CHAPTER ONE
INTRODUCTION
1.1 Background of the Study
Internal control systems play a vital role in achieving the objectives of an organization; it is a very fundamental component of the risk management systems. It can be applied to several parts of a business whether strategic, financial operational and compliance. Adeoye (2014) opined that internal control system is a topical issue following global fraudulent financial reporting and accounting scandals in both developed and developing countries. Internal control system is the process designed, implemented and maintained by those charged with governance, management and other personnel to provide reasonable assurance about the achievement of an entity’s objectives with regards to reliability of financial reporting, effectiveness and efficiency of operations, and compliance with applicable laws and regulations. Benjamin (2012), also explained internal control system as the whole system it control, financial and otherwise, established by management in order to carry on the business of the enterprise in an orderly and efficient manner.
For any organization to maximize its finances and safeguard its assets, it must be able to manage its business processes which is one reason why internal control system is very crucial. Operating a business entity is a full time job that requires the skills and resources of several individuals. Business owners must organize an accounting system, information technology and an efficient system of communication between employees and customers. The strength of each system directly affects the financial success of a business entity. An understanding of internal control and its components allows business owners to structure an organization in a way that promotes growth and discourages confusion.
A successful system of internal control is not built overnight, but is an ongoing process of fine tuning the inner workings of an organization. (Financial Reporting Council, 2014) reported that internal control system ensures that both the accounting and administrative activities are in order with the laid down procedures, standards and statutory requirements, it also detects deviation if any and calls for immediate corrective measure.
Internal control system comprises not only internal check and internal audit but the whole system of controls, financial and otherwise, established by the management in order that activities of the organization are conducted in an efficient and well ordered manner.
It is the responsibility of management to establish controls to: safeguard its assets, ensure reliability of records, promote operational efficiency, and monitor adherence to policies and directives.
It is a system that increased efficiency and makes the perpetrating of fraud more difficult. It also makes easier and more likely the early detection of both errors and fraud. The existence of internal control system in an organization is of great assistance to both the management and the auditors of such an organization,not only does it aid the management in the process of decision making, but, also providea basis upon which the auditors place reliance when carrying out audit. With a sound knowledge of the system of internal control operation in a firm, one can easily make a valid judgment on why a firm failed or succeed in its business within the period under review.
The method of procedures adopted by a business to control its operations provide the management with an assurance that the data available are authentic and factual. Such system of control comprise measures taken by an organization for the purpose of protecting its resources against waste and fraud, ensuring accuracy and reliability of accounting and operating data, seeming compliance with company’s policy and evaluating the level of performance in all the sections of the company. In the words of Meigs (2010) the basic principle of internal control isthat no one person should handle all phases of transaction from beginning to the end. Meigs made it known that when business operations are organized, that two or more employees are required to participate in every transaction; the work of one employee gives proof of the accuracy of the work of another.
The primary aim of any business organization is to achieve a maximum profit at a minimum cost. This is made possible by internal control system which acts as a canopy section of an organization. This type of control existing in a firm therefore plays a very important role in the sense that it helps in the efficient conduct of the firm’s business. Internal control has been defined by the Institute of Chartered Accountant of England Wales (2001) as the wide system of controls, which involves financial and asset established by management in order to carry on the business of the enterprise 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. It could be inferred from the above definition that internal control system embraces other controls such as internal check and internal audit which operates by appraising and reputing the effectiveness of other control. This will minimize errors, fraud and ensure the presentation of accurate and reliable data. The internal control structure of a company consists of the policies and procedures established to provide reasonable assurance that specific entity objectives will be achieved. In small scale business organizations, generally, the owner manager controls the total activities of the business by personal supervision and direct participation. For instance, the owner generally purchases required business materials and other properties. Gives appointment of employees, completes the contract with them through discussion and also keeps constant watch over their activities, signs cheques for payments in different heads. Being the one signing all the cheques, it will enable him easily have an idea what commodities, assets and services is being signed for.
But with the expansion of business, the appointment of additional employees and officers is needed and the scope of business also widens. Under such condition, it becomes almost impossible on the part of the manager to perform all the activities of the business alone for which willlead to delegate authority and so overall control tends to decrease. In the light of these, it became imperative that the manager adopts policies and plans aimed at ensuring proper execution of business activities which is termed internal control system.
The American Institute of Certified Public Accountants (AICPA),(2010) says; the plan of organization and all of the co-ordinate methods and measures adopted within a business safeguard its assets, check the accuracy and reliability of its accounting data, promote operational efficiency and encourage adherence to preserved managerial policies.
According to Committee of Sponsoring Organization of Treadway Commission (CSOTC), (2014) there are four components of an internal control system which will certainly lead to effectiveness of internal control system in small scale business organizations in IkotEkpene Local Government Area, AkwaIbom State. Among them are control environment, risk assessment, information and communication and monitoring.
         Control environment simply means controlled environment of the entity in which operations of the business are carried out. It is this control environment that keeps anyone in the entity from committing any wrong doing. For example, if management is honest and encourages honesty and is strict towards falsehood then employees would expect harsh consequences and only this will keep the employees away from committing any fraud individually or in collusion with others. Another fact here is that the control environment supplements the other functions (components) of internal control system. An auditor is required to obtain understanding whether such environment has been developed by management through its management philosophy and behaviour in the entity.
Jones and George (2009), maintained that, the control environment is arguably the most important component because it sets the tone for the organization.Factors of the control environment include employees’ integrity, the management’s philosophy and operating style and the attention and direction of the board of directors and its audit committee. The control environment provides discipline and structure for the other components. Management must be fully aware of the need to have functional, flexible and operational internal control system.
Risk assessment is one of the very roles of internal control system as it aimed at presenting, identifying and correcting misstatements. However, entity would not wait for misstatement to happen, it should be prevented, detected and corrected. Most of the time, entity established its own risk assessment process to identify the risk of material misstatement to happen before time. Auditor obtains understanding of how entity’s risk assessment process is, whether it is working as per expectations in the light of business risk or not by considering:effects of such risks, likehood that risk will realize,decisions taken to curtail such risks.
Kan (2013) confirmed that internal control will vague and incomplete without properly integrating risk assessment into other business processes of a business. For example, managementare inclined to accept only projects with low risk in comparison with other business opportunities.
         According to Gray and Manson (2011), effective information and communication channel is both the live blood and the medium of any meaningful internal control system you can ever have. Remove effective communication of information and watch all the efforts that have been put into building a sustainable investment crumble to the ground. During audit engagement, auditor gains understanding regarding the information and communication system of the entity that acts as one of the component of internal control system. However, information system does not only mean the accounting system; it is the system through which entity or to be precise management establishes and communicates within and outside the entity.
The last component of an internal control system is monitoring process. It can be considered as an inbuilt service to the internal control system that assesses to effectiveness of internal control system. Kwok (2008), maintained that without effective monitoring, controls would become counter productive. What is the point putting measures in place when they are not actually monitored to see if stipulated procedures are been followed.Such evaluations may consider external information for example customer feedback. In the light of such information management or those charged with governance take necessary steps to keep the internal control system up to the mark so that risk of material misstatement is dealt appropriately and updates of the system are done as and when necessary. Based on the aforementioned background, the success or failure of an enterprise depends to a large extent on effective evaluation of internal control system. This informs the reason the researcher embarked on this study to assess the effectiveness of internal control system in small scale business organizations in IkotEkpene Local Government Area, AkwaIbom State.
1.2 Statement of the Problem
Internal control system is a system which comprise the plan of organization and all the coordinate methods and measures adopted within a business to safeguard its assets, check the accuracy and reliability of its accounting data, provide operational efficiency and encourage adherences to the prescribed management policies.
Small scale businesses constitute the main stabilizing force in the Nigeria Economy. Small scale businesses are the principal catalysts of economic development which constitute the major backbone of economic advancement of IkotEkpene Local Government Area, AkwaIbom State. The present and future economic advancement of IkotEkpene Local Government Area AkwaIbom State lies in the dynamism and growth of small scale businesses. Ayan (2010), opined that small scale business are essential to the development of any economy as theyposses great potentials for employment, improvement of local technology, output diversification and development of indigenous entrepreneurship.
         However, it has been observed that a good number of small scale businesses in Ikot Ekpene Local Government Area over the years have not exercise internal control system in their businesses. This omission has led to poor accounting records, financial mismanagement, slow growth of the business, lack of continuity, inability to ascertain the physical quantities of materials on hand at a particular time, inability to determine the period when order should be placed for new stock and inability to account for the asset of the business.It is on this note that the researcher deemed it necessary to research on the evaluation of effectiveness of internal control system in small scale business organizations in Ikot Ekpene Local Government Area, Akwa Ibom State.
