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IMPACT OF INTERNAL CONTROL SYSTEM ON PROFIT PERFORMANCE
OF COMMERCIAL BANKS
(“A CASE STUDY OF ORIENT BANK OF NIGERIA PLC AND UNITED BANK
FOR AFRICA PLC”)
BY
EZE PRISCILLA NGOZI
REG.NO. PG/MBA/91/11382)
DEPARTMENT OF BANKING AND FINANCE
FACULTY OF BUSINESS ADMINISTRATION
ENUGU CAMPUS
NOVEMBER, 1992
TITLE PAGE
IMPACT OF INTERNAL CONTROL SYSTEM ON PROFIT PERFORMANCE
OF COMMERCIAL BANKS
“A CASE STUDY OF ORIENT BANK OF NIGERIA PLC AND UNITED BANK
FOR AFRICA PLC”
BY
EZE PRISCILLA NGOZI
REG. NO. PG/MBA/91/11382)
DEPARTMENT OF BANKING AND FINANCE
FACULTY OF BUSINESS ADMINISTRATION
ENUGU CAMPUS
NOVEMBER, 1992
CERTIFICATION
This is to certify that this project was written by Eze Priscilla Ngozi, PG/MBA/91/11382
presented to the Department of Banking and Finance, University of Nigeria Enugu
campus as original and has not been submitted for award of any Degree or Diploma
either in this University or any other tertiary institution.
--------------------------- ------------------------
Student Date
This is to certify that this research work is done by Eze Priscilla Ngozi, Reg No
PG/MBA/91/11382 presented to the Department of Banking and Finance, University of
Nigeria, Enugu Campus (UNEC), was submitted in partial fulfillment for the award of
MBA in Banking and Finance.
Dr J.E Ezeanyagu -------------------
Project Supervisor Date
Mr O.E.Aneke -------------------
Head of Department Date
APPROVAL SHEET
In partial fulfillment of the requirement for the award of the Masters in Business
Administration (MBA) Certificate in Business Administration, this Project entitled
IMPACT OF INTERNAL CONTROL SYSTEM ON PROFIT PERFORMANCE OF
COMMERCIAL BANKS.
“A CASE STUDY OF ORIENT BANK OF NIGERIA PLC AND UNITED BANK FOR
AFRICA PLC.”
Has been prepared and submitted by EZE PRISCILLIA NGOZI (REG. NO.
PG/MBA/91/11382).
DR. J. E. EZEANYAGU ___________________
PROJECT SUPERVISOR SIGNATURE & DATE
EXTERNAL EXAMINERS ____________________
SIGNATURE & DATE
HEAD OF DEPARTMENT _____________________
SIGNATURE & DATE
DEDICATION
This piece of work is dedicated to my mother Mrs. Victoria Okeke Eze and my fiancé Dr.
Daniel Okey Ugwu for their selfless efforts towards my educational career.
It is also dedicated to the memory of my beloved father late Mr. Joseph Okeke Eze.
ACKNOWLEDGEMENT
Though, I own responsibility for any mistakes or shortcomings of this project, I
wish to acknowledge my indebtedness to many persons whose assistance facilitated the
completion of this research work.
My appreciation goes to my project adviser Dr. J. E. EZEANYAGU whose
academic zeal and wealth of experience were of immense help to me.
My gratitude goes to the head of the department of Finance Prof. F. OKAFOR, the
Associate Dean Dr. J. EZIKPE, Mr. J. EZE of department of Management and all my
lecturers in Enugu Campus of University of Nigeria for their comprehensive lecturers
which guided me through my course of study.
I also acknowledge Mr. Cosmos U. Agbo and Mr. Onyenye Nwosu – Igbo of
Orient Bank of Nig. Plc and United Bank of Nig. Plc for their tireless effort in making
necessary information available for the projects.
I adore and owe my gratitude to my parents Mrs. Victoria Okeke Eze and my Late
father Mr. Joseph Okeke Eze, my Brother in-laws Mr. C. C. Ome, Mr. A. O. Ugwu, C. Y.
Ugwu, S. O. Ugwu and Mr. D. O. Ugwu, my brother and Sisters Mr. Okwudili Eze, Tina
Eze, Mrs. Dipuna Ome and Miss Nkeiru Eze
I will not forget Mrs. Ossai P. for her effort in typing the project. Finally, I pay my
tribute to the Almighty God without whom nothing would have been possible.
Eze Priscilla Ngozi
Department of Banking and Finance
Faculty of Business Administration
University of Nigeria, Enugu Campus
November, 1992
ABSTRACT
This study primarily aims at finding out the impact of internal control system on
the profit performance of commercial banks in Nigeria with an empirical study on Orient
Bank of Nig. Plc and United Bank of Africa Plc.
Internal control systems impact on commercial banks might be as a result of non-
adherence to the system or stringent, inflexible adherence on the system. These two
extremes will invariably have adverse effect on the profit performance of the commercial
banks and as such the management will always try to strike a balance or trade-off for
their profit maximization.
The paper therefore tends to evaluate the extent of adherence to internal control
system, its impact on the profit performance of OBN PLC and UBA PLC and control
strategies to be adopted to revitalize or moderate the system.
This project is divided into five (5) chapters –
Chapter One: This is the introductory chapter that provides information about internal
control system. This chapter gives insight of the problem identification, objectives and
significant of study, hypothesis to be tested and scope and limitations of the study.
Chapter Two: This is the Literature Review which makes good references to people that
carried out the studies on internal control. It includes the importance and qualities of
good internal control and also qualities expected of bank staff. Chapter Three: This
includes Research design, scope and methodology.
Chapter Four: This involves presentation and analysis of data collected.
Chapter Five: This includes the Summary, Recommendation and Conclusions.
TABLE OF CONTENT
PAGES
Title Page i
Approval sheet ii
Dedication iii
Acknowledgement iv
Preface v
Table of Content vi
CHAPTER ONE: INTRODUCTORY ANALYSIS
1.1 General Introduction 1
1.2 Problem Identification 2
1.3 Statement of Objectives 3
1.4 Significant of Study 3
1.5 Hypothesis (formulation and method of testing) 4
1.6 Scope and Limitations 7
1.7 Definition of terms 8
CHAPTER TWO: LITERATURE REVIEW
2 .1 Introduction 11
2.2 Definition of internal control 14
2.3 Types of Internal control 18
2.4 Structure of Internal control 21
2.5 Importance of Internal control 27
2.6 Qualities of good internal control system 28
2.7 Elements of financial / accounting internal control 38
2.8 Specific areas of internal control 43
2.9 Users of internal control system 52
2.10 Electronic Data processing and internal control 55
2.11 Banking Approach to Internal Control 64
2.12 Expected qualities of banking staff for affective
internal control 68
CHAPTER THREE: RESEARCH METHODOLOGY
3.1 Research Design 72
3.2 Scope 72
3.3 Methodology 73
3.3a Primary source of data 73
3.3b Secondary source of data 81
3.4 Determination of sample size 82
3.5 Design of Strategic Position and Action Evaluation
(SPACE) 83
CHAPTER FOUR:DATA PRESENTATION AND ANALSYSIS
4.1 Questionnaire distribution, collection and analysis 84
4.2 Departmental collection and usage of questionnaire 84
4.3 Testing of Hypothesis and Analysis of Data 85
CHAPTER FIVE: SUMMARY, RECOMMENDATION AND CONCLUSION
5.1 Summary 110
5.2 Limitation of Results 111
5.3 Recommendation 112
5.4 Conclusion 114
CHAPTER ONE
INTRODUCTION ANALYSIS
1.1 GENERAL INTRODUCTION
Internal control is the set of accounting and administrative control and practices
that helps managers in operating their organization more effectively and efficiently. It
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. In any profit oriented organization, the
objective of management is to maximize profit, and internal control is a technique that
can be of assistance in attaining such maximizations.
Banking is a venture undertaken primarily for profit and whose operation should at
least include taking money on account and releasing of such money wholly or partly on
demand or authority of the depositor.
An important object of banking particularly in the developing countries is the
promotion of economic development. In pursuance of this economic development as well
as banks’ profitability, banks tends to improve on their services by devising methods of
sound and effective system of internal control.
This study therefore, intends to evaluate how the internal control policies have
affected the profit performance of commercial banks with particular reference to Orient
Bank of Nigeria Plc and United Bank for Africa Plc.
1.2 PROBLEM IDENTIFICATION
There have been incessant cases and stories been told about high frequency
of fraud, embezzlement, overcharging, manipulation, missing files and ledger cards
and other banking malpractices in banks today, with the management and
shareholders not knowing how to handle the adverse situation.
The Orient Bank of Nigeria (OBN) Plc and United Bank of Africa (UBA)
Plc were not left out in these increase in crime – wave problems and banking
malpractices, despite the existence of inter-control and devices adopted to detect
fraud. This situation has culminated in the lack of confidence by the staff,
shareholders and customer over the growth and profitability of the banks.
Moreso, with the proliferation of banks and also the increase in rural
banking, with commercial bank’s branches, the volume of accounting records has
drastically increased, thereby necessitating the appraisal of the adequacy and
reliability of records, and overall efficiency of operations.
Furthermore, with the public interest in the “truth and fairness” of financial
statements – profit and loss account and balance sheet, whose stratum of reliable is
on the internal control system, the research is therefore aimed at investigating the
extent of adherence to the internal control system and its impact on the profit
performance of the banks.
1.3 STATEMENT OF OBJECTIVE
The objective of this research include among others the following:
1. To identify and appraise the internal control designed, installed and operated
by the management of OBN and UBA with a view to assessing its impact on
profit performance.
2. To examine the extent of adherence or compliance to the policies, standards
and procedures by the members of the staff in order to recommend operating
improvement.
3. To identify possible deficiencies and weaknesses of the existing internal
control to find means of ameliorating them.
4. To review the profit performance of the banks OBN and UBA and relate it to
their internal control.
5. To critically analyze the effectiveness, adequacy and applicability of the
various internal control.
6. To offer useful recommendation to proper design, installation and operation of
an adequate and good internal control system.
1.4 SIGNIFICANT OF STUDY
The research is intended to define the level of internal control and its impact on
profitability of OBN and UBA Plc. It will be of great importance to the banking staff
especially the managers and officers whose interest are geared towards the enhancement
of the chances of bank profitability; in serving as a guide in the performance of their
duties. It will assess the effect of fraud, manipulations, errors, improper authorization,
dishonesty, inadequate accounting records etc on profitability in view of the existing
internal control system.
A comprehensive knowledge of system of internal control will form a foundation
on which the auditor’s report on “true and fair view” final account is based and as such,
the study will be of immense values to the practicing Accountants, Auditors, Lawyers,
shareholder and other interested parties for acceptance and reliance of financial
statement.
Furthermore, it will include more research in the improvement of banking services
in Nigeria for the interest of the shareholders, customers and government.
Finally, the study will provide the basis for recommendation to the management of
the best approach to designing, installing and operating an improved system of internal
control aimed at promoting operational efficiency and eliminating or at least minimizing
waste.
1.5 FORMULATION OF HYPOTHESIS
1. The management of OBN and UBA Plc designed and installed 50% good system
of internal control which their policies, standards and procedures are adhered to by the
members of the staff.
2. The system of internal control adopted by UBA Plc enhances its profit
performance than the system adopted by OBN Plc.
3. The present internal control systems adopted by the banks are effective and
adequately operated.
4. The existing internal control systems of the banks enhance their profit
performance.
1.5 METHOD OF TESTING HYPOTHESIS
HYPOTHESIS I: - This hypothesis will be analyzed based on the respondents response
to the Strategic Position and Action Evaluation (SPACE) of features of a good internal
control system in OBN and UBA Plc. The rating ranges from 1 to 4, representing weak to
very strong. The SPACE average will be used.
Average responses to question I of the general questionnaire taken according to
department will be subjected to single proportion testing using the following test
statistics:
Z = X - npo
Npo (L – po )
Where
n = sample size
x = number of responses in favour
po = proportion to be tested
The level of significance will be 5% for the testing to give a critical value of z<I.64
(.one tailed test)
See appendix I for SPACE.
It will also be analyzed based on the following:
A. Responses to questions of the general questionnaire will be tested to obtain the
part played by the management in the design and installation of internal control
and ensuring that the policies standards and procedures are adhered to.
B. Oral interview will be conducted on the bank officials at their convenience for
elaborate discussion on the extent of staff adherence to the installed system.
There will be proper investigation of documents and records to find out the
reliability of the oral responses.
HYPOTHESIS II: This hypothesis will be tested based on the comparative analysis
of the ages and financial statement of the Bank.
It will also be analyzed from the responses to the relevant areas covered by the
questionnaire. Such areas include electronic data processing, purchasing, cash receipts
and disbursement, petty cash, payroll and fix assets.
HYPOTHESIS III: This hypothesis will be tested with the following;
a) Oral interview will be conducted on the employees to find out the extent of their
adherence to the procedural manual of the banks.
b) Further information will be elicited from responses to question 4,5 and 7 of the
general questionnaires.
c) Employees will be observed during working hours (8am – 1.30pm) to ascertain the
processes involved in their operations mainly withdrawals and deposits of money
in the banks and also to detect errors and flaws.
d) A thorough study on authorization will be made to know whether employees
conform to effective and adequate operation.
HYPOTHESIS IV: In analyzing this hypothesis, the following test will be carried out.
a) Data collected from the general questionnaire will be tested and also oral
interview conducted. A five year financial statement will be analyzed and each
year’s profit compared with the proceeding years to ascertain the
direction of profit performance. This will then be matched with the
degree of adherence to internal control features within these periods.
1.6 SCOPE/LIMITATIONS OF STUDY
This study covered the internal control systems adopted by various
commercial banks in Nigeria. The population sample was taken from only two
banks OBN and UBA and their branches in Enugu State. Other parts of the country
were not covered, though empirically generalized view was made of them.
The study was restricted to two major areas of internal centre. They are:
i) Administrative control
ii) Accounting and financial control (internal checks, internal audition and
other financial system of control). This was done based on a
comprehensive understanding of the principles of good internal control.
However, the study encountered a lot of constraints as regards time, money and
sourcing of information. Effort geared towards obtaining adequate information
proved abortive due to the uncooperative attitude of some interviewed staff.
Besides, no bank likes the public to know the deficiencies in its internal control as
the confidence reposed on it by the public might be lost. But, irrespective of these
limitations, an in-depth study was still carried out.
1.7 DEFINITION OF TERMS
The researcher at this point believes that some key words and terms that will be
encountered while reading this research work will be defined.
1. Internal Control System: This is the whole system of controls, financial and
otherwise established by the management in order to carry on the business of the
enterprises in orderly and efficient manner, ensure adherence to management
policies, safeguard the assistance and secure as far as possible the complements
and accuracy of the records.
2. Internal Accounting/Financial Control: Measures that relate to protection of
assets and to the reliability of accounting information and financial statements.
3. Internal Administrative Control: A sub category of internal controls which
reply principally to operational efficiency and compliance with company policy
and which do not bear directly on the dependability of financial statement.
4. Cheques: A cheque is a bill of exchange drawn on a banker, payable on demand”
(Bill of exchange ordinance 1917 73).
5. Embezzlement: Theft by a person of assets entrusted to him or her
6. Internal Auditing: An activity carried on in some organization by a professional
staff to investigate and evaluate the system of internal control on a year round
basis. Also to evaluate the efficiency of individual department within the
organization.
7. Documentation: This includes all the charts, firms, tapes, reports and other
business papers that guide and describe the working of a company’s system of
accounting and internal control,
8. Fraud: Dishonest acts intended to deceive, often involving the theft of assets and
falsification of accounting records and financial statements.
9. Organization chart: A diagram showing organizational lines of authority and
responsibility with emphasis on separation of function.
10. Irregularities: Acts by individuals in an organization aimed at perpetrating fraud
or embezzlement.
11. Fidelity bond: A form of insurance contract is which a bonding company agrees
to reimburse an employer for losses caused by theft by bonded employees.
12. Independent Auditor: Professional level accountants that examine the books and
records of companies and express opinions the accounting records in the interest
of third parties.
13. Effectiveness: Attainment of a predetermined goal.
14. Efficiency: Relationship between inputs and outputs
15. Collusion: Where two or more persons conspire to commit an illegal act such as
fraud and embezzlement.
16 Illegal Acts: Actions that are not in conformity with prescribed company practices
that are capable of leading to fraud.
ABBREVIATIONS
1. OBN - Orient Bank of Nigeria
2. UBA - United Bank of Africa
3. ICAEW - Institute of Chartered Accountant in
England and Wales
4. AICPA - American Institute of certified public
accountant
CHAPTRE TWO
LITERATURE REVIEW
2.1. INTRODUCTON
Internal control is the type of control designed and installed by the management of
an organization for the growth and survival of the organization. It is the responsibility of
the management to ensure and maintain this system of control to enhance profitability.
Sequel to this, adequate attention has been given to the study of internal control in
business enterprises by experts.
Hermanson, Edwards and Salmonson (1987) in emphasizing the importance of
internal control in business stated …..
However, as the business grows and the need arises for additional employees,
including other managers, the owner begins to lose total control and must trust employees
to take over some of the affairs of the business. At this point, an owner realizes that
precautions must be taken to protect the company’s interest. As a result, the owner
establishes internal control measures. 32
Internal control in profit-oriented enterprise is of utmost importance due to human
nature’s susceptibility to dishonesty and carelessness-universal phenomena. People in the
business world have always known that dishonest situation rather than dishonest people
exist, and those enterprises that have continued to operate profitably have taken steps to
control this temptation; through internal control. It should be emphasized that the taking
or misappropriate of money or assets by a worker is not contained to persons of the
criminal class, and as such internal checks are not designed primarily to thwart a handful
32 Hermanson R. H, Edwards J. D Salmanson R. F., Accounting principles Special Ed. Plano, Texas, Business
Publications, Inc 1987 p. 268
of habitual thieves, but to help respectable God-fearing, normal citizens of the
community to resist temptation2
For profitability to be enhanced an internal control system will be operated
constantly, and with impartiality, being directed to situation rather than individual.
Employees should also be made to understand that internal control is for everyone’s
protection as it provides proof of honesty as well as transgression.
The value of a good system of internal control in deterring errors, frauds and waste is
undoubtedly greater than value in detecting them. One of its basic objectives is to remove
the opportunity to commit irregularities or to use assets in a manner contrary to the
objective of the business. The level of the accomplishment of this objective, however,
depends on the degree of honesty among employee. Indeed, it is always rare for the
management to design a system so perfectly that it will foil all fraudulent schemes3
A good internal control system is peculiar and internal to the organization
concerned and never imposed from outside. The procedures are tailored to the particular
business entity more than perhaps any other features of the accounting system. They
depend upon the size and type of the business, the physical location of parts; the number,
ability and characteristics of its employees; and the wishes of the management.
Management of both privately and publicly owned enterprises, big or small are
autonomous in decision making and implementation, but are held responsible for
failure to attain the organizational goal to the satisfaction of the owners. To avert
2 Duncan G. M “Dishonesty among stores clerk” Sociology and social Research. 1948 9p. 25. 3 Ibid. p 40.
this failure and make profit, the management must design, install and operate an
adequate system of internal control.
Nwoke C. (1988) in discussing further on the importance of internal control
stated…..
Indeed, without it there can be no successful business. It may explain why one
business enterprise succeeds, and the other fails, why the prices of the products
of one enterprise are higher than those of a similar enterprise and to a large
extent, why many public enterprises and parastatals fail. Indeed, the subject is an
important one.4
Recently, a good number of study have been done and texts written on internal
control system by both academician and practitioners in the field of auditing. Top
business management have always focused attention on how to ensure the
effectiveness of the system. In this respect the researcher indents to start from the
“know” to the “unknown”, through the review of related work done by some
experts.
2.2 DEFINITION OF INTERNAL CONTROL
Numerous experts in business both academicians and practitioner have
written on the subject matter of internal control and have defined it from different
perspectives. In many organizations, accountants have often used the term internal
4 Nwoko C. Internal control in Business. Nigeria Abic Books 1988 p9.4
control as a synonym for control within business organization. This term has been
defined by the American Institute of Certified public Account. (AICPA) as;
“The plan of organization and all of the co-ordinate methods and measures
adopted within a business to safeguard its assets; check the accuracy and reliability
of its accounting data, promote operational efficiency and encourage adherence to
prescribed managerial policies” 5
This definition possible is broader than the meaning sometimes attributed to
the term. It recognizes that a ‘system’ of internal control extends beyond those
matters which relate directly to the function of the accounting and financial
department. This broad definition was conveniently summarized by Steller thus:
“Internal control is means by which the management obtains the
information, protection and control for successful operation of business
enterprises”6
Holmes A. (1964) in his definition states:
“Internal control constitutes the methods followed by a company
i) Protect assets.
ii) Protect against improper asset disbursement
iii) Protect against incurrence of improper liabilities
iv) Assure the accuracy and dependability of all financial and operating information.
v) Judge operating efficiency
5 AICPA, Codification of statements on Auditing standards, No. 1-23 I 6 Stetler H. F Auditing principles 4th Edition prentice-Hall 1977 p.
vi) Measure adherence to company’s establishment policies.7
He further stressed that internal control may be administrative or financial.
Administrative control normally pertains to activities which are not directly financial in
nature and are built into the system to promote the attainment of the major goals of
internal control. Financial control pertains to financial activity and may be exemplified
by the separation of the duties of personnel in disbursing cases and recording related cash
transaction.
The institute of chartered Accounting in England and Wales (ICAEN) statement of
Auditing U4 defines internal control as:
“Not only internal check and internal audit, but the whole system of controls;
financial and otherwise, established by the management in order to carry on the business
of the company in an orderly manner, safeguard its assets and secure as far as possible
the accuracy and reliability of its records”.8 From this definition, internal control may be
summarized as consisting of internal checks, internal audit, other financial system of
control and administrative systems of control. These system are established by the
management to achieve a number of purpose identified as; orderly conduct of enterprise
business, safeguard of assets and accuracy and reliability of records.
Furthermore, Nwoko C (1988) in his view defined internal control as “a system of
controls, financial, administrative and otherwise installed and maintained by internal
management to achieve at least four major purposes. 7 Holmes A. W. Auditing: principles and procedures Recorded Drwrwin INC. Homewood Ulinow 1964 p.77 8 ICAEW, statements of Auditing
i) Safeguard the assets of the enterprises from all forms of misuse and error.
ii) Establish and maintain the accuracy and reliability of accounting data, information
and records.
iii) Promote operational efficiency and effectiveness
iv) Seek, encourage and obtain adherence to prescribed management policies and
methods9
The definition has three main features which should be emphasized.
a) Good internal control should safeguard the company’s asset
b) Good internal control should make accounting record and therefore the financial
statement prepared from them so accurate that management can safely rely on
them in making their business decision.
c) The responsibility of the establishment and working of internal control lies with
the management and not the internal auditor the company.
Cyasi Kwame (1982) further stressed that the system and techniques for
implementing internal control are aimed mainly, at improving the accountability for
actions, the accuracy and reliability of records, the safeguarding of assets, and overall
efficiency of operation”10.
Writing further on the internal control system, corns classified that “Internal controls,
contrary to the frequent misconception are not operating procedures but a check on
operating procedures. They are not part of an audit function, but the establishing of rules
9 Nwoko C. Internal control in Business Nigeria Abic Books 1988. p. 4 10 Cyasi Kwame, An International Guide to Auditing 1st Ed. United Kingdom: Graham Burn 1982 p. 15
and regulations, proofs and balances covering transactions, which under an audit program
are verified and their authority established”11.
It can be seen from the above definitions that even the small, one-owner business
can benefit from the use of some internal measure. Internal control as observed goes
beyond the accounting and financial controls that exist in an organization, preventing
theft and waste is only a part of internal control. In general the purpose of internal control
is to ensure the efficient operation of a business, thus making it possible for the business
to effectively reach its goal.
2.3 TYPES OF INTERNAL CONTROL
The various definitions given by different authors depict that some types of internal
control exist in many organizations.
Horngren C. (1982) in discussing the subject matter of internal control mentioned
two types :
(i) Administrative control
(ii) Financial control
Administrative control comprises the plan of the organization and all the methods and
procedures that facilitate management planning and control of operations.
11 Corns C. Marshall: How to Audit a Bank Boston Bankers publishing company, 1971 p. 52.
Accounting control comprises the methods and procedures that are primarily
concerned with authorization of transaction, safeguarding of assets, and the accuracy of
the financial records. Good accounting control helps maximize efficiency, minimizes
waste, unintentional errors and frauds.12
Usually, there are no mutual exclusive boundaries between administrative and financial
control. They are always interwoven. However, in an audit engagement, the auditor is
more interested in financial control, while in none—audit engagement involving
management advisory services; he/she is more interested in administrative internal
control.
Also Nwoko C. (1988) broadly subdivided it into administration and accounting
(financial) control but went further in analysis the components of each control.
Administrative controls consist of all non-accounting and non-financial systems
and methods which are built into the system to promote the attainment of the four major
goals of internal control. They are often non-pecuniary in nature, and their effects usually
non-qualifiable. They essentially consist of the plan of the organization; promotion,
recognition and commendation procedures and methods; discipline and code of business
ethics and conduct; rotation of duties, transfer and valuations; and final education and
training programme.
Accounting and financial controls are all accounting, finance and monetary control
techniques and systems built into the internal control system to promote and encourage
the attainment of the objective of internal control. They have an err of immediate and
urgency in them; and are normally built around large losses. They are meticulously
12 Horngren C. T. Codt Accounting: A managerial Emphasis; 55th Edit Prentice Hall International London 1982 p.
80
enforced and glared towards the achievement of qualitative objectives. They generally
consist of; internal check, counter-cheeks and balances, policies, procedures and
regulation for assets records, reconciliations etc; internal planning and budgetary control
system and procedures, and finally internal monitoring, review and audit unit.
Accounting and financial is further subdivided into (I) Physical control and
Documentary control. Physical controls are measures taken to physically safeguard assets
while documentary controls are proper documentation of all accounting records like
voucher and passbooks.13
Barry Cushing (1978) had a different view from the above two accounts. He
classified internal control into three (3) general types:
(i) Feedback control
(ii) Feed forward control
(iii) Preventive control14
Feedback control- This is defined as the informational output of a process which
returns as input to the process, in the sense that it initiates that action necessary
for process being controlled and adjusting the process when the measures indicates
that the process is deviating plan.
Incorporating feedback control into a system creates a dynamic self-
regulating system. In such a system, the process is expected to deviate from
equilibrium occasionally. However, the ability both to restore the process to
13 Nwoko C. Op. cit., p.5 14 Barry Cushing Accounting Information and Business Organization 2nd Ed. Addison Wesley Pub. Co. Reading 1978 p.72
equilibrium and to know when such restoration is needed is built into the system
itself.
Its function in business corresponds roughly to the internal control objective of
promoting operational efficiency and encourage adherence to prescribed managerial
policies. These functions are effectively accomplished by means of a reporting system
adhering to the general outlined principles. Feedback reports promote operational
efficiency by highlighting inefficient operation requiring management attention.
Furthermore, such reports encourage adherence to managerial policies through the
knowledge that deviation from such policies and standards are promptly reported. Its
main disadvantage is that it does not signal a deviation until after it has become
significant.
Feed forward control. It is a control that stops error and deviation from
occurring. It monitors both operations and input in an attempt to predict potential
deviation, in order that adjustment can be made to avert problems before they occur. It
also corresponds to the AICPA administration control. It is the least effective and very
difficult to implement due to uncertainty in predicting future process outputs.
Preventive control – This operates from within the process by placing restriction
on and requiring documentation of employees’ activities in such a way that the
occurrence of errors and deviation is retarded. This type of control is perhaps most
consistent with the original meaning of the terms internal control. It is interpreted to
correspond to what the AICPA referred to as accounting controls. The functions of this
control are mainly safeguarding assets and checking the accuracy and reliability of its
accounting data.
2.4 STRUCTURE OF INTERNAL CONTROL
For the purpose of understanding, internal control can be subdivided into three (3)
parts-
1. The control environment
2. The Accounting system
3. The control procedures
CONTROL ENVIRONMENT
This is a set of characteristics that define good control working relationship in an
organization.
It is characterized by organizational chart, good communication control objectives and
supervision of personnel and activities.
Terry R. George (1963) enumerated the following characteristics of good internal
control environment.
(i) Personnel capable of performing their jobs well
(ii) A plan of organization that provides appropriate segregation of functional
responsibilities.
(iii) Control over access to assets and over access to important documents and blank
forms.
(IV) Periodic comparison of records with actual assets and liabilities and action to
correct differences.”33
(V) Supervision.
(i) Capable personnel
33 Tarry R George Principles of management Illionis, Richard D. Tirwing Inc, 1963 p.43
Personnel of an organization are the most vital feature of internal control. They are
the people that make the system to work and their problems cause internal control
problems. When inexperienced people are doing the accounting and control tasks, they
make more mistakes resulting to high accounting jobs turnover. New accounting officers
and managers unfamiliar with the organizational accounting are prone to technical and
judgmental errors and when competent accounting officers and employees do not adhere
to their improper accounting methods, they are fired.
Meigs and Meigs (1981) in their book, Accounting:
The Basis for Business Decision wrote “even the best designed system of internal control
will not work satisfactorily unless people assigned to operate it are competent”. 16
Each person involved must have a level of competence sufficient for the work assigned
and a willingness to assure responsibility for performance.
(ii). Plan of the organization
A plan of the organization according to Woolf, Emilie (1982) involves segregation
of responsibilities.34 (see figure 1)
Division of duties or appropriate segregation of functional responsibilities is
detailed in the organizational chart designed by the management for a good internal
control system. It is a necessary condition to make control procedures effective.
Four kinds of functional responsibilities should be performed by different
departments or different persons as the organizational accounting staff. 34 Meigs B and Meigs F. Accounting: The basis for business decisions, 5th Ed. Mc Graw, Book company, New york 1981 p.62 17 Woolf Eilie, Auditing Today, 2nd Ed. Prentice Hall International, englwood Cliffa 1982 p. 72
1. Authorization to execute transaction by people who have the authority and
responsibility for initiating the record keeping for transaction. It may be general or
specific.
2. Recording of transaction; a bookkeeping function delegated to a computer system.
3. Custody of assets involved in the transaction periodic reconciliation of existing
assets to recorded amounts for appropriate action with respect to any differences.
If these functions are done by different departments or persons, two things will be
achieved.
(a) Irregularities made more difficult because they would require collusion of two or
more persons, and most people hesitate to the help of others to conduct wrongful acts.
(b) By acting in a co-ordinate manner, innocent errors are more likely to be found and
flagged for correction.
(iii) Controlled Access
There should be limitation of access to assets and important record, documents, and blank
form to only authorized personnel. Access to assets like securities and inventory should
not be available to persons who have no need to handle them. Also people without record
keeping responsibilities should not have access to cost records and account receivables.
Blank forms such as blank sales invoices and blank cheques should not be made available
to person not responsible for them.
(iv) Periodic comparison
Recorded accountability for assets and liabilities is the responsibility of the
management. There should be a periodic comparison of recorded amounts with physical
existence to determine whether the accounting records-the recorded accountability
represents real assets and liabilities. However, person independent of the authorization
of related transaction accounting or recording or custodial responsibility should carry
out the periodic comparison. According to Alderman and Dietrich, (1981) the periodic
comparison may include counts of cash on hand, reconciliation of bank statement,
counts of securities, confirmation of accounts receivable and accounts payable etc. 18He
further stressed that a management that performs frequent periodic comparison has
more opportunities to detect errors in the records than a management that does not.
However, there should be a cost-benefit analysis before embarking frequent periodic
comparison.
Subsequently, there should be immediate corrective measures taken if any
difference is detected. Such comparison should be assigned functions of internal
auditors and other employees.
(v) Supervision
This is also an important element of control environment.
Management should make provision for the supervision of work as it an important
means of monitoring and maintaining a system of internal control. A supervisor could
oversee the credit manager’s performance or could periodically compare the sum of
customers’ balances to the accounts receivable control account total. Supervisor can
correct errors found by the clerical staff and make or approve accounting decisions.
18 Alderman and District, “Internal Adult impact of financial inform
Reliability” The Internal Auditor 1981 p.43
ACCOUNTING AND CONTROL SYSTEM
An accounting system processes transaction, records them in journals and ledgers
(computerized or manual), and produces financial Statement without necessarily
guaranteeing their accuracy.
An internal control system, however, is a set of client procedures (computerized
and manual) imposed on the accounting system for the purpose of preventing,
detecting, and correcting errors and irregularities that might enter it and flow through to
the financial statement.19
The least requirement for a good control oriented accounting system includes a
chart of account and some written definition and instruction about classification of
transaction. Depending on the organization, such material is incorporated in computer
system documentation, computer program documentation, system and procedure
manual, flow charts of transaction processing etc.
This documentation is often reviewed and evaluated by internal auditors, system staff
and subsequently by independent auditor.
Statement of objectives polices and procedures are all contained in the accounting
manuals. Management should approve statement of specific control objective and
assure that appropriate procedures are used to accomplish them. Control objectives can
be generalized into seven (7) categories – validity, completeness, authorization,
accuracy, classification, accounting and proper period.
19 lam perti A.F and Thurston B J. Internal Auditing for Management
New Jersey: Prentic-Hall Inc. 1953 p32
20Ibid p51
CONTROL PROCEDURE
A control procedure is an action taken for the purpose of preventing, detecting,
and correcting errors and irregularities in transaction.20 A control procedure should be
designed to accomplish the seven (7) control objectives which are validity, completeness,
authorization, accuracy, classification, accounting and proper period
2.5 IMPORTANCE OF INTERNAL CONTROL
Internal control is of utmost importance to every business enterprise regardless of the
size and ownership structure, mainly for profit maximization.
Management of various organizations recognized that internal control is a valuable
tool for efficiency in carrying out their responsibilities. It ensures that management
policies and direction are adhered to.
The management of a complex organization is at a distant from the scene of
operation, making its adequate supervision of employees impossible. As a result
management must rely on various control techniques to implement its decision and
goals, and to regulate various activities.
Corns c (1971) wrote that internal control is important for the following reasons:
(i) to protect weak people from temptation
(ii) to protect strong people from opportunity
(iii) to protect innocent people from suspicion21
21 Corns C. Marshall. How to Audit a Bank; Boston, Bankers publishing company, 1971 (viii|)
It is also useful to the auditors “true and fair” view of final account and this was
highlighted by the advisory statement made by institute of chartered Accountants in
England and Wales (ICAEW) to its members as follows:
“The auditors should aim to reduce their detailed checking to the minimum consistent
with the system of internal control and state which they find the records. If their
enquires and test satisfy them that the system is sound in principles and is carried out
in practice, then no useful purpose is served by entire detailed checking.22
The above statement shows that adequate internal control is relied upon by all users of
fine accounts in the acceptance of its true and fair view. Its importance to auditors is to
reduce the need for routine, mechanical verification of accurate recording, and
invariably using the less time –consuming approach that involves reasoning and
judgment, and stresses such activities as review, and evaluation and statistical sampling.
Generally, a good internal control is a key factor in the effective management of a
business enterprise. It is a means by which management can properly discharge its
primary responsibility for the reporting of adequate and accurate financial and operating
information to such interested parties as auditors and shareholders.
2.6 QUALITIES OF A GOOD INTERNAL CONTROL SYSTEM
Internal control system is internal and designed specifically to suit the organization
operations. That notwithstanding, there an certain essential characteristics which a good
internal control system must posses, and whose absence indicates that the system is
faulty.
35
In auditing standards and procedures, the predecessor volume to statement as auditing
standing N.O.I. states that internal control includes at least these characteristics.
1. A plan of organization which provides appropriate segregation of functional
responsibilities,
2. A system of authorization and record procedures adequate to provide reasonable
accounting control over assets, liabilities, revenues and expenses;
3. Sound practices to be followed in performance of duties and function of each of
the organization department; and
4. Personnel of a quality commensurate with responsibility.23
The above enumerated qualities are expected to a good internal control. The plan
of the organization ensures that no one department should be responsible for handling
all phases of transaction, and if possible, the division of responsibility should keep
operation and custodianship separate from accounting. Such divisions of responsibility
provide for the efficiencies derived from specialization and make possible a cross-check
that promotes accuracy and yet entails no duplication of wasted efforts.
For proper authorization and recording transaction, forms and procedures should
be designed, with the records of such transaction serving to establish full accountability
for all action. Devised means of classification of accounts and proof of accuracy are
also desirable. Sound practices and administration are achieved by reducing all
delegated responsibility and established procedures and policies to writing in form of
organizational chart, job description and procedures manual.
35 ICAW, statement of Auditing U4, principles of Auditing 23 Stettler H.F, Statement on Auditing Standards. No. 1
Severe screening of prospective employees for employment; training program for
employees’ development; and adequate remuneration, are all geared towards the
achievement of good internal control.
Helmes (1964) outlined the cardinal principles of internal control as follows:
1. Responsibility for the performance of each duty must be fixed. Without the proper
charge of responsibility, the quality of the control will be inefficient.
2. Accounting and financial operations must be separated. An employee should not
be in a position which he has control of both the records and operation giving rise to
entries in the records. For example, the person in charge of general ledger should have no
access to the cash or records of cash sales.
3. All available proofs of accuracy should be utilized in order to assure correctness of
operation.
4. No one person should be in complete charge of a business transaction. Any person
purposely or inadvertently will commit errors, but the probability is that an error will be
discovered if the handling of a transaction is separated between persons.
5. Employees must be carefully selected and trained for better performance, cost
reduction and more alert employees.
6. Employees should be bonded as it serves as a psychological deterrent to a tempted
employee.
7. Employees should be rotated on a job, and valuation for those in position of trust
should be enforced.
8. Operating instruction for each position should be reduced to writing. Manual of
procedures, promote efficiency and prevent misunderstanding.
9. The protective advantage of a double-entry system of accounting should not be
exaggerated. A double-entry system is not a substitute for internal control. Errors are
made under double entry; and the system alone will not prove omission, incorrect entry,
or dishonesty.
10. Controlling accounts should be used as extensively as possible. Controlling accounts
serve as a proof of accuracy between account balance and between duty-segregated
employees.
11. Mechanical equipment should be used, if feasible. Although error and manipulation
must be watched even when mechanical equipment is used, operating procedures are
facilitated, the division of labour is promoted, and internal control may be strengthened.24
Horngren C and George F (1990) enumerated the following checklist that
summarizes the guidance that is found in much of the system and auditing literature.
1. Reliable personnel with clear responsibilities.
A successful system depends immensely on honest, reliable and competent personnel.
Incompetent or dishonest individual can undermine a system no matter how well it is
designed and operated. Responsibility means tracking action down in the organization so
that results may be related too individual. Its psychological impact tends to promote care
and efficiency.
2. Separation of duties. This can be subdivided into 4 parts.
(a) Separation of the custody of assets from accounting
(b) Separation of the authorization of transaction from the custody of related assets.
24 Holmes A.W Op. cit p. 79
(c) Separation of operation responsibility from record keeping responsibility.
(d) Separation of duties within the accounting functions.
An employee should not be able to record a transaction from its origin to its ultimate
posting in a ledger.
3. Proper authorization- it can be general or separate. General authorization is usually
found in writing, setting definite limits for cost, price, credit limit to grant to customers.
Specific authorization means that a superior manager must sanction in writing any
particular deviation from the Limits set by general authorization.
4. Adequate documents- There are various types of documents and records, all aimed at
immediate, complete and tamperproof recording. All source documents should be
prenumbered and accounted for by the use of cash registers and locked compartment on
invoice.
Immediate recording for handling cash is achieved by use of cash register with loud bells
and compiling tapes and private detectives.
5. Proper procedures- For effective operations, most organization are to have procedures
manual, which will specify the flow of documents and provide information and
instruction to facilitate adequate record keeping. Routine and automatic checks are major
ways of obtaining proper procedures.
6. Physical safeguards – Assets such as cash inventories and records can be safeguarded
through the provision of safes, locks, guards and limited access. They are also used to
safeguard documents that provide access to assets.
7. Bonding, vacations and rotation of duties – To forestall temptation; top executives,
branch manager and individual who handle cash or inventories should have understudies,
be forced to take vacation, and bonded. Receivables and payable clerks should be
periodically rotated on duties.
8. Independent check – All phase of the system should be subjected to periodic review by
external auditor and internal auditor who have no contact with the operation under
review. The independent check extend beyond professional auditors to reconciliation of
bank statement with book balances, bank reconciliation conducted monthly by
independent clerks, monthly statement set to credit customers and periodic unannounced
physical counts of inventory to check against perpetual records.
9. Cost – benefit analysis-internal control system that is very complex, tends to strangle
people in red tape, so that system impedes rather than promote efficiency. Management
must ensure that the cost of installing and operating a system is not more than the
expected benefit.25
No framework for internal control is perfect in the sense that it can prevent some shrewd
individual from “beating the system” either by out right embezzlement or by producing
inaccurate records. The task is not total prevention of fraud, nor is it implementation of
operating perfection, rather the task is designing a cost – effective tool that will help
achieve efficient operation and reduce temptation.
Nwoko C. (1988) in summarizing the feature of a good internal control system
stated.
The internal control system should not revolve about a person, no matter how highly
placed otherwise in his absence, or when indisposed, there would be obvious flows. A
good internal control system should revolve around procedures, processes and
techniques. A good system of control should have among others.
1. Honest dedicated staff
2. Clearly defined and segregated duties
3. Effective countercheck system
4. Clearly authorization process for transaction
5. Adequate recording and documentation of transaction
6. Efficient procedures
7. Good physical security for stock
8. Reasonable staff rotation and vacation program
9. An enforceable code of business and ethical conduct
10. Spain of control and chain of command.26
Meigs, Lawson and Meigs (1979) states that reasonable assurance should be
provided so that
1. Transactions are executed in accordance with management general or specific
authorization.
2. Transactions are recorded necessarily. .
(a) to permit preparation of financial statement in conformity with general acceptable
accounting principle or any other criteria applicable to such statement; and
(b) to maintain accountability of assets
26 Nwoko C. Op. cit p. 14
3. Access to assets is permitted only in accordance with management authorization.
4. The recorded accountability for assets is compared with the existing assets at
reasonable intervals and appropriate action is taken in respect of any difference.27
For the above enumerated principles to be effective, it then follows that a good
organization must exist before an internal control system could work. The principles of
good organization as viewed by Lamperti and Thurston as follows:
(I) An organization should be built around main functions and not individuals or
groups. The basic pattern should be tailored to the needs of the business.
(II) Function should be broken down so as to promote balance
in the organization and avoid duplication, overlapping, neglect of essential functions,
over-emphasis on any one function to the detriment of another; no function should be
assigned to more than one independent use.
(III) Definite and clear cut responsibilities with commensurate authority, should be
assigned to each officer/executive
(IV) Delegation of authority should be explicit and placed close to the point at which
action occurs.
(V) Line function should be separated from staff with the other. A service and
advisory activity channels of command must not be violated by staff units. Span of
supervision usually ranging from a minimum of three to a maximum of some major
subordinates reporting to him
(VI) Every employee should know definitely to whom he reports and who reports to
him. No one should report to more than one line supervisor.
(VII) Organizational structure should be kept at a minimum
27 Meigs W.B, Lawson E.J and Meig R. Principles’ of Auditing, 6th Ed.; IIIionis: Richard O. Irwin Inc; 1979 p.141.
(VIII) Provision should be made for the co-ordination of related activities.
(IX) The organization should be flexible, capable of adjustment to changing business
condition. The plan should be adoptable to expansion or contraction.
(X) Each executive should be permitted to exercise the maximum initiative within the
limits of his delegated authority.
(XI) Organizational charts and manuals must be kept accurate28
In line with this, Waldren Roberts (1953) emphasized that
“There is need to prepare organizational charts on practical basis. The flow charts will
enable the weakness in the internal control system of the business to be pin-pointed;
quickly and accurately through the compliance of all concerned “29
The above measure taken to achieve a good internal control system is to
eliminate, or at least minimize risk involved in business to improve profitability. It is
done primarily to ensure that fraud is made impossible without collusion and very
difficult even with collusion. Moreso, it aims at ensuring that fraud or errors committed
are detected immediately.
It is pertinent to mention that of the aforementioned feature of good internal
control system, the feature that it should not revolve around individual, and its
application to all those employees of banks who have any responsibility or connection
with the operation of the bank from the lowest to chairman of the board, are the most
indispensable.
28 Lamperti A.F and Thurston B.J Internal Auditing for Management New Jersey, prentice- Rall Inc. 1953 p.22. 29 Waldson Roberts Auditing: A practical manuals for Auditing, 18th Ed.; London, Gee and company (publishers) Ltd. 1969 p.367
Generally, in designing a good internal control system, the personnel should be
segregated by functions into
(i) Those who initial or authorize transactions
(ii) Those who executive the transactions
(iii) Those who have responsibility for the asset, liability, expense or renewal resulting
from the transaction.
2.7 ESSENTIAL ELEMENTS OF FINANCIAL/ACCOUNTING INTERNAL CONTROL
There are principles which could be referred to as essential elements of internal
control. This shows that for internal control to work effectively there must be in
existence these essential elements. These elements include:-
(a) Sound organizational practices
(b) Sound personnel practices
(c) Written guides to policies and procedures
(d) Physical protection of assets
(e) Well-designed documents
(f) Supervision.
SOUND ORGANISATIONAL PRACTICES
The plan of organization mentioned in the definition of internal control underscores
the importance of sound organizational practices. Of particular importance is the
separation of assigned duties and responsibilities in such a way that no single
employee can both perpetrate and cancel errors or irregularities.
Kell and Ziegler (1980) defined sound organizational as tactical policy measures
taken by a company in creating a good control environment. The features of sound
organizational practice include-
(i) Carrying fidelity assurance on persons in positions of trust
(ii) Having a written code of officer and employee conduct pertaining to moral
standards of behavior and prohibition against illegal acts 36
(iii) Having a clear-cut conflict of interest policy relating to actions that incompatible
with company objectives.
(iv) Re-establishing a mandatory vacation policy for personnel in positions of trust 30
The separation of functions in often referred to as organizational independence. This
organizational independence can be effectively maintained by segregating those functions
involving custody of assets such as writing cheques or handling cash, from those
functions involving recording of transactions, such as maintaining the disbursement
journal or preparing the bank reconciliation.
The incorporation of an effective organizational independence into a system
makes it almost impossible for any single employee to successfully commit
embezzlement. In such a system collusion, or conspiracy of two or more persons to
commit fraud, may still be possible, but a well designed system can minimize the chances
of successful collusion.
SOUND PERSONNEL PRACTICES
Barry e. Cushing (1978) wrote on sound personnel practices “Both the safety of
assets and the reliability of accounting records are affected by an organization’s
personnel policies”31
36 Kell G and Ziegler E. Modern Auditing warren, Gorham, Lamount, Boston 1981 30 Kell G and Ziegler E. Modern Auditing warren, Gorham, Lamout, Boston 1980 p. 89
Also Meigs and Meigs (1981) in their book wrote “even the best designed system
of internal control will not work satisfactorily unless people assigned to operate it are
competent32
The qualification established for each job designation in an organization should
reflect the degree of responsibility associated with the position. Qualification for
responsible position may include a level of experience, intelligence, character, dedication
and capacity for leadership. Training programme should be carefully planned to
formularize new employees with their responsibilities. Polices with respect to working
conditions, salary increment, and promotion are very important and can be a powerful
force in encouraging efficiency and loyal service. Fidelity bond is essential for employees
in position involving direct access to property.
Annual valuation for personnel in key positions is necessary for someone else to
perform their function and discover cases of fraud committed if any. Periodic rotation of
duties for other employees is also important.
WRITTEN GUIDES TO POLICIES AND PROCEDURES
For sound organizational personal practices to work, there is need for manuals of policies
and procedures.
(1) The functions of the manual should include, description in detail the
responsibilities of each individual position in the organization, a feature which
makes them useful in training new employees.
(2) Giving an overview of the functioning of the system with respect to each type
of transaction so that the relationship of one employee’s functions to other is
clear.
31 Barry Cushing Op cit p 76 32 Meigs and Meigs Op. cit p. 70
(3) Detailed listing of the chart of accounts, in order to facilitate the accurate initial
recording of transactions.
(4) Encourages uniformity in data processing and financial operations, thereby
preventing the confusion and inefficiency which would result from
unnecessary inconsistencies.
PHYSICAL PROTECTION OF ASSEST
Nwoko C. (1988) in defining internal control included safeguarding of assets as one of
the purpose of management in installing and operating an adequate system of internal
control”33
The important factor in this safeguarding of assets is an adequate program of
physical protection. Access to cash should be limited to responsible employees.
Important documents or records should be stored in limited-access file cabinets or
perhaps a safe. Access to inventory storage arears should be limited.
WELL-DESIGNED DOCUMENTS
Barry Cushing (1978) in discussing the practice of well-designed documents wrote:
‘An important practice with respect to the design of any document used for control
purposes is the sequential prenumbering of documents. This practice makes it
possible to account for and review every document used in a process. Any missing
document would create a missing number in the sequence. This practice reduces
the like-lihood of fraudulent use of document by dishonest employees”34
Carefully defined and effectively used documents can contribute greatly to both
the safeguarding of asset and accuracy of records.
Source transaction documents should be designed to facilitate the collection of all
necessary information with respect to the transaction. Document which initiates a
transaction should contain a space for the authorization of the person or persons
charged with that responsibility. Transfers of reasonability for assets from one
department to another should be recorded in order to enable the pin pointing of
responsibility for any subsequent shortages,
In any business organization, the record-keeping system should be well
coordinated in other to facilitate the taking of individual transactions through the
system. The path which a transaction traces through a data processing system,
from source document to summary report is referred to as the audit trial, and it
consists of things as reference numbers, dates and names which are recorded in
files, ledgers and journals to facilitate the tracing of these records to source
documents or to records in other files. Good audit trail facilitate the correction of
errors and the verification of output information in a system.
SUPERVISION
Adequate supervision contributes to accuracy of records by reducing the
possibility that employees engaged in data processing activities will err in
recording situations with which they are unfamiliar. Generally, supervision is a
means of safeguarding assets in business which are too small to fully achieve
organizational independence.
2.8 SPECIFIC AREAS OF INTERNAL CONTROL
In order to understand, report and render an opinion about an organization’s
degree of internal control, attention should be given to some specific areas where
it is highly needed to enhance growth and survival. These areas include.
(i) purchase of assets or services
(ii) Sales of assets and services
(iii) Cash receipt
(iv) Cash disbursement
(v) Petty cash and postage
(vi) Bank reconciliation
(vii) Payroll
(viii) Marketable securities
(ix) Inventory
(x) Accounts and rates receivable
(xi) Fixed assets
(xii) Liabilities
(xiii) Journal entries
PURCHASE
The preliminary point to consider in reviewing the system of internal
control relating to purchases according to Vivian corper, is whether there is a
clear-cut division of responsibilities and definition of authority between:
(a) requisition of supplier or services
(b) placing of order
(c) inspection and recording of goods received
(d) processing and recording of invoices
(e) payment35
This as a matter of fact, follows that for the maintenance of proper internal control,
purchasing should be segregated from receiving, recording of purchases and from
payment.
The executive power to authorize and place order for any assets needed by an
organization lies with the purchasing departments. For the purchase of services, such
as labour, the personnel department has the responsibilities of both originating and
authorizing. To acquire fixed assets or professional services, the executive officers or
board will approve the acquisition. All daily or routine purchases made by the
purchasing department should bear the approval of a major executive. In organization
without separate purchasing department, the power to initiate all purchases is vested
on the individual whose purchases should receive the approval of another person.
SALES OF ASSETS AND SERVICES
Business enterprises make sales of either assets or services. Banks sell both assets
(e.g. Cash a liquid asset) and extend services to customers. The object of a sound
system of internal control for sales of assets and services is to ensure that customers’
order or loan requests in case of banks are properly executed and that the amount of
money leaving the bank or services rendered to customer, are covered by the issue of
invoices, which are duly processed37
and recorded in the books and subsequently repaid. This require that there should be
segregation of duties and responsibilities for
(a) Accepting customers’ order
(b) Control and dispatch of goods/loan
37 Vivian Corper R.V Manual of Auditing Gee & Co (publisheds) 151 stand, London wez 1972 p.56
(c) Processing and recording invoices
(d) Cash receipts function
CASH RECEIPTS
Many organizations incur great losses because money is received in the offices and
retained by an employee who received it without paying it into the company’s cash or
bank balance. The system of internal control should therefore be designed to ensure that
all remittances received are properly accounted for and recorded in the books. Control of
cash receipt is principally the problem of separating the function of handling of the cash
coming into the client’s office.
The same person who opens the mail should not be the person who is responsible
for making up the bank deposit or the person who credits the accounts receivable for
payment received, or the person who goes to the bank, or the person who keeps the
general ledger or the person who reconciles the bank accounts.
An independent person should receive duplicate deposit slips duly authenticated
by the bank. The receipt for each day should be deposited intact in the clients’ bank
account. Cash expenditure should be made from a separate petty cash fund, instead of
from daily cash receipt. All account receivable credit, cash received from sales, services
or any one are totaled and compared with the daily bank deposits as shown on the
duplicate deposit slips. An independent person who does not have access to sales invoice,
sales record or accounts receivable records should handle and record cash.
CASH DISBURSEMENT
Procedure for cash disbursement is a critical issue in internal control. For its
control, it is necessary that there is a separation of activities of invoice approval,
recording of the payables, preparing the cheques in payment of invoice, controlling the
cheques and reconciling the bank accounts.
All cheques should be prenumbered and a very rigid control should be kept over
the cheques and cheque books not being currently used. All spoiled or unused cheques
should be retained and all cheques number accounted for. A cheque protector in custody
of the person responsible for the preparation of the cheque should be used. Every cheque
should bear two signatories and no blank cheque should be signed by one of the two
persons required to countersign the cheque because this is the same as requiring only one
signature on a cheque. Cheque presented for signature has the supporting documentation
attached to it.
PETTY CASH AND POSTAGE
It is preferable to keep petty cash on the imprest system with small amount and the
petty cash book or vouchers should be produced to the signatories of the reimbursement
cheque, who should initial the petty cash book as evidence of approval of payment. The
petty cash fund should not be replenished at reasonably short interval. The custodian of
the petty cash should not be the same person who prepares the petty cash replenishment
cheque, and also have no access to the cash receipt or disbursement function of the
business. Prenumbered vouchers approved by an independent person should support any
expenditure made from petty cash. The vouchers with supporting documents should be
properly controlled and canceled at the line the disbursement cheque is drawn, to
preclude their further use.
The petty cash book should be regularly examined, and surprise accounts made of
the cash balance, by a senior official entirely independent of record keeping. Vouchers
for traveling and entertaining expenses should be supported by the persons incurring
them and should be supported by documentary evidence. The vouchers should be
approved by a responsible official for junior staff and by a director for senior or executive
staff.
BANK RECONCILIATIONS
An independent employees who has no responsibility of cash receipts or disbursement,
should reconcile the bank account promptly and monthly. The official should receive the
bank statement and paid cheques direct from the bank.
In reconciling the bank account, all cheques should be examined with attention to
the apparent validity of the signature; also the endorsement on the cheque should be
compared with payee as shown on the face of the cheque. The official should also
compare the debits and credits shown on the bank statement with the cash book. Also a
comparison of the paid cheques with cash book as to names, dates and amount will be
carried out. These will be a test of the detailed paying in slips with the cash book.
PAYROLL
The system of control of payroll is dependent on the size and nature of the
business but generally, the procedure involves:
1. Hiring, promotion, transfers and discharge of employees.
2. Time attendance
3. Compilation of payroll and wages analysis; individually and in total
4. Make-up and paying the employee
Without proper precautions taken, payroll manipulation may be accomplished
by an individual. But the collusion of employees make fraud comparatively
easy, however tight the system might be.
The principal features of a sound system of internal control for payroll
according to Holmes are as follows:
(a) There should be a proper separation of the above duties to prevent
collusion, payroll padding, and to facilitate the work of the various persons
charged with payroll duties toward the proper computation of the payroll.
(b) History records should be kept of each employee by the personnel
department if any.
(c) Payroll records usually made up of timecards, an individual earning record,
and a payroll journal are maintained by different individuals.
(d) A paymaster who is not a member of the accounting department or the
person who originally computed the payroll should pay the employee.
(e) The employee must be given a statement of his gross earning, deduction
and net cash or cheque received.
(f) Unclaimed enveloped or cheques are returned to the accounting
department, and the paymaster or a payroll clerk retains the unsigned
receipts until the wages are claimed or are returned to general cash or to a
specific fund.
MARKETABLE SECURITIES
Securities should be purchased and sold only under proper authorization. For
internal control, there should be a separation of the function of the custodian from those
who record transaction relating to marketable securities. Subsidiary records containing all
the necessary information about the securities should be maintained and kept under
control. These records should be regularly reconciled with both the control accounts and
the actual securities themselves. The securities and their interest coupon should be kept in
a safe-deposit box, or in bank vault or fire proof safe and access to the safe or vault be
forbidden to any one person alone.
INVENTORY
Proper inventory control prevents theft and misuse. Inventory is a single largest asset of a
business and, consequently, there may be loss resulting from inaccurate record keeping or
dishonesty of employees in connection with these assets than in connection with other
assets.
There should be in operation, a perpetual inventory system and the maintenance of
general ledgers controlling accounts. The stores clerk or accounting department may be
in control of inventory. An individual should be responsible and sign for all the materials
received and issued from the store rooms. A controlling accounts record of the receipts,
issues and inventory balances should be kept in the accounting department. Periodically,
this department will make its entries in summary form. The record of the store keeper in
summary form and records of the accounting department should be in agreement.
A properly authorized requisition authorizes the storekeeper to issue materials from the
store.
The controlling accounts, the sum of the perpetual inventory accounts, and the
results of a physical inventory should be in agreement.
ACCOUNTS AND NOTES RECEIVABLES
The control here is the safekeeping of both the notes and the receipt accompanying
their settlement. The element of control is that the subsidiary ledger should be regularly
balanced with the control accounts and any difference should be investigated thoroughly
and carefully. Any person other than the person that does daily book-keeping activities in
the subsidiary ledger should balance it. The general ledger bookkeeping should be done
by someone other than the accounts receivable and notes receivable bookkeepers.
FIXED ASSETS
Fixed assets should be controlled like any other asset including physical control. They
should be supported by subsidiary plant ledger accounts and acquired only upon proper
requisition and authorization. Fixed asset retirement should be properly authorized, and
accounts department notified for proper account entries. Fixed assets should be guarded
against theft and frequently compared with the properly inventory records.
LIABILITIES
A liability results from the acquisition of an asset, the incurrence of an expense, or the
conversion of another liability. The internal control of these liabilities is concerned
mainly with the verification of the occurrence of such liabilities before payment. Their
major internal control procedure includes separation of accounting and bookkeeping
functions from the signing of cheque and the authorization of the payment.
Proper internal control ensures their occurrence was authorized and the subsequent
liquidation made at the proper time, in order to take advantage of discounts, to maintain
good credit rating and to comply laws.
JOURNAL ENTRIES
The principle of internal control is that all general entries should be properly
authorized and approved before being entered into the general records. This will forestall
any diversion of assets by means of authorized or arbitrary write-off of assets, or increase
in liabilities. Accounting function should be separated between the person authorizing
journal entries and the person whose duties include the entering and posting of these
entries.
2.9 USERS OF INTERNAL CONTROL SYSTEM
The main users of internal control system are the following:
(a) Management
(b) Directors
(c) Independent auditor (d) Creditor
MANAGEMENT
Management is usually responsible for the design, installation, and operation of an
internal control to meet the organizational objectives and also ensures the maintenance of
its operation adequately. The control system is useful to the management for the
following reasons:
(1) It help in the adequate safeguarding of assets
(2) It helps for easy location of responsibilities
(3) It helps in detecting, eliminating and preventing frauds and errors.
(4) It provide for immediate corrective measures taken in event of error detection
(5) It helps to protect the employees from suspicion.
DIRECTORS
There are two types of directors in various organizations.
They are executive and non-executive directors.
The executive directors are the employees of the organization. They take part in
the policy decision of the organization with respect to their individual department and
implement such decision in the day-to-day activities of the organization.
The non-executive directors are external bodies representing mainly the
shareholders of the organization. They take policy decision on a long term issues
embracing the whole organization. They are responsible to the shareholders and do not
take part in the day-to-day operation of the company but can interfere in exceptional or
emergency cases.
Their interest in the internal control system is as a result of its ability in giving
them the idea of how stable and functional the performance of the entire organization is.
The internal control assures the directors the possibility of achieving the
organizational objective for example, one expects that a well designed, installed and
operated internal control will enhance profitability which is the major objective of any
business set-up than enhancing the possibility of realizing high dividend from invested
interest. This shows that the shareholders whom the directors represent also make use of
the internal control indirectly.
INDEPENDENT AUDITORS
An independent auditor is an external auditor who is invited periodically on
contract bases to audit the performance of the organization. Internal control therefore
helps the auditor in carrying out his/her auditing functions. It also enables him/her to
ascertain the degree of reliance which he may place on the accounting records of the
organization.
The extent of adherence to the internal control policies and procedure will
help the auditor in determining whether transactions were reflected in the accounting
records. The auditor can perform the following test (walk- through-test, weakness test,
rational tests, vouching audit) depending on the nature and extent of internal control. The
results of this test will determine the extent of reliance the auditor should place as the
internal control system of the organization.
It is pertinent to note that however tight the internal control might be, the auditor
cannot express an opinion based on the efficient operation of an internal control system.
CREDITORS
Creditors also make use of the internal control system of the organization in which they
deal with or intend to deal with. When the internal control system is weak, there is an
enhanced chances of committing frauds and errors which will ultimately reduce the
profitability of the organization and also its ability to settle liabilities as and when due.
This will automatically affect the credit facilities extended to the organization by
creditors, who on learning about the weakness in the control will not give their credit
facilities.
2.10 ELECTRONIC DATA PROCESSING (EDP) AND INTERNAL CONTROL
With the introduction of an EDP system in an organization a new control is
established to replace each old control lost. This new internal control in EDP ensures that
the same balance of control or risk exiting in old system is maintained.
The EDP unit is usually established as a separate responsibility centre,
independent of employee originating or authorizing source data and of employees using
or approving end results. In additions, controls are established over employees operating
equipment by a strict accounting for processing and rotating operators between shifts.
The accuracy and reliability of a computer-based system can be achieved only
with conscious planning designed to ensure satisfactory results.
According to the auditing standard executive committee of the American Institute
of certified Public Accountants, the objective and essential characteristic of accounting
control do not change with the method of data processing. However, the organization and
control procedures used in EDP may differ from those used in manual or mechanical data
processing 38
The management of the organization should therefore install and maintain internal
control system which EDP is in use. Its operation should therefore alien with all other
departments of the organization for proper co-ordination.
INTERNAL CONTROL IN EDP
Steller identified two major types of internal control in EDP. They are General and
Application controls37.
GENERAL CONTROLS
General control embraces all EDP activities and
Kenvironment which include the following:
(a) A plan of the organization and operation for the EDP activity.
(b) Procedures for documentary, reviewing, testing, and approving system or
programs and changes therein.
38 AICP Auditing standards Executive Committee New York, 1974.
(c) Built –in equipment also referred to as hardware control
(d) Controls over access to equipment, programs and data files.
Kell and Zieglar in addition to the four above attributes, included other data and
procedural controls affecting overall EDP operations. 38
ORGANIZATIONAL AND OPERATION CONTROLS
The data processing department may be an independent department from the accounting
department or both may be under the chief financial officer. These organizational
controls involve the segregation of responsibility between the EDP department and the
user department such as accounting, marketing, personnel and purchasing. For adequate
internal control the head of the EDP department should report directly to an executive
who is not involved in the day-to-day operation of the business.
Within the data processing department, a major concern of organizational control
is the programming activity. The most effective protection against programming error of
the EDP should be lodged with different people to achieve maximum internal control.
Different person should be responsible for system analysis and designs, computer
operation, data entry,
card, taps, file, diskpack library and storage.
A hypothetical organizational chart of an EDP department is presented below.
HEAD OF COMPUTER DEPARMENT
System
analyst
Programmers
Computer
operators
Data entry
operators
File
Librarian
Control
group
37 37 Steller H.F Op cit p.524 38 Kell and Ziegler op.cit p. 30
Fig. 2 Organizational chart of the EDP department
For effective control measure, errors other than the one originating from the EDP
department should not be corrected by EDP personnel.
Further, workers in the EDP department should not authorize or initiate transaction
or have auditing of non EDP assets.
Documentation, Review And Testing Controls
Documentation, review and testing control are all system development and
documentation control. In designing the system; user department, accounting and internal
audit department must be adequately represented. Management and user department must
agree and approve each system of control.
Documentation consists of work papers and records which describe the system and
procedures for performing a data processing task. It is a basic means of communicating
the essential elements of the data processing systems and the logic followed by the
computer programs.
Full documentation of all program is an important supporting element of internal
control in the organization area. A lack of documentation is an indication of a serious
weakness within the management control over a data processing installation.
Debugging and program testing are programmer responsibilities but the
programmer in carrying out these responsibilities should not have direct access to the
computer or to programs or data file. All inputs should be handled by authorized
computer operating personnel.
Any new program or changes in existing program should be reviewed at a higher
level before they are approved and authorized for introduction into the system.
Hardware control
Hardware controls are controls built into the equipment by the manufacturer to detect any
malfunctioning of the equipment. The control may be either automatic or programmable.
Some of these in built control measure include:-
1. Dual-read an automatic control in which the records on cards, tapes or random
access media are read twice. The result of both read operations are thus compared
internally in the machine for accuracy.
2. Read-after-write is another automatic control which helps the computer to read
back the data after they have been stored for comparisons with their original
source.
3. Parity checks is also automatic control system that checks the accuracy of data
within computer system. All data transfer is subjected to it to detect dropped or
added bits.
4. File project rings is a kind of programmable control that must be physically
removed before it is possible to erase and write out a file thus helping to avoid
accidental destruction of data by writing over a file that contains “live” data.
5. Boundary protection is a control that permits section of the main core memory to
be locked out to prevent accidental access and alteration to the stored programs
under which computer is operating.
6. Echo check: This involves the transmitting of data received by an output device
back to the same unit for comparison with their original source.
Access and Environmental Control
Access control involves making the computer operations area a “secure” area by
physically limiting access to authorized persons, while environmental control includes
the protection of hardware and data storage media from temperature, humidity, and dust.
Data and Procedure Control
There is a control group in the EDP department that monitors the daily computer
operation, as an internal auditor. Some of its function includes:
(i) Receiving and screening all data to be processed
(ii) Accounting for all input data
(iii) Monitoring the distribution of output.
(iv) Following up on processing errors
These data and procedural controls are function of the control group as
recognized by Kell and Ziegler and Emille Woolf.
General controls are furthermore supported by the following:
(i) Fire protection of secured areas to avoid the loss of data or processing capacity.
(ii) Maintenance of adequate written manual to support systems and procedures.
(iii) Storage outside the premises so that organization in case of destruction of
document within the organization can lay hands on vital information.
(iv) Ensuring that the environment in which files are kept is safe and fire from
factors that can cause physical deterioration such as humidity and heat.
(v) Replacement or reconstruction of lost or damaged files.
Application controls
Application controls assure that recording, processing and reporting of data are
properly performed. They include
(1) Input controls
(2) Processing controls
(3) Output controls
Input controls
Input controls are designed to authenticate the contents of source documents and
to check the conversion of source documents and to check the conversion of this
information into machine readable formats or media. These controls ensure that input
materials are:-
(a) Properly authorized
(b) Converted into machine-sensible form, and
(c) Subsequently accounted for.
Input authorization generally originates from the managers of the users department either
in form of stamps or signature on the source documents. Some authorization such as the
determination of Economic order quantity (EOQ) and initiation of recorder level when
inventory reduces are done by the computer itself.
Emile Woof also identified other input controls to include the following:
(i) Print out-This is to provide printed list of all items included in the input.
(ii) Check digits-This involves attaching a code to each number in the input
data to make it comply with a simple formula.
(iii) Parity check-The computer may be built into operate parity codes such as
inserting for example binary digit. This affords the computer the
opportunity to reject any character that does not conform to the parity codes
when it is reading data in.
(iv) Tapes labeling-In this an identifying label is included in the input tapes.
This label will contain details of the application, the date the tape was
made, its sequence, and also the “scratch data”. This will help to prevent
the destruction of records and also the processing of irrelevant data.
These controls generally include the rejection, correction and re-submission
of data that were initially not corrected.39
Processing controls
The codification of statement on auditing standards of the American
institute of certified public Accountant (ACCPA) looks at processing controls as
ensuring that all the data processing have been performed according to plan, that is
to say all transactions are processed as authorized: No authorized transactions are
omitted, and no unauthorized transactions are added. 40
Processing controls include regular processing control divided into
hardware controls and programmed control. Programmed control include label
control, total check controls and limit control.
(i) Label control-This involves both external and internal labeling. External label
permits visual identification of a file. Internal file labels are matched with
specific operator’s instruction incorporated into the computer program before
processing can begin or to successfully complete.39
(ii) Controls totals- There control entail balancing of the input totals with the
processing totals for each run by computer.
39 Emilie Woolf Op Cit p.80 40 AICPA Op. cit
(iii) Limit controls-involve comparison of processing result with a programmed
limit, before the computer is permitted to use the result for output or further
processing.
(iv) Cross footing test: This provide assurance that the sum of a series of
classification totals equals to total of the amount being distributed.
(v) Computing editing of input data-In this case, the computer reads the input
twice and compares the result to ensure that data is transferred to the storage
section of the computer only when it has been proved accurate.
Other type of programmed control is the printing of console messages for operator
direction, and programmed tests to determine whether equipment and switch setting
are correct.
Output controls
These controls are designed to assure the accuracy of the processing results such
as account listings or displays, reports, magnetic files, invoice or disbursement checks
and to assure that only authorized personnel receive the output.
It is generally a process of checking if the operation of input control and program
and processing control has produced the proper result.
Output controls involves the following.
(a) Reconciliation of totals. This involves reconciling output totals to input and
processing totals by the user department, the data control group and/or the
computer program.
(b) Control over the distribution of output by the data control group through a report
distribution sheet.
(c) Comparison of source document in which output data are subjected to detailed
comparison with source documents.
2.11 BANKING APPROACH TO INTERNAL CONTROLSYSTEM
Usman E. Bello (1985) in one of his lectures titled “Fraudulent Activities in
Banks” stated that “Banks strengthen and effectively enforce their internal control system
so that it will be impregnable to would be fraudsters. As a result, banks concentrate more
on preventive rather than curative measures to combat frauds in banks. While we may
learn our lessons from a given event that has taken place, it is by and large, better to
prevent the event from taking place. Banks should include ways of monitoring the
activities going on in the bank. The rule is that nothing is left to chance”41.
Banks like any other profit-oriented organization design and install a system of
internal control specifically to achieve their organizational objectives. Banks
management, regardless of the incessant fraudulent activities in the banking system, still
maintains a tight system of control to restore the confidence of both shareholders and
public on their potentialities.
There are two categories of internal control system in banks. According to corns
Marsh” a good internal control
program consists of two distinct parts; Viz: Rules and regulations, and proof and
balances.
1. Rules and regulations:
There are those guides of conduct or procedures established for the purpose of preventing
a person from handling an entire transaction without having their work checked by
another person, guarding against one person exercising complete charges over an entire
department, division or section without someone exercising right of approval and
41 Usman E Bellow, Fraudulent Activities in Banks. Business times
March 25 1985,p.23.
preventing one person from maintaining sole custody and control over subsidiary or
major control accounts.
The principles, rules and regulations under an internal control system cover the
following phases of bank operation and management.
1. Compulsory annual valuation by all officers and employees.
2. An established procedure that will make no person indispensable pertaining to
such duties as reconcilements, complaints, confirmations etc as any person can
handle the work if given time and assistance.
3. The segregation of all inactive or dormant current and saving accounts and the
placing of such accounts under dual control.
4. The establishing of a procedure under which all customer complaints shall be
referred to one person who is not actively connected with operations,
5. An unsystematic but periodical rotation of individual and saving book keepers.
6. The setting up of dual control over all bank official checks, such as cashier
checks, drafts, certificate of deposit, expenses vouchers etc.
7. Segregation of paying and receiving function from book-keeping and other
accounting functions.
8. Periodical exchange of cash assets between tellers (cashers) under official
supervision and verification of saves.
9. Periodic rotation of all personnel whenever possible
10. The daily review and initiating by an officer, of all general ledger tickets.
11. Frequent test checking of signatures on cheques with resolution and signature
cards, having authorization for all withdrawals from savings and current
accounts on file.
12. Approval by an officer, other than the person handling the purchasing, of all
purchase orders, and the establishing of a system of approvals covering the
payment of all invoices.
13. Substitution of the regular signature card with a typical signature on all
accounts whose balances are carried on the inactive or dormant ledger.
14. Annual review of salaries paid all personnel together with a review of their
duties and responsibility and appraisal of their value to the bank, prior to the
time, one of the senior officers has had a conversation with each employee and
determined any change in the status of his domestic life, such as illness, deaths
etc.
2. PROOFS AND BALANCES
They are established procedures that check to determine whether the work
performed under the daily routine or system, balances and are correct with regards to the
balance sheet operations.
The principal factors covering proofs and balance as applied to internal control
system generally cover the following:
1. Periodic trial balancing and proofing at undeterminable times of the savings
and commercial ledgers, by employees other than those regularly employed in
the department.
2. Reconcilement of “Due from Bank” account by an employee other than the one
who is responsible for issuing bank draft or posting general ledger entries.
3. Periodic spot checking and verification of interest income in investments,
4. Periodical mailing of cancelled cheques and statements to current account
customers.
5. Periodical balancing up of saving pass-book at interest times and refiguring of
interest paid by some one other than the person ordinarily employed in the
saving department.
6. Periodical verification of merchandise received for which an expense voucher
has been issued.
7. Periodical test checking of the purchase price with the market quotations on all
purchases and sales of securities.
8. Periodic verification of loans and collateral pledged by directly confirming
balance outstanding and security pledged with borrowers.
9. Periodical paying of signatures on cheques drawn on current accounts by
person unfamiliar with the signatures, necessitating the reference to the
signature cards and resolutions.
10. Tracing back to the respective income accounts, all interest income from loans
for a specific period of time.
11. Verifying, by suitable means discrepancies in date on deposit tickets of savings
and current accounts.
12. Prohibiting any teller or cashier plugging his cash at the end of the day in order
to effect a balance.
13. Compulsory reporting of all cash difference, irrespective of amount.
14. Subjecting, all tellers or cashiers found to have a ‘KITTY’ to investigation and
dismissal.
The establishing of internal control, which is not a guarantee against crimes being
perpetrated, is a forced weapon in that it is evidence of supervision and policing, and
has the effect of keeping the person, who might be inclined to commit a crime, if the
opportunity presented itself, off balance. This factor is magnified and increased to the
extent that proofs and balances procedures are placed on a surprise bases where the
timing is unknown except to few.
2.12 EXPECTED QUALITIES OF A BANKING STAFF FOR EFFECTIVE
INTERNAL CONTROL SYSTEM
According to sanrocki, there are eight (8) qualities expected of a staff to ensure
effective system of internal control. They include the following.
1. HONESTY -A staff is expected to be honest in carrying out his/her banking
activities. This honesty will enhance the growth and profitability of the bank by
ensuring an adequate system of control.
2. TACT - A staff should be tactful in dealing with customer so as to avoid
unnecessarily irritating them. A banker should endeavour to be polite, pleasant and
understanding in relating to people. But nevertheless, a banker should be firm, exact
and strict whenever circumstances demand that.
3. COMMON SENSE -Common sense can be defined as “practical good sense” or
“good sense in every day affair”, or practical intelligence”. Thus a banker in carrying
out his/her duties should exhibit common sense.
4. METHODICAL AND PAINSTAKING NATURE - Banking work is mainly
mechanical and routine in nature, and therefore should be thoroughly and carefully
done. To achieve this, a staff must adopt methodical and painstaking nature.
Unnecessary fastness should be avoided as this can lead to a lot of mistakes before a
book can be balanced. Example, a cashier who is always in a hurry to go home ends
up making numerous mistakes unabling his/her to balance her work at the end of the
day. This, however, does not call for dullness in carrying out one’s job.
5. PRACTICAL NATURE -The practical nature of a business must be understood
by the staff. The staff must master the business accounting system and have
reasonable technical knowledge of the activity he/she is to control. Emphasizing
more on this, is the publication of international labour organization on cash control
using a cash register which mentioned “the essence of proper instruction or training”
It further stated that training” of cashier is very important as the reverse will lead to
frequent shortages and overs”
6. Capacity To Search And Explore - The capacity to search and explore
means the ability to ask the right person, the right question, at the right time and in the
right form. The question though may be somewhat unpleasant and embarrassing,
should always be in the right form. This required both skill and courage.
7. Capacity to Assess, Evaluate and judge - This means the ability to assess,
evaluate and judge both fellow staff and customers. This helps to arouse your interest
or suspicious in fraudulent practice. Besides, it will also help a staff to ascertain the
degree of carefulness and integrity of everyone around him/her.
8. Capacity to work independently - The staff must have adequate knowledge
of his/her duty, doing it independent of direct or indirect pressures. The courage to
say NO whenever situation demands is very good quality expected of a banker.
SUMMARY
The importance of internal control in any organization can not be over-
emphasized. It is being recognized as an essential aspect of organization because of its
numerous benefits to the management, external auditors, shareholders and the public.
It can be seen from the literature review that internal control affects all aspect of an
organization.
It is pertinent to note however, that though an extensive literature review had been
carried out on internal control and an elaborate investigation into the studies carried
out by various academicians and authors none has been able to provide a solution to
the incessant crime-way or fraud pervading various organizations by recommending
adequate internal control system to be adopted.
This study therefore, after identifying this key problems aims at recommending or
suggesting a good system that will ameliorate the adverse situation.
CHAPTER THREE
THE RESEARCH DESIGN, SCOPE AND METHODOLGY
3.1 THE RESEARCH DESIGN
Research design was defined by Donald Tull and Del Hawking as “the
specification of procedures for collecting and analyzing data necessary to define
and/or solve the problem”.
Certain methods and procedures were adopted in the collection of all vital
data needed for achieving the objectives of this research, solving the outlined
problems and testing the hypothesis. They were also vividly patterned and
implemented in accordance with the faculty approved guidelines.
In doing this work, the researcher took certain points into consideration. Such
points are as follows:
i). Procedures for collecting and analyzing relevant data must be specified.
ii).The entire work must be as economical as possible.
iii).Constraining factors such as time, human elements particularly the negative
attitude of bank staff towards questionnaires and interviews and also their policy
against the release of vital information must be considered.
iv). Adequate test validity must be ensured by the researcher
3.2 SCOPE
The researcher intended to evaluate the existence and staff adherence to the
internal control system in various arms of the bank.
The study covered the two major areas of internal control
i) Administrative internal control
ii) Accounting/financial internal control
The specific areas covered in the study include those areas contained in the
questionnaire as follows:
i) Electronic data processing
ii) Purchases
iii) Cash receipts and disbursement
iv) Petty cash management
v) Payroll
vi) Fixed assets
vii) Impact on profit performance
viii) Adherence to the feature of good internal control
POPULATION
Data collection was made from a sample of population covering all main
offices and branches of Orient Bank Nigeria Plc and United Bank of Africa Plc
within Enugu State.
3.3 METHDOLOGY
For the purpose of this research work, both primary and secondary sources
of data were gathered and used.
PRIMARY SOURCES OF DATA
Primary data refer to initial information collected by the researcher for the
study. These data are the first hand information collected and aimed at making the
research original. Our primary data were collected from head offices and branches
of the banks within Enugu municipality.
The respondents were mostly the bank officers.
The researcher, in obtaining primary data, used three (3) sources as follows:
i) Oral Interviews
ii) Questionnaires
iii) Observation
ORAL INTERVIEW
Oral interview is a technique of asking questions and obtaining explanations
on issues for clarification purposes. It helps to provide reliable and valid
information in the form of verbal responses from respondents in order to confirm
or reject hypothesis. Its primary value lies in corroborating other evidential matter
and finding out matters or issues that merit further investigation.
Interview could be structured, unstructured, or specific organized interview.
STRUCTED INTERVIEW:
An interview is structured when prepared and predetermined questions are
asked and repeated to different respondents. This means that the same questions in
a given order are presented to different respondents. It has the disadvantages of
being rigid and deters in-depth probe. It is however, more scientific than
unstructured interview and could allow for scientific generalization based on data
obtained.
UNSTRUCTURED INTERVIEW:
This is an open-ended and flexible interview and therefore, allows the respondent
free expression of thoughts. It provides no restrictions and has greater flexibility
than the structured interview. It gives the researcher a wider scope to make an in-
depth probe which affords the respondents unrestricted freedom to express their
thoughts. Questions could also be restructured to suit the respondent’s direction of
thinking, his environmental influences and the prevailing occasion.
Its major disadvantage is, its inability to provide information that would be used
for generalization that can enhance wider applicability. Since it lacks basic
scientific ingredients, quantification of data becomes difficult and therefore, cannot
afford a strong basis for testing Hypothesis.
SPECIFIC INTERVIEW:
This form restricts the interviewers structuring of questions along a specific line. It
restricts the respondent’s discussion to a specific issue and therefore, the
respondent cannot deviate from the outlined area, but can make in-depth discussion
on it.
The researcher, in carrying out this study, utilized structured form of interview for
testing the hypothesis whose questions are supposed to be in questionnaire but are
not.
The unstructured form of interview was used to help in general understanding of
banking sector’s operation to have a firm basis of data collection and collation.
Finally, in areas concerning the hypothesis, research problems and objectives, the
specific form of interview was used.
QUESTIONNAIRES
A questionnaire is a research instrument that consists of a series of questions
relating to the area of study, which the respondents fill. It is aimed at eliciting the
feeling, beliefs, experiences or activities of respondents that will be used to test the
hypothesis.
Some questions in the questionnaire are usually phrased in a manner that results in
either a “yes” or a “no” responses.
The questions contained therein are structured and pre-determined thereby
minimizing the possibility of eliminating vital aspects of the study area.
Various forms of presenting questionnaires exist:-
a) Direct Contact: this provides the researcher the opportunity to present
the questionnaire personally to the respondent. It helps to remove all
unnecessary bias, as the researcher explains certain points and
emphasizes the significance of the study. It has the disadvantage of being
very expensive and time consuming.
b) Mailed questionnaire:- this, depending on the degree of efficiency of
the postal service, ensures wider coverage. It has some disadvantage over
the direct contact
1. The return of answered questionnaire by mail may be very low especially
where people do not appreciate the importance of the research work.
2. Personal bias of respondents may render the data irrelevant due to the nature
of the research work and the geographical area covered, the researcher
adopted the direct contact form of questionnaire administration. The
impersonal nature of this questionnaire ensures some uniformity from one
measurement situation to another.
QUESTIONNAIRE DESIGN:
The questionnaire was the major research tool used. In designing it the following
were taken into consideration.
i. The academic level of bank officials
ii. The research objective
iii. The research problem, and
iv. The research hypothesis.
It is pertinent to say, that the questions contained were drafted in such a way
that its answers will test our previous stated hypothesis, provided solution to the
identified problems and achieve the objectives of the study.
The questionnaire was administered to all the sensitive officers of the bank,
within the branches covered. It was intended to elicit information regarding
administrative and accounting/financial controls.
It was designed on the basis of department of both banks. Eight (8) departments
were studied in each bank.
For the various departments, questions were arranged such that they start
and/with simple questions while the complex ones come in between.
This arrangement took cognizance of the fact that if complex questions came
first the respondent might loss interest and if they came late fatigue might set in.
Most of the questions contained therein required Yes or No, Not applicable or
comments. The provision made for comment enabled the respondents to bare their
minds on facts they feel that cannot be accommodated in the Yes or No answer.
Generally, questionnaire validity is affected by response consistency problem,
questions were made very simple and unambiguous; the number of were reduced
mainly to most essential area of the subject matter.
To ensure high rate of response and return of filled questionnaires certain
measures were taken, these measures include.
1. The period of completion of questionnaire was between twenty to twenty
five minutes
2. Information regarding respondent’s identity were purposefully avoided
since it was neither necessary nor relevant.
3. Questionnaire were administered personally to enhance the explanation of
technical terms which otherwise would increase the degree of bias by
respondents.
4. Questionnaires were cross-checked before collecting, to eliminate and
correct all irrelevancies.
5. Collection of questionnaires was mainly done when the banks had closed
their doors to the public as this gave room for detailed discussion.
6. The researcher made several calls and waited for discussion at the officer’s
convenience. Care was taken to identify questionnaires collected from the
two banks.
OBSERVATION
Observation involves the personal witnessing of performance. It has been defined
by Goods and Hatt as a direct means of studying the overt behaviour of people.
The researcher here has the opportunity to acquire direct personal knowledge about
the subject matter. It helps for easy assessment and recording of information as the
action goes on.
It is pertinent to note that the degree of usefulness of observation as a scientific
research tool to any researcher depends on the following:
(i) It must have the capability of addressing vital issue that relates to the
research problem and objective.
(ii) The extent to which the researcher is able to interpret the observed action.
(iii) The planning and recording system must be related to the research
hypothesis.
(iv) The researcher should ensure that the recording observed information is
valid and reliable.
There are various types of observation which could be grouped into controlled and
uncontrolled observation.
CONTROLLED OBSERVATION
This type of observation restricts the researcher to organizational activities relevant
to his/her research work. For instance, this study that bordered on internal control
and profit performance will have its observation process restricted to internal
control processes and their impact on profit performance.
The controlled observation though helps the researcher to specify his plan for
recording the results of observation also intimate others researcher on the
limitation on the research work.
UNCONTROLLED OBSERVATION
Uncontrolled observation covers a wider area than the controlled observation. It
gives the researcher the opportunity to conduct an in depth investigation in case of
an unexpected events, to find out information that will be relevant to the study.
The academic level of the observed persons and also the conditions under which
they will be observed are established.
Generally, to enhance the quality (validity and reliability) of the study, the
researcher should endeavour to keep accurate record of both the observation and its
interpretation.
3.3b SECONDARY SOURCES OF DATA
Secondary data were already-made data. These were collected from already-
written works on the subject matter. Secondary data were collected from banks
official magazines, financial post, CBN bullion, accounting and management
journals, newspapers, periodicals and libraries.
The secondary data were available because of the extensive use of various
libraries within Enugu State. Among the libraries used are:
(i) University of Nigeria Library, Enugu Campus
(ii) ESUT library Enugu
(iii) National Library, Enugu
(iv) Enugu State Central Library, Enugu
Most of these libraries adopted the Dewy Decimal and Library of congress
system of classification methods. A good knowledge of library procedures and
methods made it easy for the effective use of the library towards, realization the
goals of this study
3.4 DETERMINATION OF SAMPLE SIZE
The two banks, OBN (PLC) and UBA (PLC) have eight (8) departments each. In
determining the sample size, the statistical formula below was used.
n = S 1 + 2 (e)2
Where
s = population
n = sample size to be determined
e = tolerable error term (5%)
A total of sixteen (16) departments exist in both OBN and UBA (PLC). Applying
this to the above formula,
N = 16 = 16 = 15.3846 1+16(0.05)2 1+0.04
a sample size of 15.3846 were studied indicating that the entire department represent the
sample size.
3.5 DESIGN OF STRATEGIC POSITION AND ACTION EVALUATION (SPACE) FOR FEATURES OF A GOOD INTERNAL CONTROL SYSTEM
This was adopted from strategic management and business policy by Howe A, Richarch
M, and Karl O and modified to test the hypothesis that OBN have a good internal control
system. See appendix. I
Features of good internal control system were tabulated along with this strength as
follows:
RATING
1 - Weak
2 - Fairly strong
3 - Strong
4 - Very strong
Respondents were asked to tick good (√) the relevant rating for each feature as
it relates to their bank.
The responses were recorded and arranged according to bank.
CHAPTER FOUR
DATA PRESENTATION AND ANALYSIS
4.1 QUESTIONNAIRE DISTRIBUTION, COLLECTION, AND ANALYSIS The analysis was done based on the information elicited from
questionnaires, observations, oral interview and secondary data. Eight (8)
departments were chosen from each bank, A total of thirty-eight (38)
questionnaires and strategic position and action evaluation each containing nine (9)
copies were distributed to the two banks. Out of this number a total of thirty-three
(33) were returned while two (2) were rejected as a result of irregularities in the
response pattern.
The table (4.2) below shows the distribution and collection analysis of the
questionnaires and SPACE. The percentage return is an indicative of the interest
generated by the questions contained in the questionnaires and SPACE. It also
shows the quality and quantity as well as the validity of the responses from the
respondents.
4.2 DEPARTMENTAL COLLECTION AND USAGE OF QUESTIONNAIRE & SPACE
Department No Distributed
% Distributed No collected
No Rejected No used % Ratio usage
Personnel 4 10.53 3 - 3 9.68 Finance & A/C 4 10.53 4 1 3 9.68 Administration 6 15.79 5 - 5 13.16 Advances 6 15.78 5 - 5 16.13 Forex 4 10.53 4 - 4 12.90 Computer 4 10.53 3 - 3 7.90 Legal 3 7.89 3 - 3 7.89 Branch Banking 7 18.42 6 1 5 13.16 TOTAL 38 100% 33 2 31 81.58%
Table 4.2
Form the table above, the response rate of the questionnaires and SPACE can be
deduced. Out of the 38 copies distributed, the return rate is 81. 58% which is a
high rate and provides adequate information for analysis and testing of hypothesis.
4.3 TESTING OF HYOPTHESIS AND ANALYSIS OF DATA
Hypothesis 1. “the management of OBN (PLC) and UBA (PLC) designed and
installed 50% good systems of internal control which their policies, standards and
procedures are adhered to by the members of the staff”
This hypothesis was tested based on the response elicited from the general
questionnaire on internal control system of the banks. From this questionnaire, the
response to the first question “Is there any system of internal control installed in
your bank? Was ‘yes’ by all the respondents. Likewise the response to the second
question “who installed it?” was management and board for all respondents.
The strategic position and action evaluation (SPACE) was also used. The
respondents response to the 12 features of good internal control system which
include reliable personnel with clear responsibilities, separation of duties,
independent checks, proper authorization, adequate documentation, proper
procedures, adequate physical safeguards, bonding, valuation, rotation of duties,
record keeping and ethical conduct in business; were collected and tabulated for
analysis. In using this SPACE, codes were used for the rating of the features of
good internal control. The coding for responses is as follows:
1. For weak
2. For fairly strong
3. For strong
4. For very strong
The coding for the features is as follows.
(i) for reliable personnel with clear responsibilities
(ii) for separation of duties
(iii) for proper authorization
(iv) for adequate documentation
(v) for proper procedures
(vi) for adequate physical safeguards
(vii) for bonding
(viii) for valuation
(ix) for rotation of duties
(x) for independent checks
(xi) for record keeping
(xii) for ethical conduct in business.
A total of 38 copies of the SPACE form were distributed to the 2 banks 19 to each
bank. Out of this number 17 were collected from OBN while 16 were collected
from UBA totaling 33 of the number collected.
The table (4.3) 1 and (4.3)2 below shows the average responses of the
various department of each bank.
From the above 2 tables, the total average of each internal control features
obtainable for all the features was 384 an indicative of a very strong internal
control.
OBN PLC
Department i ii iii iv v vi vii viii ix x xi xii Total Obtainable Percentage
Personnel 4 3 3 3 3 3 2 2 3 3 3 3 35 48 72
Fin. & Accs. 2 3 2 2 2 2 2 2 2 2 1 1 20 48 42
Administration 3 3 2 3 3 2 1 1 3 2 2 2 26 48 54
Advances 2 3 2 2 2 3 1 1 3 1 3 1 21 48 44
Forex 3 2 2 3 3 2 1 1 2 2 2 2 25 48 52
Computer 2 3 2 2 2 3 2 2 3 2 3 1 29 48 60
Legal 3 3 3 3 2 2 1 2 2 1 3 3 27 48 56
Branch Banking 2 3 2 2 2 2 3 1 1 3 2 3 24 48 50
Total Obtainable 20 23 18 20 19 19 10 11 21 14 20 15 201 -
Total Obtainable 32 32 32 32 32 32 32 32 32 32 32 32 384 -
Percebtahe % 63 72 56 63 59 59 31 34 66 44 63 47 51 - -
Table 4.3.1 Good internal control feature (-SPACE) Averages analysis by Department
UBN PLC
Department i ii iii iv v vi vii viii ix x xi xii Total obtainable percentage
Personnel 3 3 3 4 3 4 3 3 4 4 3 2 39 48 81
Fin. & Accs. 3 3 3 3 2 3 2 2 4 3 3 2 33 48 69
Administration 4 4 2 3 3 3 3 3 3 3 3 3 36 48 75
Advances 2 3 3 3 3 4 2 2 3 3 3 2 30 48 63
Forex 3 3 4 2 2 3 2 2 2 3 3 2 220 48 63
Computer 3 3 3 3 3 3 2 2 2 2 2 3 33 48 69
Legal 3 3 3 3 2 3 2 3 3 3 3 2 31 48 67
Branch Banking 3 3 2 3 3 3 2 2 3 3 2 2 31 48 65
Total Obtainable 24 25 23 24 21 26 17 19 25 24 21 18 248 - -
Total Obtainable 32 32 32 32 32 32 32 32 32 32 32 32 384 - -
Percebtahe % 75 78 72 75 66 81 53 59 78 75 65 56 65 - -
Table 4.3.2 Good internal control feature (-SPACE) Averages analysis by Departments.
In OBN, the result showed that the personnel department had the strongest
internal control (72%) followed by the computer department. This high internal
control in personnel implied that the administrative internal control is high in the
bank. The departments with the least internal control were the finance and
accounts departments. This implied that the financial/accounting control is weak
and could adversely affect the profit performance of the bank.
From the features of good internal control, separation of duties ranked
highest with 72% and this was followed by rotation of duties with 66%
respectively. Lack of staff bonding and vacation could lead to fraudulent
practices by the staff as longevity in office could perfect ways of avoiding
policies and perpetuating fraud. Six (6) features were in existence up to 50%
while two features independent checks and ethical conduct were below 50%.
The total rating obtained from OBN was 210 out of the maximum
obtainable 384. This showed that 51% of internal control was in existence in the
bank.
In UBA, the rating was generally higher than in OBN. On the departmental
basis, the personnel department rated the highest with 81% followed by
administrative department with 75%. Other department rated more than 60%.
On the basis of features of internal control, the result showed that the
strongest was adequate physical safeguards rating 81%. It was followed by
separation and rotation of duties rating 78%. The weakest feature was bonding
53%.
In UBA, the total rating obtained was 248% representing 65%, an indication
of strong system of internal control.
The researcher further tested the hypothesis using the proportional test by the
us of formula.
Z = x-npo Npo (1-op) Where
Z = observed value of test
N =sample size = 384
X = number of responses in favour = 201 (UBA), 248 (UBA)
Po = proportion tested
Ho = Po = 0.5 or 50%
= 0.05 (level of significance)
Critical value z = 1.04 (one tailed test)
Applying the formula to the data obtained from the two banks .
1. OBN
Z = x – npo = 201 – 384 (0.5) = 9 = 9 = 0.92 Npo(1-po) √384 (0.5) (1-05) √ 96 9.8
2. UBA
Z = x-npo = 248-348 (0.5) = 56 = 56 = 5.7 Npo(1-po) √348 (0.5) (1-05) 96 9.8
From the above result, the OBN observed value Z=0.92 was less than the critical
value z = 1.64 and the null hypothesis that the bank has 50% good internal control is
accepted. For (UBA) the observed value Z= 5.7 is greater than the critical value
1.64 and therefore the null hypothesis is rejected and the alternative hypothesis
that the bank has more than 50% good internal control is accepted.
Hypothesis ii “ The system of internal control adopted by UBA PLC enhances its
profit performances than the system adopted by OBN PLC” in testing this
hypothesis, the researcher used the profit performance indicators which include the
following.
1 Return of Assets
2 Return of equity
3 Dividend cover (times)
4 Return on loans and advances
5 Gross profit margin
6 Bad and doubtful debts provision
The results from these indicators were obtained through the following
calculations made with data collected from the annual report and financial
statement of the two banks for three (3) Years.
For United Bank of Africa PLC (UBA) the calculations are as follows:
1 Return on Assets = Profit After Tax Total Assets
1991 1990 1989 10,000 = 0.078% 74,143 = 0.65% 64,764 = 0.70% 12,684,496 11,350,873 9,205,430
2 Return on Equity = Profit After Tax Shareholder’s fund
1991 1990 1989
10,000 = 2.06% 74,143 = 15.7% 64,768 = 15.54% 484,475 472,092 416,755
3 Dividend cover (times) = Earning per ordinary share Dividend per ordinary share 1991 1990 1989
10k = 1 times 74k = 3.3 times 65k =3.5 times 10k 22.5k 18.7k
4 Return on loans and Advances = Interest on LAD LAD 1991 1990 1989 579,108 = 23.7% 407,578 = 18.7% 350,211 = 11.5% 2,435,482 2,505,400 3,044,131
5 Gross profit margin = Operating income less overheads = PBT Operating Income op.income
1991 1990 1989
16,667 =1.90% 116,445 = 17.17% 101,234 = 21.6% 878,565 678,253 469,426
6 Bad and doubtful debts provisions = Provision and int. on bad Dept Gross loan and Advances 1991
344,798 =14.15% 2,435, 482 For Orient Bank of Nigeria PLC, the calculations are following:
1 Return on Assets
1991 1990 1989
2,000 = 0.04% 5,511 = 1.6% 7,134 =2.7% 542,033 3,51, 866 265,901
2 Return Equity
1991 1990 1989 2,000 = 6.4% 5,511 = 18.88% 7,134 =27.6% 31,350 292,350 25,839
3. Dividend covers (times)
1991 1990 1989
5k = 0 times 13.8k =2.8 times 17.8k = 3.6 times 0 5k 5k 4. Return on loans and Advances
1991 1990 1989
61.216 = 51.7% 40,735 = 49.2% 15,842 = 9.67% 118,450 82,738 80,548 5. Gross profit margin
1991 1990 1989
3,400 = 8.96 9,468 = 32.4% 12,842 =52.4% 37,938 29,197 23,931
6. Bad and Doubtful debts provision
1991
5,929 = 5% 118,450 The above results are tabulated as follow
UBA
YEARS INDICATORS 1991 1990 1989 Return on Assets 0.078% 0.65% 0.7%
Return on Equity 2,06% 15.7% 15.54%
Dividend cover (times) 1 times 3.3 time 3.5 times
Return on loans and Advances 23.7% 18.7% 11.5%
Cross profit margin 1.90% 17.17% 21.6%
Bad and doubtful debts 14.15%
Provision
Table 4.3.3 profit performance indicators of UBA PLC.
OBN
INDICATORS YEARS
1991 1990 1989
Return on assets 0.04% 16% 2.7%
Return on equity 6.4% 18.8% 27.6%
Dividend cover (times) - 2.8times 3.6 times
Return on loan and Advances 51.7% 49.2% 19.67%
Gross profit margin 8.96% 32.4% 52.4%
Bad and Doubtful debts 5% - -
Provision
Table 4.3.4 profit performance indicators of OBN PLC
Also the asset and liability mix were used to determine the asset structure and liability that
could affect the bank profitability.
1. Asset Mix = Income Earning Assets Total Assets 2. Liability Mix = Deposits Total liabilities
ASSET MIX
UBA
1991 1990 1989
4,500,442 = 35.48% 3,583,840 =31.57% 5,351,923 = 58% 12,684,496 11,350,873 9,205,430
OBN
1991 1990 1989
361,783 = 66.7% 350,761 = 71.26% 144,053 = 54% 542,033 351,886 265,901
BANK YEAR
1991 1990 1989
UBA 35.48% 31.57% 59%
OBN 66.7% 71.26% 54%
Table 4.3.5 Asset mix of both Banks
LIABILITY MIX
UBA
1991 1990 1989 11,895,450 = 97.5% 9,694,080 =89.1% 8,159,295 = 92.8% 12,200,021 10,878,776 8,788,675 OBN 1991 1990 1989 221,617 = 43.4% 144,848 = 44.9% 96,891 = 40.36% 510,683 322,516 240,662
BANK YEAR
1991 1990 1989
UBA 97.5% 89.1% 92.8%
OBN 43.4% 44.9% 40.36%
Table 4.3.6 Liability of mix of both Banks
From the result above, it can be seen that the return on assets decreased over the 3
years period for the 2 banks. However, in the first 2 years, OBN performed better
than UBA, while in 1991 UBA was better. This return on assets is an indicative of
the rate of profit made on each naira of assets utilized. But for the CBN prudential
guideline of 1990, UBA would have performed better in the first two years.
The return on equity also decreased over the 3 years but OBN performed
better then UBA. The ownership structure must have affected the performance here,
since the profitability measures are restricted to shareholder’s fund.
On dividend cover, UBA paid divided many times than OBN, which did not
pay any dividend in 1991.
On return on loans and advances, OBN performed better than UBA. This was
as a result of the asset structure of the banks.
While OBN invested more on income earning assets which yielded more income for
the bank, UBA did otherwise. See table 4,3.5
The OBN also performed better on gross profit margin than UBA. This
indicated the high ability of the OBN management to generate income from proper
asset management. It gave an idea of their ability to cut operating cost through
optional viability management and through effective management of overhead.
For bad and doubtful debts provision, UBA provided 14.15% for the year
1991 while OBN provided only 5%. This provision though affected both banks’
profit was higher on UBA which is an older bank because of the prudential guideline
of 1990.
The liability mix (table 4.3.6) also showed the banks performance in the
management of their liabilities. UBA had higher percentage liability mix than OBN.
This implied that the cost of funds for UBA was higher than that of OBN and as a
result must have affected profit performance.
The above performance indicators showed that UBA was better than OBN in
some aspect while OBN was better in other aspects.
Generally, the inability of the management to generate adequate income, manage
overhead effectively and realize interest charged are indicative of non-adherence to
the policies, standards and procedures of internal control by the management and the
bank staff. Thus the hypothesis that UBA adopted internal control system better than
OBN is rejected.
Hypothesis III –“The present internal control system adopted by the banks are
effective and adequately operated”. This hypothesis was tested by the use of the
following;
a) Oral interviews were conducted on some bank’s staff including the heads of
various departments
b) Responses from questionnaire on relevant areas which include EDP,
purchases, cash receipts and disbursement, petty cash, pay roll and fixed
assets.
c) Employees were observed during working hours
d) There was a thorough study of the existing accounting and administrative
system to see if the policies were adequately adhered to.
The following findings were made in the two banks.
UBA
In this bank, it was discovered that there existed an installed internal control
system. On electronic data processing, the department is independent of accounting
department.
There is pure segregation of responsibilities, qualified employees, rotation and
vacation of employees. Also there is adequate physical security, documentations,
review and testing of all programmes. The only weak feature is proper
authorization of transaction and master file changes. Total control reconciliations
and done by persons independent of EDP department.
Cheques for cash disbursement are pre-numbered by the printer, spoiled and
unused cheques are properly controlled. There is segregation of duties between
persons that sign cheques, have access to petty cash; approve cash disbursement
and record cash receipts.
The person who sign cheques however, are not prohibited from posting to ledger
accounts. The person that prepares cheques and pass book does not have access to
cash, but signs cash vouchers. There is proper authorization and securitization of
passbooks before payment by the cashier. Adequate recording and monthly
reconciliation are also maintained.
Authorization for the addition of fixed assets is done by the board of
directors except on few occasions. Requisitions are always raised before the
addition of fixed assets. There is differentiation between capital and revenue
expenditure. Inventory of fixed assets is periodically compared with physical
counting. Prior to the sale or scrapping of fixed assets there must be a written
approval to that effect. The transfer of fixed assets from one department to another
is properly authorized and the accounting department also notified.
On payroll, the bank’s salaries department is not a separate entity that deals
with payroll alone. The staffs of the salaries department are periodically rotated.
There is proper segregation of duties in executing payroll transactions. The
personnel manager authorizes the engagement and dismissals of employees.
He/she also authorizes the alteration of pay, deduction from salaries and advances
of salaries. Adequate records are kept of each employee showing engagement,
retirement or dismissal, salaries and deductions.
Purchases of items are properly approved through requisitions made. All
capital items are purchased in the head quarters and delivered to various branches
by the administrative department according to request order. The bank branches
however, make the purchases of consumable like typing, writing materials etc.
The flaw in the control feature is issuance of some official orders without
showing suppliers names, quantity ordered and prices. Also the best source and/or
competitive bids were no obtained before issuing purchase order. All purchased
goods are inspected, compared and with the purchase orders and received in the
centralized receiving department. The recording of received goods is done by
persons independent of ordering function and processing and recording of invoice.
Before the preparation of payment vouchers for customers, the requisition forms,
purchase orders, receiving reports and vendor’s invoices are matched or compared.
In event of goods returned to the supplier or cases of short deliveries, records or
documents are prepared. Personnel who authorize purchases do not have access to
store room.
It is also interesting to note that adequate internal control measures were
recorded in cash receipts and petty cash.
OBN
Orient Bank of Nigeria Plc, recorded adequate internal control measures in
electronic data processing, payroll and fixed assets.
On cash disbursement, except that the persons who sign cheques are not
prohibited from the approval of cash disbursement and recording of cash receipts, all
other features are maintained.
The banks’ purchasing system lacks adequate internal control measures. Not
all the capital items purchased were approved or authorized by the Board. Although
received goods are inspected and compared with purchase orders, the recording of
these goods is not done by persons independent of ordering function, processing and
recording of invoices.
There was to an extent, the maintenance of the procedural manual in cash
receipt system of the bank. All mails and cheques are prepared and endorsed by
person who does not prepare the bank deposit or has access to accounts receivable.
Bank stamped duplicate deposit tickets are not compared with cash receipts journal.
This is a wrong internal control measure.
On petty cash, there is imprest fund system in use. However, the system lacks
segregation of duties between the cashier or other employee handling remittances
from customers and other cash receipts.
Generally it was observed during working hours that bank staff do not
adhere to the procedural manual in the banks especially in cash disbursement
when customers stay longer than others.
The officers of the two banks interviewed maintained that though the
management installed adequate system of internal control, some staff either by
omission or commission do not adhere by their policies and standard.
It is then reasonable based on the above finding and analysis to
conclude that the internal control systems adopted by the two banks are not
effectively and adequately operated.
Hypothesis IV – “The existing internal control systems of the banks enhance
their profit performance”. This hypothesis was tested using responses elicited
from the general questionnaire on impact of internal control on profit
performance and the analysis of a five year financial summary from 1987-1991
(see table 4.3.7 and 4.3.8).
The researcher also studied the detailed profit and loss account of the two
banks for the years 1989,1990 and 1991 (see table 4.3.9 and 4.3.10) as it was not
possible to get the profit and loss account for 1987, 1988 and 1992. Each year’s
profit was compared with the proceeding year to ascertain the direction of
performance.
It was discovered from the 5 year financial summary that being a new
bank OBN in its first two years of operation 1987 and 1988 recorded very low
profit of N72, 000 and N634, 000 respectively.
This is understandable as a result of the problem generally encountered by
new banks, especially in the early period of operation. In 1983 UBA made high
profit of N73.6m which was later decreased to N54.7m in 1988.
The profit and loss account for the 3 years showed that in 1989 UBA made a
profit of N64.1m and this rose by N9.3m to N74.1m in 1990, an increment of 14.4%.
In 1991 the profit decreased by N64.1m to N10m showing 86% decrease. The OBN
after making a very high profit in 1989 of N7.1m decreased over the years. The
profit decreased by 22.75% to N5.5m a decreased of N1.6m. Also in 1991 it reduced
by N3.5m to N2m showing a percentage decrease of N63.71%.
From the responses of the general questionnaire, it was ascertained that
though the management installed a good internal control systems there had been
cases of fraud and embezzlement. Even employees have been caught colliding to
cheat the banks.
This invariably affected the profit performance of the two banks and was
authenticated by the decrease in yearly profits. However, some officers interviewed
in UBA maintained that case of fraud and embezzlement has been reducing while in
OBN the reverse was the case.
During the study, to determine if other factors may have influenced the profit,
it was discovered that the 1990 CBN prudential guideline affected both banks with
more impact on UBA which is an older bank. UBA and OBN under the prudential
guideline made a provision of N390m (N45.728 and N344.798) and N5.9m
respectively.
The above analysis implied that though the management installed a good
system of internal control it did not enhance profit performance and therefore the
hypothesis is rejected
OBN PLC
FIVE YEAR FINAANCIAL SUMMARY
FOR THE YEAR ENDED
1991 1990 1989 1988 1987
N1000 N1000 N1000 N1000 N1000
ASSETS
Cash 7,808 3,471 4,183 5,887 279
Balance with Bank 85,648 14,409 29,146 36,357 399
Due from banks 223,366 148,519 50,809 126,649 17,424
Loans & Adv 118,450 82,738 80,548 4,030 64
Investments 800 5,880 880 7,500 500
Other assets 86,714 83,225 82,919 9,199 254
Fixed assets 15,929 13,624 11,816 7,203 4,710
Equipment on Lease 3,238 - - - -
542,033 351,866 265,901 188,526 23,630
FINANCED BY
Deposits 221,617 144,848 96,891 74,603 3,995
Due to Banks 97,000 83,000 22,500 - -
Taxation 3,379 6,681 6,379 1,477 24
Dividend - 2,000 2,000 - -
Other liabilities 188,687 85,987 112,292 95,740 3,539
510,683 322,516 240,062 171,820 7,558
Shareholders Fund 31,350 29,350 25,839 16,706 16,072 542,033 351,866 265,901 188,526 23,630
Gross earnings 78,966 51,126 29,089 7,459 490
Profit before tax 3,400 9,468 12,542 2,096 96
Profit after tax 2,000 5,511 7,134 634 72
Dividends - 2,000 2,000 - -
Earnings per 50k
Ordinary shares 5.0k 13.8k 17.8k - -
Dividend per 50k
Ordinary share - 5.0k 5.0k
Equity Dividend
Cover Times - 2.8 3.6
Table 4.3.7 1991 Annual Report and Financial Statement of Orient Bank of Nigeria Plc
UBA PLC
FIVE YEAR FINANCIAL SUMMARY
1991 1990 1989 1988 1987
N1000 N1000 N1000 N1000 N1000
BALANCE SHEET
USE OF FUNDS
Cash & short term funds 4,943,418 5,116,758 3,530,329 2,279,591, 1,865,212
Cash reserve deposits 159,764 115,232 144,713 33,308 37,325
Bills discounted 1,461,385 912,696 753,034 1, 507,51 4925,572
Investments 22,409 8,895 302,995 329,415 319,432
Loans & Advances 2,435,482 2,505,400 3,044,131 2,008,138 1,798,628
Stabilization
Securities 437,108 - - - -
Other assets 2,729,369 2,411,709 1,251,763 763,718 624,971
Fixed assets 495,561 280,183 178,465 139,420 85,572
12,684,996 11,350,873 9,205,430 7,061,104 5,656,712
SOURCE OF FUNDS
Share capital 10,000 75,000 75,000 75,000 75,000
Reserves 384, 475 397,09 7 341,755 253, 468 210,904
Shareholders funds 484,4 75 472,0 97 416,75 5 32 8,468 285,904
Deposit and others
Customer’s accounts 11,894,450 9,694,080 8,159,295 5,872,884 4,766,726
Accounts payable
Including items in
Transit, taxation and
Dividend 305,571 1,184,696 629,280 859,752 604,082
12,684,496 11,350,873 9,205,430 7,061,104 5,656,712
PROFIT AND LOSS ACCOUNT
Gross earning 1,457,673 1,145,831 819,63 7 641,0 19 569,172
Profit before taxation 16,667 116,445 101,234 83,9 92 105,891
Taxatiom (6,667) (42,303) (36,470) (29,226) (32,238)
Profit after taxation 10,000 74,142 64,764 54,766 73,653
Transfer of reserves - (51,268) (46,000) (36,746) (57,213)
Prior year adjustment - - - - 26
DIVIDENDS
- Preference - - - - (1,339)
- ordinary (N10,000) (22,500) (18,750) (18,000) (15,000)
brought forward 931 557 543 523 396
931 931 557 543 396
earnings per share 10k 74k 65k 55k 72k
Dividend per share 10k 22.5k 18.7k 18k 15k
Equity interest per
Share 484 4.72 4.16 3.28 2.85
Table 4.3.8 1991 annual report and financial statement of UBA plc
ORIENT BANK OF NIGERIA PLC
PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED 30TH SEPTEMBER
1991 1990 1989
N’000 N’000 N’000
INCOME
Interest on loans and placement:
Bank 36,051 15,962 15,842
Customers 25,165 24,733 -
Commissions 14,960 8,981 5,704
Income on equipment on lease 1,128 - 7,125
Other income 1,662 1,473 418
78,966 51,126 29,089
Deduct interest 41,028 21,929 5,158
37,938 29,197 23,931
LESS OPERATING EXPENSES
General and administrative 24,175 15,919 -
Depreciation of fixed assets 3,865 2,975 2,390
Depreciation of equp. on lease 569 - -
Provision for bad and doubtful
Debts including provision for
Interest in suspense 5,929 835 -
34,538 19,729 -
Profit before taxation 3,400 9,468 12,542
Taxation 1,400 3,957 5,408
Profit after taxation 2,000 5,511 7,134
Appropriations
Transfer of statutory reserve 600 1,378 1,784
Proposed dividend - 2,000 2,000
1,400 2,133 3,350
Profit brought forward - 3,879 529
Retained profit transferred
to general reserve 1,400 6,012 3,879
Table4.3.9 1991 Annual report p.19 & 20
UBA PLC
PROFIT AND LOSS ACCOUNT FOR THREE YEARS ENDED 31ST MARCH
1991 1990 1989
N’000 N’000 N’000
General earnings 1,457,673 1,115,831 819,637
Interest expenses 579, 108 467,578 350,211
Net earnings 878,565 678,253 469,426
Overhead expenses 579,037 462,926 308,808
Provision for bad
And doubtful debts 45,728 69,500 34,655
Depreciation on fixed
Assets 50,654 29,382 24,729
615,419 561,808 368,192
Net income before provision under prudential guidelines 263,146 116,445 101,234 Exceptional income 82,237 - -
345,383 116,445 -
Overprovision for
taxation in provisions year 16,082 - -
361,465 116,445 -
Provision under prudential
Guidelines 344,798 - -
Net income after provision
under prudential guideline 16,667 116,445 101,234
Taxation 6,667 42,303 36,470
Profit after taxation 10,000 74,142 64,764
Appropriations:-
Statutory reserve - 9,263 8,100
General reserve - 17,000 37,900
Bonus issue reserve - 25,000 -
Dividends 10,000 22,500 18,750
10,000 73,768 64,750
Profit retained for the year - 374 14
Unappropraited profit
brought forward 931 557 543
carried forward 931 931 557
Table 4.3.10 1991 Annual report & Financial Statement of UBAPLC P.20
CHAPTER FIVE
SUMARY, RECOMMENDATION AND CONCLUSION
5.1 SUMMARY
It is necessary at that this point of our study to summarize with respect to the
objective of the study, the result of the tested hypothesis and the findings of the
research work.
From the study and thorough examination of the internal control systems,
installed by the two banks, it was discovered that both banks have adequate internal
control features but the percentage installation of UBA (PLC) was higher than OBN
(PLC).
The research work further discovered that the internal control system adopted
by UBA does not enhance its profit performance than OBN as shown by the profit
performance indicators which includes include return on assets, return on equity,
dividend cover, return on LAD, Gross profit margin and bad and doubtful debts.
Further studies also revealed that the installed internal control system was not
effectively and adequately operated. This can be seen from the non-adherence of the
bank staff to the banking policies and standard of operation, thereby giving room for
conspiracy that ultimately leads to incessant fraud and embezzlement in the banking
industry.
Another finding showed that the internal control installed by the management
and Board does not enhance the profit performance of the banks. This is
authenticated by the analysis of the P & L account for 3 years period which
especially for OBN showed a steady decline in profit as a result of perpetrated fraud.
But we have to recall that however perfect a system is designed, it cannot in
its entirety completely foil all fraudulent schemes.
5.2 LIMITATION OF RESULTS
The researcher on the course of the study encountered some limitations in the
following areas:-
1. Library –secondary data collected from the library were relevant
but effort to get some of the references proved abortive.
Also materials collected from the library were not sufficient for the study and
so the researcher was limited to the few available materials. All efforts by the
researcher to get the most recent annual report (1992) from the banks were all
vain and so restricted the analysis between 1987 and 1991.
2. Resources, time and cost:- These were other major constraints encountered
by the researcher. The time and money involved in visiting the banks and
the cost of photocopying available material wee major limitations.
3. Interviews:- Most officers interviewed were reluctant over revealing some
crucial information as this may affect the bank’s credibility. Efforts geared
towards obtaining adequate information proved abortive due to the
uncooperative attitude of some other interviewed staff.
4. Questionnaire – Not all the distributed questionnaire were collected. Some
of them were wrongly filled and therefore rejected. Much time was taken
in completing the questionnaire by some officers that complained about
time constraints
5.3 RECOMMENDATIONS
The researcher through this study was afforded the opportunity to make the
following recommendation that will enhance the operational adequacy and
efficiency of internal control installed by the two banks and also promote their profit
performance
1. From the analysis of the hypothesis, it was discovered that bonding, vacation
and ethical conduct were the features of good internal control not adequately
observed by both banks.
As a result of this fraud is perpetrated. In line with this, the researcher
recommend that bank staff be adequately bonded, mandated to go on annual
leave when due and tutored on the importance of maintaining good rapport
and relationship with customers however small or big.
2. The banks’ personnel departments should endeavour to review their
recruitment system; qualified and honest applicants should be employed,
instead of using the Nigerian current wave in “IM” in offering employment.
An in-depth study of the applicants’ past life or history should be made before
appointment or confirmation.
3. In EDP department hardware and data storage media should be protected
against damage from fire or any accidental damage.
4. The internal auditor should issue reports of his examination of the banks’
internal control and if the proper procedures are not followed should alert the
management and Board of Directors of the development
5. On cash disbursement, persons who sign cheques should be prohibited from
having assess to petty cash, recording cash receipts and approving cash
disbursement.
6. The salaries department should keep a history record of engagement,
retirement or dismissal, salaries and deduction of each employee.
7. The accounting department function should not be completely divorced of
cash disbursement.
8. The custodian of petty cash should be independent of cashier or other
employees handling remittance from customers and other cash receipts.
Finally, the amount of fund should be restricted so as to require
reimbursement at relatively short intervals.
9. On purchases, the purchase of capital items must be approved by board. All
official orders issued must be show suppliers names, quantities ordered and
prices. The best source of supply and competitive bids should be obtained
before issuing purchase order.
10. Cash received from miscellaneous sources should be independently
controlled. Also bank stamped duplicate deposit tickers should be compared
with the cash receipts journal.
11. On-the-job training should be given to all staff on the legal implication of
circumventing any type of control. This will help to create more awareness on
the members of staff. Moreover, they will be exposed to the dangers of fraud
and its legal implications.
12. The management of the banks should try to establish research and
development department that will ensure regular research and review of their
operational efficiency. This will help in updating the various controls adopted
for the system.
13. Preparation of payroll should be separated from the actual payment of salaries
14. The administrative and personnel department functions need to be properly
separated. This will facilitate a clear flow of authority.
5.4 CONCLUSION
The researcher having come to the end of this study, opines that for accelerated
banking development in Nigeria, there should be a sound basis of internal
control system, this means that the system should be adequate and effective by
being able to remove opportunities that will lead to fraud and embezzlement.
Both banks had done fairly well in the installation of the internal
control system as the exercise was carried out by some of the interested group
including the management, Board, auditors and consultants. Though the design
is adequate, a lot more still requires to be done to enhance a positive impact on
profit performance.
This the management should achieve by being alert so as to eliminate any
possible loophole that may arise.
This research work has really proved that an internal control not
effectively operated does not enhance profit performance of any profit oriented
organization.
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