operations of a bank, it isimperative that there should be reliable accounting and internalcontrol system. The effectiveness of accounting system of any organization depends on the manner and methods used in therecording of financial transactions, which must be in agreement withthe International Accounting Standard,(IAS) regulations.

Installation of an effective accounting and internal control system is compulsory for every banks especially the Microfinance Banks. If proper records of accounts are not be given to the shareholders and other users of accounting information. This may therefore leads to shareholders, customer, and general public not having confidence in the operation of Microfinance Banks.

There must be a periodic review of the accounting andinternational control system of Microfinance Banks from time to time toensure proper reporting and accounting.Proper keeping of accounting records will enable themanagement to determine whether or. not the firm is operating at a profit. If there is constant review of accounting and internal controlsystem, it will prevent fraud/mismanagement of funds.

1.2     STATEMENT OF PROBLEM

Most Microfinance Banks do not have proper books of accounts and the accounting records of some Microfinance banks in Nigeria are inefficient and unreliable. Also, some of these Microfinance banks have collapsed and closed for business due to improper keeping of records and maintain adequate internal control system.

This research study will provide suggested solution to the above problem and if followed, will ensure proper accountability.

1.3     AIM AND OBJECTIVES OF STUDY

The aim of this research work is to evaluates the financial implication of internal control systems with spcial reference to Mercury Microfinance Bank. The obecjectives includes:

·        Ascertains whether the internal control system provide adequate internal framework of checks and balances of the fund of Microfinance banks.

·        To investigate whether the internal control system currently in operation at Mercury Microfinance Bank is inline with the International Accounting Standard (IAS).

·        Investigate if the internal control system has ever been compromised and led to a negative financial implication.

·        Find out how they could overcome the negative financial implication caused by the poor internal control system.

·        To find out whether books of account are kept by Microfinanace banks as required by statute.

The research work will also look into the methods and systems of accounting to be adopted for day - to – daytransaction and means of installing and effective internalcontrol system, and  also provide recommendation to solving various Internal control systems in Microfinance banks.

1.4     RESEARCH QUESTIONS

These objectives raise a number of questions, that requires answers in a later chapter of this research work. Themajor question is whether or not the established internal control systems in Mercury Microfinance bank are effective. Thisraises the following minor but inter-related questions:

·        What role should internal control system play Microfinance banks?

·        Does application of internal control system has any financial implication on Microfiinance banks?

·        Does management of Microfinance banks appreciate, understand, and clearly respond to this rules?

·        What internal control systems are currently in use?

·        Do they include all the expectedelements of internal control systems?

·        Are internal control systems of Microfinance banks adequately documented and regularly updatedas changes occur?

·        Is Internal control system really useful on organization’s profit maximization decision making process?

Answering the research questions requires use of research methods to address the concernsraised. A later section of this chapter discusses the methods selected and the justification ofthe study.

1.5     STATEMENT OF HYPOTHESES

To provide answer to the research questions arising from this study, the following hypotheses are postulated.

Hypothesis One

Ho:    Effective internal control system does not make fraudulent practices and other incidences of irregularities very difficult to perpetrate.

H1:    Effective internal control system make fraudulent practices and other incidences of irregularities very difficult to perpetrate.

Hypothesis Two

Ho:    Constant review of accounting and internal control system will not reduce incidence of fraud and irregularities in Microfinance banks.

H1:    Constant review of accounting and internal control system will reduce incidence of fraud and irregularities in Microfinance banks.

Hypothesis Three

Ho:    The internal control system currently in operation at Mercury Microfinance Bank is not inline with the International Accounting Standard (IAS).

H1:    The internal control system currently in operation at Mercury Microfinance Bank is inline with the International Accounting Standard (IAS).

1.6     RESEARCH METHODOLOGY

Data for this research will be sourced from both Primaryand Secondary source of data.Primary data will supply first hand information in form ofQuestionnaires and oral interviews. . The distribution of the questionnaires will be limited to only the staff of Microfinance banks.

Secondary data will be sourced from review of literature, textbooks, journals and magazines. It will also be source fromstatutory books relevant to the banking operations.

In this study, descriptive method will be used to present data and also in testing hypothesis, chi-square (X2) will be employed.

1.7     SIGNIFICANCE OF STUDY

Corruption is prevalent and transparency often lacking in the Nigeria banking industries including the Microfinance banks. Corporate accounting scandalsoccur where the systems of internal controls are abused by those responsible for their operationaleffectiveness. The Corruption Perceptions Index (CPI) 2006, compiled by Transparency Internationalcovering 163 countries, reveals that majority of the African countries in the index scored within thelow range of 1.9 - 3.6. Not more than five African countries scored within the range of 4.1 - 4.6. Incontrast, majority of the European countries scored between 7.4 and 9.6. The Corruption PerceptionsIndices suggest a prevalence of corruption in African countries.

These issues further justify thisstudy that focuses on Microfinance banks in Nigeria. The study investigates whether the controls used fordirecting, controlling and governance of Microfinance banks in Nigeriaare effective to ensure optimalutilization of funds.

1.8     SCOPE AND LIMITATION OF STUDY

The premise on which this study is based is, Financial Implication of Internal Control System in Microfinance banks with special reference to Mercury Microfinance Bank. The study will ascertains whether the internal control system provide adequate internal framework of checks and balances of the fund of Microfinance banks.

The study will further identify the fundamental limiting factors that could hinder complying with internal control system of Microfinance banks

Limitations

In the course of conducting this research work it is expected that the following will constitute impediments to the effective conduct of the study

a)       Time constraint within which the study must be completed.

b)      Financial constraint

c)       Inaccessible and inadequate data

d)      Also, combining project work with several other activities is another stressful task that may not allow me to cover research materials extensively.

Nevertheless, I believe the above limitations will in no way affect the reliability and validity of the research study.

1.9     DEFINITION OF TERMS

INTERNAL CONTROL: An accounting procedure or system designed to promote efficiency or assure the implementation of a policy or safeguard assets or avoid fraud and error etc.

INTERNAL CONTROL SYSTEM: An Internal Control System (ICS) is the part of a documented quality assurance system that allows an external certification body to delegate the periodical inspection of individual group members to an identified body or unit within the certified operator

FINANCIAL MANAGEMENT: The management of the finances of a business / organisation in order to achieve financial objectives

OPERATING GOALS:At the heart of operations are the systems and processes that keep information moving through a business and provide structure for those doing the work

RISK ANALYSIS:A procedure to identify threats & vulnerabilities, analyze them to ascertain the exposures, and highlight how the impact can be eliminated or reduced.

RISK MANAGEMENT:The process of identification, analysis and either acceptance or mitigation of uncertainty in investment decision-making.

INTERNAL AUDIT: Frequent or ongoing audit conducted by a firm's own (as opposed to independent) accountants to  monitor operating results,  verify financial records, evaluate internal controls,  assist with increasing efficiency and effectiveness of operations and, to detect fraud.

CONTROL ACTIVITIES: Control activities are the policies and procedures that help ensure management directives are carried out

CONTROL ENVIRONMENT: Actions, policies, values, and management styles  that influence,  and set the tone of a firm day-to-day activities

MONITORING: Monitoring is the assessment of internal control performance over time; it is accomplished by ongoing monitoring activities and by separate evaluations of internal control such as self-assessments, peer reviews, and internal audits.

---

---