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