THE IMPACT OF INTERNAL CONTROL SYSTEMS ON THE PERFORMANCE OF SMALL AND MEDIUM SCALE ENTERPRISES

CHAPTER ONE

1.0 INTRODUCTION

1.1 Background of the study

Every organisation both profit and non-profit has its objectives and goals in mind to achieve (Chukwu, 2012). For a profit making organisation, the goal is to satisfy the expectation of the owners through the maximization of expected return on capital. The size and scope of Small and Medium Scale enterprises may be small but they still require efficient running of their organization. This is where internal control becomes relevant.

As a result of the increase in accounting scandals in recent years, the internal control function has received impressive attention as an important contributor to effective corporate governance and financial reporting. This is because a high quality internal control function focuses on improving financial reporting through ensuring standard compliance. ( Prawitt, Smith and Wood,2008).

According to Chukwu (2012), for an organisation to carry out its business there must be some resources put in place for the smooth running of the organisation like, materials. machines, money etc. These need to be well co-ordinated in order for the success of the organisation to be achieved .These factors are used by a group of persons known as management. Management can neither exist without an organisation as both are inseparable. The system of internal control therefore provides assurances to management on the dependability of the accounting data used in the decision making of the organisation.

An internal control system has been found to be so significant to organisation especially in the assurance of the reliability and accuracy of the financial reports. Besides, it is a subject that receives too little attention in the management literature (Changchit,Holsapple and Madden,2001 ). Similarly, quality of an organisation’s internal control system has significant impact on the accuracy of management guideline. Likewise, firms that disclose ineffective internal control system have larger tendency of experiencing management errors in their operation than those firms that report effective internal control system (Feng, and McVay, 2009). Therefore, it is the responsibility of management of an organisation to ensure that effective internal control system is put in place that will ensure the achievement of    organisational established objectives. This is because establishment and supervision of effective internal control systems are the responsibility of management not auditors

(Changchit, Holsapple, and Madden, 2001). At the same time effective internal control system are fundamental drivers toward earnings quality (Church and Schneider, 2008). In the same vein, effective internal control system has an essential role to play in a firm’s success (Jokipli, 2010). In line with the above issue, effective internal control system could also play an important role in ensuring the effectiveness of internal audit.

Internal control systems are integral component of any organization’s managerial process be it process of small and medium scale enterprises or not. It should be established in order to provide reasonable assurance that the operations are carried out efficiently and effectively.

Organizations establish systems of internal control to help them achieve performance and organizational goals, prevent loss of resources, enable production of reliable reports and ensure compliance with laws and regulations. An internal control system comprises the whole network of systems established in an organization to provide reasonable assurance that organizational objectives will be achieved.

1.2 Statement of problem

One might not really appreciate the impact of internal control system in an organisation until one see an organisation that is run without internal control system. The absence of effective internal control measures exposes an organisation to the preparation of inaccurate financial statements and records, stealing and mismanagement of organisation’s funds and also non implementation of accounting policies in consistence with the applicable standards.

An internal control system is valuable to an organisation especially in the aspect of assurance of reliability and accuracy of the financial reports. The subject of internal control has received less attention in management literature (Changchit, Holsapple and Madden,2001). The rapidly changing economic and competitive environments, shifting customer demands and priorities, and restructuring for future growth and social trend indicates how extensive an organization internal controls should be structured to ensure continuous growth in organisational performance. At all levels of the organization, the management and personnel have to be involved to address risks and to provide reasonable assurance of the achievement of the organization’s mission and general objectives.

Internal control, which assures the stability of every organisation, therefore has gained importance today. This is because the control systems in place are a pillar for an efficient accounting system as well as the achievement of organizational goals. Therefore there is the need to conduct more research on the impact and effectiveness of internal control system.  This study seeks to examine the relationship between internal control system and the performance of small and medium scale enterprises in Ilorin metropolis.

1.3 Objective of the study

The overall objective of this research is to evaluate and determine the impact of internal control systems on the performance of small and medium scale enterprises in Ilorin metropolis.

The specific objectives of this study are:

1. to determine the impact of internal control system on return on investment (ROI);

2. to ascertain whether the occurrence of fraud and loss of revenues is as a result of weakness or absence of internal control system in the organisation.

1.4 Research questions

The following research questions will be used to guide this study.

1. To what extent does internal control system impact on return on investment?

2. To what extent does the occurrence of fraud and losses of revenue in an organisation arise as a result of weakness or absence of internal control system?

1.5 Statement of hypotheses

The following hypotheses stated in null term will be tested in this study:

Ho1: Internal control system does not ensure the proper use of organisations funds and assets.

Ho2: Fraud perpetration and loss of revenue in an organisation are not as a result of weakness or absence of internal control system.

1.6 Justification of the study

There is no controversy that some research works have been conducted on internal control system; however this present study places much emphasis an effective internal control system on the performance of small and medium scale enterprises in Ilorin metropolis

This research work will go a long way in helping small and medium scale organisations to discover the impact of weakness or absence of internal control in an organisation and suggest measures in correcting them. It will also reveal the problems caused by bad internal control system.

This would further serve as a dependable reference upon which future researchers can rely on to advance their studies.

1.7 Scope and limitations of the study

This research will specifically focus attention on the activities of small and medium scale enterprises in Kwara. Small and medium scale enterprises in Ilorin metropolis will be sampled for the study. The focus of this research is to show the impact of internal control system on the performance of selected small and medium scale enterprises.

The major limitation of the study would be the short period of time granted to carry out this study. Other limitations include financial constrain, limited human and material resources available for the conduct of the research and the low literacy level of the study respondents.

1.8 Definition of terms

The following terms will be used in the course of this research work and as such need to be explained.  They are stated below:

Internal auditor

By contrast to the external auditor, the internal auditor is an employee of the SME with the major task of advising management on whether its major operations have sound systems of risk management and internal controls (Putra, 2008, p. 1).

Internal audit’s role in evaluating internal controls is wide ranging because ‘everyone from the mailroom to the boardroom is involved in internal control’ (Institute of Internal Audit, 2008). The internal auditor’s work includes assessing the tone and risk management culture of the organization at one level through to evaluating and reporting on the effectiveness of the implementation of management policies at other SMEs (Institute of Internal Audit, 2005, p.1).

Control

Is an exercise performed in the present to achieve a plan drawn up for the future.

Management

It is defined as the process of planning, organizing, coordinating and con trolling the activities of an organization. It is seen as a group of people who monitor and control the organization’s activities towards the achievement of the organization’s objectives.

Audit

This is an independent examination and expression of opinion of the financial statement of an enterprise by an appointed auditor in pursuance of that appointment and in compliance with statutory requirements and professional obligation.

Performance

It refers to an on-going process that involves managing the criteria for which an institution, agency or projects can be held accountable

1.9   Plan of the study

The report of this study is organised into five chapters. Chapter one is the introduction to the study. Chapter two is the review of relevant literature. Chapter three is the methodology of the research study. Chapter four would contain the data presentation analysis and discussion of findings and lastly, chapter five is the summary, conclusion and recommendation of study.