CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Internal controls have been in place since the start of history. There existed a parallel administration in Hellenistic Egypt, with one set of officials entrusted with collecting taxes and the other with monitoring and controlling them. The Control Yuan (Pinyin: Jiancha Yuan), one of the five departments of government in the Republic of China, is an investigative agency that oversees the other branches of government. Mismanagement has wreaked havoc on Nigeria's banking industry on multiple occasions, arising from either non-observance of management and regulatory bodies' established principles and policies (internal control systems) or the lack of such systems. Whatever the case may be, every organization, not just banks, must implement an efficient and effective internal controls measures to safeguard their assets from potential losses resulting from misappropriation of funds, misuse and vandalism of company property, expropriation, and mistakes made by inefficient and inexperienced personnel. Internal controls, according to Abdul (2019), are analogous to the central nervous system of a human being, whose breakdown, according to medical experts, would end in the perpetrator's death. In this way, the failure of an organization's internal controls system results in its extinction or distress. As a result, prudent and proactive businesses devote a significant percentage of their resources to ensuring the establishment of an adequate and effective internal control system.
Internal control is defined by the Institute of Chartered Accountants of England and Wales as "the entire system of control created by management in order to carry on the business of the organization in an efficient and orderly manner, to safeguard its assets, and to secure the accuracy and reliability of its records to the greatest extent possible." Internal controls establish a baseline for the amount of work required of the experts assigned to the role, since they are expected to maintain the security of the organization's money, efficient and effective asset management, and the accuracy of financial statements at all times. Though internal controls systems cannot completely eradicate errors and irregularities, they are meant to alert management to possible problems so that they can be addressed before they become major issues. However, the efficiency of an established internal control system should be assessed on a regular basis to provide management with some assurance. The effectiveness of an internal controls system can only be determined if all of its components are present and functioning properly for operations, financial reporting, and compliance. The board of directors and its audit committee are responsible for ensuring that the organization's internal controls system is adequate. Internal and external auditors are involved in the evaluations, and this task involves establishing the extent to which internal controls are examined.
Internal controls are procedures put in place by an organization's management to guarantee that goals are met. An organization's internal control system functions similarly to the human nervous system, spreading throughout the hierarchy to carry out directives at various levels. Internal controls in government institutions, often known as management policing, are critical to maintaining public trust. This is accomplished by putting a check on the custodians of public funds on a regular basis. As a result, businesses must build effective and efficient control mechanisms to ensure that the entire organization's operations and day-to-day activities comply with specified rules and regulations.
In this respect, the Internal Control System (ICS), of which the Internal Audit function is a key component and one of the devices in any control mechanism, must be authorized to report serious issues to management for rectification and informed decision-making. Various control mechanisms have been built by sub-regional African countries in recent years to integrate new concepts aimed at bringing in improved procedures in government services in general.
Introduction Following worldwide financial reporting and accounting crises in both developed and developing countries, internal control systems have become a hot topic (Mattie & Cassidy, 2002). Internal control, according to the Treadway Commission's Committee of Sponsoring Organizations (2004), is a system comprising of particular rules and processes meant to give management with dependable confidence that the entity's goals and objectives will be completed on time. Internal controls, they believe, are necessary to improve operational effectiveness and efficiency, provide reliable financial and administrative information, secure assets and records, and promote adherence to prescribed rules and regulatory compliance. As a result, internal control components like the control environment, control activities, risk assessment, information and communication, and monitoring and evaluation will aid operational effectiveness and efficiency.
Internal control is also assumed to be the domain of accountants and auditors, whose principal role is to control, safeguard management assets, and report to management. This is part of their stewardship role in the management of government resources. Managers are essential components of internal control because of their activities, policies, communicating, planning, implementing, overseeing, and monitoring (Arens, 2006).
In today's economic context, protecting a company's (or institution's) commercial and financial information is a common activity, with internal control systems being the most prevalent word for the activities. Although these operations are not new, the name "internal control system" is not. Internal control systems enable firms to provide stakeholders with accurate financial reports, comply with laws and regulations, and run more efficiently and effectively. Many public universities, including Burao University, have been found to be deficient in accountability as a result of inadequate or non-existent internal control systems, as well as a reluctance to recognise and assume responsibility for activities taken within the scope of a job or position. The phrase "internal control system" was coined by the American Institute of Accountants in 1949 to describe a procedure including curators/regents/directors, management, and other people and aimed to provide reasonable confidence over the attainment of objectives in the following areas: (1) Operational effectiveness and efficiency; (2) financial reporting dependability; and (3) compliance with applicable rules and regulations. Various scholars have defined internal control systems, but Banerjee (1997) defined it as the entire system of control, financial or otherwise, established by management in order to carry out an organization's business in an orderly and efficient manner while ensuring that assets are safeguarded and reports are accurate, complete, and reliable. Internal control, according to COSO (Committee of Sponsoring Organizations of the Treadway Commission), (1992), consists of five fundamental components: The (1) control environment is likely the most essential component since it sets the tone for the organization. (2) Risk assessment is the detection, analysis, and management of uncertainty in an organization. (3) Control activities comprise an organization's policies and procedures for dealing with risk-prone regions; (4) Information and communication includes the prompt identification, capture, and exchange of financial, operational, and compliance information; and (5) Monitoring refers to the evaluation of the effectiveness of internal control systems. Since the 1990s, accountability has been a widespread phenomenon in many public sectors, including higher education. It is considered to be the major purpose of external quality processes. Accountability has been a widely used term in various public sectors, including higher education, since the 1990s. It is regarded as a primary goal of external quality processes. Accountability is described as the process by which institutions and individuals are expected to demonstrate compliance with their responsibilities, including the responsible use of public monies (Cambell and Rozsnyai, 2002). In other words, Wojtczak (2002) defined accountability as "the responsibility for decisions and the ability to explain to others or the public all undertaken activities to carry out what was required to be done; to ensure reaching or making progress toward planned objectives or targets." Carmen et al. (2004) describe accountability as the requirement of those in positions of power (resources) to account for or accept responsibility for their actions and the resources at their disposal by establishing an effective and efficient organization. In this study, accountability refers to the acceptance and assumption of responsibility for activities taken within the boundaries of a function or position, including the requirement to report and be accountable for the consequences.
According to Sebbowa (2009), he opined “Financial performance is the ability to operate efficiently, profitability, survive, grow and react to the environmental opportunities and threats”. Hence,the Ray and Kurt’s definition of internal control systems was culled for this study.Basically, the course studyof Internal control Systems are wide, lengthy and numerous. For thisreason, the study, Internal control systems will be narrowed to; the Control Environment, Internal Audit, and Control activities whereas financial performance will be looked at basically from the three perspectives of Liquidity, Accountability and Reporting (Donald and Delno 2009). The argument, good internal control yields good business has made organizations invest heavily in improving the quality of their internal control systems.Also, there are required reports by many organizations on the quality of internal control over financial reporting, riveting them to develop specific support for their certifications and assertions. Hence, there are five objectives that helps management in designing effective internal controls, this includes: maintaining reliable systems, ensuring timely preparation of reliable information, safeguarding assets, optimizing the use of resources, preventing and detecting error and fraud (Alvin et al, 1993). The authenticity of financial reporting is adequate for internal control efficiency to ensure that transactions and bookkeeping are in line and properly authorized, valid, correctly recorded, complete, and prompt. Moreover, as stated by Sebbowa (2009), it is very important that organizations have fairly summarized accounting information data disclosure (x). Nonetheless,in a quality reporting is affected by internal control mechanism. There is a general ideology that institution and enforcement of proper internal control systems will continuously lead to outstanding financial performance. It is also a popular belief that properly instituted systems of internal control improve the reporting process and thereby give rise to reliable reports which enhances the accountability function of management of an entity. Dixon et al (1990), said appropriate performance measures are those which enable organizations to direct their actions towards achieving their strategic objectives. Internal control makes certain effectiveness and efficiency of operations, reliability of financial reporting and compliance with applicable laws and regulations to which the company is subject. A sound internal control system helps the firm to prevent frauds, errors and minimize wastage Mawanda (2008). The increase of business units has encouraged the use of internal control as it ensures orderly and efficient conduct of business including adherence to internal policies.
The completeness and accuracy of accounting records, timely preparation of financial information, can only be achieved if the proper internal control system is in place. According to (Ndungu, 2013), the institution’s ability to maximize its profit, depends in part on the design and effectiveness of the processes and safeguards it has put in place over accounting and financial reporting. While no practical control system can absolutely assure financial reports will never contain material errors or misstatements. An effective system of internal control over financial reporting can substantially reduce the risk of such misstatements and inaccuracies in company’s financial statements (Kaplan, 2008).
Internal control is also defined by Saleemi (2008) as the entire system of controls, financial and otherwise, established by management in order to carry out the enterprise's business in an orderly and efficient manner, safeguard the assets, and ensure the completeness and accuracy of the records to the greatest extent possible. For any internal control system to meet organizational goals, the components discussed below must be present and functioning properly (COSO 1994). The control environment is the most important part of running a business. The reason for this is that it reflects management's attitude and practices on the relevance of internal audit in the economic unit, according to Theofanis et al (2011). It is, nevertheless, the fundamental basis for the other elements of the system and provides structure, according to Sudsomboon and Ussahawanitchakit (2009). The control environment also helps to reduce the level of fraudulent activity within an organization's operations. The function and quality of an entity's control environment also influence the quality of its internal controls system, according to Amudo and Inanga (2009). As a result, providing an appropriate control environment for a public institution is critical to its effectiveness.
Theofanis et al.(2011), define risk assessment as the identification and analysis of relevant risks connected with the attainment of management objectives. Likewise, Risk assessment, according to Sudsomboon and Ussahawanitchakit (2009), is the process of determining and assessing management-relevant risks to the creation of financial statements that are presented fairly in compliance with Generally Accepted Accounting Principles. Management must carefully identify the level of risk that may be accepted and must strive to keep such risk within acceptable limits. As a result, public institutions must assess the level of risk they are facing on a regular basis in order to take the necessary actions. Control activities are rules, protocols, and systems that ensure management's instructions are performed correctly (Aikins, 2011; Rezaee, Elam & Sharbatoghlie, 2001). In these areas, proper attestation of policies and procedural guidelines aid in determining not only how control activities are to be carried out, but also give adequate information for auditors to examine the overall appropriateness of control design over financial management operations (Aikins, 2011). These control activities ensure that all necessary steps are completed with the goal of addressing risks and achieving corporate goals. Delegation of authority, daily deposit of cash receipts, bank reconciliations, and limiting access to check stock are all examples of control activities. The process of discovering, recording, and conveying essential information in a timely and appropriate way in order to meet financial reporting goals is referred to as information and communication (Aldridre & Colbert, 1994). Effective communications, according to Theofanis et al. (2011), should occur in a broader sense with information within the various divisions of the organization. Because of their relevance in affecting the work relationship within the business at all levels, most current literature on internal control system frameworks has focused on information and communication as one of the internal control system elements (Amudo & Inanga, 2009).
As a result, such knowledge must be disseminated throughout the organization in order for employees to fulfill their roles in terms of achieving objectives. Internal control systems are commonly considered to require proper monitoring so as to evaluate the quality and efficacy of the system's performance over time. Monitoring ensures that the results of audits and other evaluations are established quickly. Theofanis et al, (2011) also mentions that monitoring activities ensures the internal controls system's effectiveness (Amudo & Inanga, 2009). As a result, monitoring assesses if management-designed and executed policies and processes are being carried out properly by personnel.
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