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INTERNAL
CONTROL
A COMPARATIVE
ANALYSIS BETWEEN PUBLIC AND PRIVATE SECTOR
ABSTRACT
Internal control is the
process designed to ensure reliable financial reporting, effective and
efficient operations, and compliance with applicable laws and regulations.
Safeguarding assets against theft and unauthorized use, acquisition, or
disposal is also part of internal control. Control environment. The management
style and the expectations of upper‐level managers, particularly their control policies, determine the
control environment. An effective control environment helps ensure that
established policies and procedures are followed. The control environment
includes independent oversight provided by a board of directors and, in publicly
held companies, by an audit committee; management's integrity, ethical values,
and philosophy; a defined organizational structure with competent and
trustworthy employees; and the assignment of authority and responsibility.
The main aim of this project work is to take a look at
internal control between the private and the public sectors in Nigeria, carry
out a research and make recommendations on how to make their operations more
effective.
CHAPTER ONE
1.0.
INTRODUCTION
Internal control, as
defined in accounting and controlling, is a process for assuring achievement of
an organization's objectives in operational effectiveness and efficiency,
reliable financial reporting, and compliance with laws, regulations and
policies. A broad concept, internal control involves everything that controls
risks to an organization.[1] It is a means by which an organization's resources
are directed, monitored, and measured. It plays an important role in detecting
and preventing fraud and protecting the organization's resources, both physical
(e.g., machinery and property) and intangible (e.g., reputation or intellectual
property such as trademarks). At the organizational level, internal control
objectives relate to the reliability of financial reporting, timely feedback on
the achievement of operational or strategic goals, and compliance with laws and
regulations. At the specific transaction level, internal control refers to the
actions taken to achieve a specific objective (e.g., how to ensure the
organization's payments to third parties are for valid services rendered.)
Internal control procedures[2] reduce process variation, leading to more
predictable outcomes. Internal control is a key element of the Foreign Corrupt
Practices Act (FCPA) of 1977 and the Sarbanes–Oxley Act of 2002, which required
improvements in internal control in Nigerian public corporations. Internal
controls within business entities are also referred to as operational controls.
1.1.
BACKGROUND STUDY
Internal controls have
existed from ancient times. In Hellenistic Egypt there was a dual
administration, with one set of bureaucrats charged with collecting taxes and
another with supervising them. In the Republic of China, the Control Yuan one
of the five branches of government, is an investigatory agency that monitors
the other branches of government.
There are many definitions
of internal control, as it affects the various constituencies (stakeholders) of
an organization in various ways and at different levels of aggregation.
Under the COSO Internal
Control-Integrated Framework, a widely used framework in not only the United
States but around the world, internal control is broadly defined as a process,
effected by an entity's board of directors, management, and other personnel, designed
to provide reasonable assurance regarding the achievement of objectives
relating to operations, reporting, and compliance..
·
COSO defines internal
control as having five components:
·
Control Environment-sets
the tone for the organization, influencing the control consciousness of its
people. It is the foundation for all other components of internal control.
·
Risk Assessment-the
identification and analysis of relevant risks to the achievement of objectives,
forming a basis for how the risks should be managed
·
Information and
Communication-systems or processes that support the identification, capture,
and exchange of information in a form and time frame that enable people to
carry out their responsibilities
·
Control Activities-the
policies and procedures that help ensure management directives are carried out.
·
Monitoring-processes used
to assess the quality of internal control performance over time.
·
The COSO definition
relates to the aggregate control system of the organization, which is composed
of many individual control procedures.
Discrete control
procedures, or controls are defined by the SEC as: "...a specific set of
policies, procedures, and activities designed to meet an objective. A control
may exist within a designated function or activity in a process. A control’s
impact...may be entity-wide or specific to an account balance, class of
transactions or application. Controls have unique characteristics – for
example, they can be: automated or manual; reconciliations; segregation of
duties; review and approval authorizations; safeguarding and accountability of
assets; preventing or detecting error or fraud. Controls within a process may
consist of financial reporting controls and operational controls (that is,
those designed to achieve operational objectives)."
1.1.1. CONTEXT
More generally, setting
objectives, budgets, plans and other expectations establish criteria for
control. Control itself exists to keep performance or a state of affairs within
what is expected, allowed or accepted. Control built within a process is internal
in nature. It takes place with a combination of interrelated components – such
as social environment effecting behavior of employees, information necessary in
control, and policies and procedures. Internal control structure is a plan
determining how internal control consists of these elements.
The concepts of corporate
governance also heavily rely on the necessity of internal controls. Internal
controls help ensure that processes operate as designed and that risk responses
(risk treatments) in risk management are carried out (COSO II). In addition,
there needs to be in place circumstances ensuring that the aforementioned
procedures will be performed as intended: right attitudes, integrity and
competence, and monitoring by managers.
1.1.2. ROLES
AND RESPONSIBILITIES IN INTERNAL CONTROL
According to the COSO
Framework, everyone in an organization has responsibility for internal control
to some extent. Virtually all employees produce information used in the
internal control system or take other actions needed to affect control. Also,
all personnel should be responsible for communicating upward problems in
operations, noncompliance with the code of conduct, or other policy violations
or illegal actions. Each major entity in corporate governance has a particular
role to play:
·
Management
The Chief Executive
Officer (the top manager) of the organization has overall responsibility for
designing and implementing effective internal control. More than any other
individual, the chief executive sets the "tone at the top" that affects
integrity and ethics and other factors of a positive control environment. In a
large company, the chief executive fulfills this duty by providing leadership
and direction to senior managers and reviewing the way they're controlling the
business. Senior managers, in turn, assign responsibility for establishment of
more specific internal control policies and procedures to personnel responsible
for the unit's functions. In a smaller entity, the influence of the chief
executive, often an owner-manager, is usually more direct. In any event, in a
cascading responsibility, a manager is effectively a chief executive of his or
her sphere of responsibility. Of particular significance are financial officers
and their staffs, whose control activities cut across, as well as up and down,
the operating and other units of an enterprise.
·
Board of directors
Management is accountable
to the board of directors, which provides governance, guidance and oversight.
Effective board members are objective, capable and inquisitive. They also have
a knowledge of the entity's activities and environment, and commit the time
necessary to fulfil their board responsibilities. Management may be in a
position to override controls and ignore or stifle communications from
subordinates, enabling a dishonest management which intentionally misrepresents
results to cover its tracks. A strong, active board, particularly when coupled
with effective upward communications channels and capable financial, legal and
internal control functions, is often best able to identify and correct such a
problem.
·
Controlors
The internal controlors
and external controlors of the organization also measure the effectiveness of
internal control through their efforts. They assess whether the controls are
properly designed, implemented and working effectively, and make
recommendations on how to improve internal control. They may also review
Information technology controls, which relate to the IT systems of the
organization. There are laws and regulations on internal control related to
financial reporting in a number of jurisdictions. In the U.S. these regulations
are specifically established by Sections 404 and 302 of the Sarbanes-Oxley Act.
Guidance on controling these controls is specified in PCAOB Controling Standard
No. 5 and SEC guidance, further discussed in SOX 404 top-down risk assessment.
To provide reasonable assurance that internal controls involved in the
financial reporting process are effective, they are tested by the external controlor
(the organization's public accountants), who are required to opine on the
internal controls of the company and the reliability of its financial
reporting.
·
Control committee
The role and the
responsibilities of the control committee, in general terms, are to: (a)
Discuss with management, internal and external controlors and major
stakeholders the quality and adequacy of the organization’s internal controls
system and risk management process, and their effectiveness and outcomes, and
meet regularly and privately with the Director of Internal Control; (b) Review
and discuss with management and the external controlors and approve the controled
financial statements of the organization and make a recommendation regarding
inclusion of those financial statements in any public filing. Also review with
management and the independent controlor the effect of regulatory and
accounting initiatives as well as off-balance sheet issues in the
organization’s financial statements; (c) Review and discuss with management the
types of information to be disclosed and the types of presentations to be made
with respect to the Company's earning press release and financial information
and earnings guidance provided to analysts and rating agencies; (d) Confirm the
scope of controls to be performed by the external and internal controlors,
monitor progress and review results and review fees and expenses. Review
significant findings or unsatisfactory internal control reports, or control
problems or difficulties encountered by the external independent controlor.
Monitor management's response to all control findings; (e) Manage complaints
concerning accounting, internal accounting controls or controling matters; (f)
Receive regular reports from the Chief Executive Officer, Chief Financial
Officer and the Company's other Control Committees regarding deficiencies in
the design or operation of internal controls and any fraud that involves
management or other employees with a significant role in internal controls; and
(g) Support management in resolving conflicts of interest. Monitor the adequacy
of the organization’s internal controls and ensure that all fraud cases are
acted upon.
·
Personnel benefits
committee
The role and the
responsibilities of the personnel benefits, in general terms, are to: (a)
Approve and oversee administration of the Company's Executive Compensation
Program; (b) Review and approve specific compensation matters for the Chief
Executive Officer, Chief Operating Officer (if applicable), Chief Financial
Officer, General Counsel, Senior Human Resources Officer, Treasurer, Director,
Corporate Relations and Management, and Company Directors; (c) Review, as
appropriate, any changes to compensation matters for the officers listed above
with the Board; and (d)Review and monitor all human-resource related
performance and compliance activities and reports, including the performance
management system. They also ensure that benefit-related performance measures
are properly used by the management of the organization.
·
Operating staff
All staff members should
be responsible for reporting problems of operations, monitoring and improving
their performance, and monitoring non-compliance with the corporate policies
and various professional codes, or violations of policies, standards, practices
and procedures. Their particular responsibilities should be documented in their
individual personnel files. In performance management activities they take part
in all compliance and performance data collection and processing activities as
they are part of various organizational units and may also be responsible for
various compliance and operational-related activities of the organization.
Staff and junior managers
may be involved in evaluating the controls within their own organisational unit
using a control self-assessment.
1.2.
STATEMENT OF THE PROBLEM
According to the
consolidated report of the National Water and Sewerage Corporation’s accounts
committee for the financial year end (2008), the cash balance of shs.
470,267,548= appearing in the balance sheet at National Water and Sewerage
Corporation PortHarcourt Branch was not supported by a board of survey report
on cash. For the advances of shs. 97m= there was lack of seriousness over
granting and management of such advances, which remained the same as mentioned
in the previous year’s report. This is because no recovery was made on personal
advances amounting to shs. 25, 314,000= brought forward from the two previous
years. Neither was there recovery of fresh official advances amounting to shs.
13,200,000= granted in the current financial year.
The report further
revealed that a total sum totaling to shs. 18,467,000= was paid to an
accountant and official of the National Water And Sewerage Corporation for
supply of water pipes and purchase of stationery for the branch offices. The
materials and supplies were not taken on charge as required by the set
regulations. In the absence of records relating to receipts, issues and
utilization of these materials, the internal controlor could not confirm that
the items were received and utilized for the right purpose. In violation of
tender board regulations, two members of accounts staff were paid cash
amounting to shs. 11,400,000= to buy stationery for preparing budget estimates
for the financial year 2009/2010. Cash receipts were not availed to the Controlor
General, the amount also appeared inflated and neither was their stationery
taken on charge. Basing on the above data, the study was therefore set to
establish the relationship between internal control function and financial
performance of public sector organizations while taking a case of National
Water and Sewerage Corporation- PortHarcourt Branch
1.3.
OBJECTIVES OF THE STUDY
1.3.1
General
objective
To examine the effect of
internal control on the financial performance of public sector organizations
while considering National Water and Sewerage Corporation- PortHarcourt Branch.
1.4
Objectives of the study
(a) To examine the types of
internal controls applied by National Water and Sewerage Corporation- PortHarcourt
Branch.
(b) To analyze the importance
of internal control function in the accountability of Public Corporation.
(c) To establish the
relationship between internal control and financial performance of National
Water and Sewerage Corporation- PortHarcourt Branch
1.5
Research questions
(a) What are the types of
internal controls applied by National Water and Sewerage Corporation- PortHarcourt
Branch?
(b)
Which are some of the importance of
internal control function in the accountability of Public Corporation.?
(c)
How is the relationship between internal control
and financial performance of National Water and Sewerage Corporation- PortHarcourt
Branch?
1.4.
RESEARCH QUESTIONS
·
What are the types of internal controls applied by National
Water and Sewerage Corporation- PortHarcourt Branch?
·
Which are some of the importance of
internal control function in the accountability of Public Corporation.?
·
How is the relationship between internal control
and financial performance of National Water and Sewerage Corporation- PortHarcourt
Branch?
1.5.
RESEARCH HYPOTHESES
1.6.
SCOPE OF THE STUDY
1.6.1
Geographical scope
The geographical scope of
the study was National Water and Sewerage Corporation- PortHarcourt Branch
which is located near PortHarcourt Town immediately after Nigeria Martyrs
Catholic Church in Kamukuzi Division PortHarcourt Municipality. PortHarcourt Municipality is found in PortHarcourt
district in South Western Nigeria. PortHarcourt Municipality is divided into
three divisions of; Nyamitanga, Kamukuzi, and Kakoba. This study considered the
management and staff at National Water and Sewage Corporation- PortHarcourt
Branch plus people that were selected from the public who were assumed to be
the customers of the same organization of National Water and Sewerage
Corporation.
1.6.2
Content scope
The study considered the
relationship between internal control and financial performance of public
sector organizations, the importance of internal control function in the
accountability of Public Corporation and the areas that need internal control
in Public organizations.
1.6.3
Time scope
The study was estimated to
take a period of three months and would mainly consider information related to
four years that is (2008- 2011). The period of four years was chosen because it
was long enough for the researcher to establish the effect of internal control
on the financial performance at National Water and Sewerage Corporation- PortHarcourt
Branch.
1.7.
SIGNIFICANCE OF THE STUDY
·
To examine the types of internal controls applied by National
Water and Sewerage Corporation- PortHarcourt Branch.
·
To analyze the importance of internal control function in the
accountability of Public Corporation.
·
To establish the relationship between internal control and
financial performance of National Water and Sewerage Corporation- PortHarcourt
Branch
1.8.
LIMITATION OF THE STUDY
·
The study was limited by
funds as it was not enough to cater for secretarial services. The researcher
had however got some financial support from her relatives that supported her
during the research study.
·
In addition, the study
also faced with a problem of not finding all respondents in the time of the
study due to them being too busy with the organization work. The researcher
however had to draft the appropriate time table with the top company managers
that may suit all the respondents during the process of data collection for
reliable and valid information.
·
The
study also faces with the problem of limited time to undertake the
comprehensive study in time. However, the researcher followed the drafted work
plan to undertake the study successfully in addition to the direct response in
accordance to the supervisor’s comments.
1.9 DEFINITION OF TERMS
Internal controling is an independent, objective assurance and consulting
activity designed to add value and improve an organization's operations.
A Company is a structure or
undertaking that may have been created to provide a good service to the
population with an aim of achieving the stated goals to arrive at profits.
Cash management processes consist of
procedures, mechanisms and tools that top leadership puts into place to monitor
cash inflows and outflows. These processes also relate to accounts payable and
accounts receivable recording. An accountant lists cash as a short-term asset
in a corporate balance sheet (Bernstein, 2008).
Performance is a measure of the
results achieved. Performance efficiency is the ratio between effort expended
and results achieved. The difference between current performance and the
theoretical performance limit is the performance improvement zone. Performance
assumes an actor of some kind but the actor could be an individual person or a
group of people acting in concert (Deardorff, 2008).
Performance measurement is the process whereby an organization establishes
the parameters within which programs, investments, and acquisitions are
reaching the desired results. This process of measuring performance often requires the use
of statistical evidence to determine progress
toward specific defined organizational objectives.
Mishkin (2007) argued that
Cash is ready money in the bank or at hand. It is not inventory, it is not
accounts receivable (what you are owed), and it is not property. These can
potentially be converted to cash, but can not be used to pay suppliers, rent,
or employees. Profit growth does not necessarily mean more cash on hand.
An internal control is a set of
procedures that a business owner or corporate
leader implements to prevent operating losses originating from fraud, theft,
error and technological breakdowns. An adequate control defines specific steps
to perform tasks, report operating issues and make decisions.
Value for Money Control is a financial analysis
looking into whether resources are used in an economic, efficient and effective
way.
A customer, also client, buyer or
purchaser is the buyer or user of the paid products of an individual or
organization, mostly called the supplier or seller. This is typically through
purchasing or renting goods or services. It is also the person or group that is
the direct beneficiary of a project or service.
Efficiency
refers to a functioning or prospering of a company at a given time in a given
period basing on the desired goals and objectives of a company.
·
ACCA Association of Certified
Chartered Accountants
·
AICPA American Institute of Certified Public
Accountants
·
ANOVA Australian National Control Office
·
CAE Chief Control Executive
·
CCR Coordinating
Committee on Remuneration
·
COSO: Committee of Sponsoring Organization
of the Teaching
·
GTF Guidance Task Force
·
ICPAU Institute of Certified Public
Accountants of Nigeria
·
IGG Inspector General of Government
·
IIA Institute of Internal Controlors
·
MVA Market Value Added
·
NGOs Non Government Organizations
·
NWSC National Water and Sewerage
Corporation
·
OECD Organization for Economic
Co-operation and Development
·
PEFA Public Expenditure and Financial
Accountability
·
PFM Public Financial Management
·
ROA Return on assets
·
ROE Return on Equity
·
ROS Return on sales
·
SEREP Service and Revenue Enhancement
programmes
·
SOA Sarbanes Oxley Act
·
SSC Support Services Contract
·
VFM Value-for-money
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