INTERNAL CONTROL SYSTEM AND GROWTH OF SMALL SCALE BUSINESSES
The main purpose of this study is to investigate the problems associated with the internal control system as it affects the growth of small scale businesses in Nigeria.
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CHAPTER ONE
INTRODUCTION
1.1 Background to the Study
Internal control comprises the plan of an organization and all the co-ordinate methods and measures adopted within a business to safeguard its assets, check the accuracy and reliability of its accounting data, prorate operational efficiency and adherence to prescribed managerial policies (Reid and Ashelby, 2002).
Internal control only provides reasonable assurance to the firm’s leaders regarding the achievement of operational, financial reporting and compliance objectives; promoting orderly, economical, efficient, and effective operations; safeguarding resources against loss due to waste, abuse, mismanagement, errors, and fraud. Internal controls lead to the promotion of adherence to laws, regulations, contracts, and management directives and the development and maintenance of reliable financial and management data, and accurately present that data in timely reports (Kaplan, 2008; Cunningham, 2004; INTOSAI, 2004).
Internal control encompasses the policies, processes, tasks, behaviors and other aspects of a company that, taken together: facilitate its effective and efficient operation by enabling it to respond appropriately to significant business, operational, financial, compliance and other risks to achieving the company’s objectives (Gree and Thurnik, 2003). This includes the safeguarding of assets from inappropriate use or from loss and fraud, and ensuring that liabilities are identified and managed; help ensure the quality of internal and external reporting. This requires the maintenance of proper records and processes that generate a flow of timely, relevant, and reliable information from within and outside the organization; help ensure compliance with applicable laws and regulations, and also with internal policies with respect to the conduct of business (Manasseh, 2007).
In recent years the aspect of the internal control system has achieved great importance since it is designed to safeguard the company’s assets against misuse, ensure compliance with the company’s laid policies, ensure the company’s personnel are efficiently utilized and the company runs in an orderly and efficient manner. Most importantly it ensures the company’s reliable records which are a source of information necessary for managerial decision-making processes are available whenever required by management or both the external and internal auditors. It is therefore clear that the adoption of a sound internal control system is not only helpful to the management, but also to the external auditors. However, it’s worth noting that internal controls only provide reasonable but not absolute assurance to an entity’s management and board of directors that the organization’s objectives will be achieved. “The likelihood of achievement is affected by limitations inherent in all systems of internal control,” (Hayes et al, 2005),
The small scale management has poor awareness of risk and not accurate to the operating situation. The enterprise lacks of physical risk warning mechanism for every occurrence of business, financing, and use of capital, shop management, and so on (Zhou, 2009). Due to the business scale, human resources, financial, and its own conditions affect many small scale businesses under the ownership and franchise restrictions, unwilling to establish the standard internal control system. They believe that establishing an internal control system is a high-cost method, which will bring a heavy burden to the enterprise and maybe without significant results cannot compare with the management of all aspects of business directly. Kimanzi (2004), Small businesses in Nigeria are operating in a rapidly changing environment with different issues impacting on their long term survival. The key ones include inadequate infrastructural facilities (road water electricity etc.), insecurity of lives and property, inconsistent monetary, fiscal and industrial policies, limited access to markets, multiple taxation and levies, lack of modern technology for processing and preserving products, policy reversals, capacity limitations, data inadequacies, harsh operating environment, fragile ownership base, fragile capital base. While some of the challenges that small scale business faces are induced by the operating environment (government policies, globalization effects, financial institutions, local government policies, attitude to work, etc.), other challenges are driven by the characteristics of the internal control of the small scale businesses themselves (Dyer & Whetten, 2006).
According to a World Bank report, small businesses are defined as enterprises that employ between eleven and fifty people at any given time (World Bank, 2003). The Committee of Sponsoring Organizations of The Tread way Commission (1992) defines internal control 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 in the following categories: effectiveness and efficiency of operations; reliability of financial reporting; compliance with applicable laws and regulations.”
Similarly, the American Institute of Certified Public Accountants (1987) argues that internal controls are often thought of as the primary defense against fraud. In addition, internal controls aid organizations in the following objectives: One, to safeguard the assets of the firm; two, to ensure the accuracy and reliability of accounting records and information; three, to promote efficiency and effectiveness in the firm’s operations.
Bronson et al (2006) argue that not only do internal controls aid to combat fraud but they also impact the firm’s financial performance. As a result, weak internal controls are positively related to poor financial performance and effective and efficient internal controls are positively related to superior financial performance. These authors concluded that holding other factors constant, evidence suggests that the system of internal control in place significantly impact on the financial performance of a business.
According to Haskins (1987), an organization’s size has a direct impact on the kind of internal controls kept. For example, due to fewer numbers of employees in small businesses, it is difficult to establish adequate separation of duties. It would also be unreasonable to expect small businesses to have internal auditors. However, when various components of the internal control systems are analyzed, It becomes evident that most of the internal control components are applicable in both small and large enterprises. Haskins, 1987 recommends that internal controls in small businesses can be strengthened if the owner carries out the following duties: Signing of cheques only after carefully reviewing the supporting documents, reconciliation of the bank statements, approving credit, and writing off bad debts only after the proof has been given of real efforts having been made to collect the debts. Kinney et al. (1989) argue that the more resources a firm has, the more effective and efficient is its system of internal control. This is because of the fact that the availability of resources warrants the organization to hire the services of auditors, consultants, and skilled personnel who can improve the internal controls system in place.
In this study, the researcher intends to study the effect of the internal control system on the growth of Small scale businesses in Nigeria.
1.2 Statement of Problem
Effectiveness of internal control should be considered most important in every firm because the task of internal controls is to prevent and detect fraud in the firm. Internal controls are put in place to ensure safe custody of all assets; to avoid misuse or misappropriation of the firm’s assets and to detect and safeguard against probable frauds.
Small scale businesses play a significant role in the economic and social development of Nigeria. Despite their importance to the Nigerian economy, there is still a large number of small scale businesses that fail. The lack of managerial skills, entrepreneurial skills, human resource practices, and technology of owners and/or managers of these business entities is one of the key factors which lead to small scale business failures. These factors, among others, have a direct effect on how a business is managed and internally controlled. No doubt, when a business cannot be managed, It cannot be controlled, which adversely affects the implementation of an adequate system(s) of internal controls. One of the problems, therefore, is that small scale businesses is unsustainable owing to inadequate use of effective internal controls.
According to a US study by the Association of Certified Fraud Examiners (ACFE-2004), internal controls seem to be given little attention by operators of small businesses. The failure to design and implement effective internal controls has largely been attributed to limited resources that often make small businesses overlook the benefits of internal controls. In the ACFE study of businesses in the US which had reported cases of fraud, 48% of frauds occurred in small businesses and 93% of all frauds were related to asset misappropriation. According to Marden et al. (1997), small businesses have limited monetary and personnel resources and the owner must be careful to protect those resources. Effective internal controls will, therefore, help small businesses manage their resources and ensure operations are efficient and effective. Marden argues that, when it comes to small businesses, all frauds start with the owners. This happens when the owner becomes too trustful with his/ her employees or when the owner becomes too detached from the business. Studies conducted in the US on internal controls in small businesses have shown that small businesses maintain ineffective and inefficient systems of internal control. These studies have indicated that there is a positive correlation between fewer resources controlled by an enterprise and ineffective internal control.
Audits of small scale businesses have proven to be among the most worrisome for professional accountants because of the inadequacy of the internal controls. Except for statutory demands, small scale businesses hardly give serious thoughts to the process of sound accounting, yet the inadequacy and ineffectiveness of accounting processes have been responsible for the untimely collapse of a host of them being incomplete and information being inaccurate which often results in misleading financial statements that cannot be relied on by the stakeholders of the firm. (Mukaila and Adeyemi, 2011).
In some small scale businesses, the internal audit department is not installed to help in compliance with the internal policies and procedures. Most firms put the above efforts in order to achieve positive performance. However, despite all these efforts, firms still struggle with liquidity problems, untimely financial reports, inefficient accountability for the firm’s financial resources, frauds, and misuse of the firm’s resources as well as a number of decisions made not yielding the expected results. Furthermore, business transactions are not carried out according to the Generally Accepted Accounting Principles (GAAPs). This leaves the assets of a firm being improperly safeguarded, records being incomplete and information being inaccurate which often results in misleading financial statements that cannot be relied on by the stakeholders of the firm.
Jeremiah Munene (2013) conducted a study and found out that some of the challenges experienced in regard to internal controls include; struggles with liquidity problems, financial reports are not made timely, accountability for financial resources is wanting, frauds and misuse of institutional resources have been unearthed and a number of decisions made have not yielded the expected results.
PROCASUR Africa Report (2012) stated that poor control systems have led to huge investments lost through fraud and misuse of assets that are used to generate revenues while managers or owners of small scale businesses have suffered big losses. Inadequate controls have also led to corruption and collusion of managers which contributes to the small scale businesses failing to achieve their set objectives. Technological changes have also brought with them challenges in control systems and this has necessitated the development of new ways of controlling organizations.
Many small scale businesses especially are faced with poor financial performance despite having the necessary resources to run them. It is not uncommon to hear of small scale businesses not been able to serve customers the right and not be able to pay employees their saved monies. This had led to many small scale businesses not growing with respect to time and technology as well as the financial strength to attract new customers, therefore, adding to the financial burden they are already experiencing. Small scale businesses have been in existence for years but their activities have not witnessed significant growth as compared to banks and financial services within the country.
Most Small scale businesses in Nigeria fail to thrive as a result of different factors within and outside the business environments. They die within their first five years of existence, a smaller percentage goes into extinction between the sixth and tenth year while only about five to ten percent survive, thrive, and grow to maturity (Aremu and Adeyemi, 2011). While small scale businesses in countries such as China, India, United Kingdom, South Korea, and Taiwan are showing good signs of performance, perhaps the ones in Nigeria seem to be overwhelmed by a myriad of problems (National MSME Collaborative Survey, 2010). Adagye (2015) found out in his research on effective internal control system in the Nasarawa State tertiary educational institutions for efficiency at Nasarawa State Polytechnic, Lafia that the right people are not assigned to the right job in the bursary department and that checking of a subordinate by their superior officers is not regular. The research concluded that the foregoing made the internal control system in the institution ineffective and weak. Thus ineffective staff job placement contributed to the institution’s ineffective and weak internal control. Similarly, Ndifon and Patrick (2014) in their research on the impact of internal control activities on the financial performance of tertiary institutions in Nigeria at Cross River State College of Education revealed that there is adequate internal control in place but the staff is not adequately trained to implement the internal control system and this renders the existing internal control system ineffective. Staffing is the main challenge identified by the researchers.
The investigation recommended training on the significance of internal controls among proprietors of Small and Medium-scale Enterprises. The researchers reported that there are challenges in the implementation of internal controls due to a lack of technical manpower and inappropriate business knowledge of entrepreneurs in the internal control system. It can be deduced that there are challenges in the implementation of internal control in the small scale businesses. However, the prominent challenges include ineffective staff job placement, insufficient staff, and management interference on the staff, lack of technical manpower and inappropriate business knowledge, and staff are not adequately trained to implement the internal control system. Perhaps these and /or other challenges abound in the small scale businesses in Nigeria. These have called for the urgency of this study with a view to remedying the situation.
1.3 Aims and Objectives of the Study
The main purpose of this study is to investigate the problems associated with the internal control system as it affects the growth of small scale businesses in Nigeria. Other specific objectives include:
- To identify the role of technology as an internal control factor influencing the growth of small scale business in Port Harcourt.
- To critical examine the role of human resources practices as an internal control factor influencing the growth of small scale businesses in Port Harcourt.
- To identify the role of entrepreneurial skills as an internal control factor influencing the growth of small scale businesses in Port Harcourt
- To evaluate the role of managerial skills as an internal control factor influencing the growth of small scale businesses in Port Harcourt.
1.4 Research Questions
In this study, the researcher will attempt to answer the below-listed questions:
- Does technology as an internal control factor influence the growth of small scale businesses in Port Harcourt?
- To what extent do human resources practices as an internal control factor influence the growth of small scale businesses in Port Harcourt
- Do entrepreneurial skills as an internal control factor influence the growth of small scale businesses in Port Harcourt?
- To what extent does managerial as an internal control factor influence the growth of small scale businesses in Port Harcourt
1.5 Research hypotheses
Based on the research questions stated above, the following research hypotheses were formulated:
HO1: There is no significant relationship between technology as an internal control factor and the growth of small scale businesses in Port Harcourt.
HO2: There is no significant relationship between Human Resource Practices as an internal control factor and growth of small scale businesses in Port Harcourt
HO3: There is no significant relationship between entrepreneurial skills as an internal control factor and the growth of small scale businesses in Port Harcourt.
HO4: There is no significant relationship between managerial skills as an internal control factor and the growth of small scale businesses in Port Harcourt.
1.6 Significance of the Study
The study is of value to the managers and owners of small scale businesses in making decisions on internal control mechanisms that will assist them on their growth path. This study also gives insights to government bodies on how they can form a foundation for helping or enhancing the growth of small scale businesses. It would act as a guide to the government on how they can offer or mitigate policies that affect internal control of small scale businesses. The study is finally a source of reference material for future researchers on other related topics; it can also help other academicians who will undertake the same topic in their studies. The result of this can be used by academics to discuss the internal control factors affecting the growth of small scale businesses in Nigeria. This study also highlights other important relationships that require further research.
1.7 Scope of the Study
The study is designed to examine the relationship between the internal control system and the growth of selected supermarkets in Port Harcourt.
Content Scope: The independent variables of the study are internal control systems proxied by entrepreneurial skills, human resource practices, managerial skills, technology, and the dependent variable is represented by growth.
Geographical Scope: The study is limited to selected supermarkets in Port Harcourt
Unit of Analysis: This study is concerned with supermarkets in Port Harcourt.
1.8 Limitation of the Study
As it is the case with all studies, this study is associated with some limitations. The findings of this study are therefore to be considered in light of the following limitations:
- The study considered only four proxies of the internal control system without considering other proxies that affect them. The result may be different if other variables were to be added.
- The research was faced with problems of getting current materials, textbooks, journals, and seminar papers related to the subject matter.
- The research was also faced with the problem of selecting the right variables to proxy the independent and dependent variables.
1.9 Definition of Terms
Entrepreneurial Skills: This is ‘an individual’s ability to turn ideas into action. It includes creativity, innovation, and risk-taking, as well as the ability to plan and manage projects in order to achieve objectives.
Growth: This is the process of something becoming bigger.
Human resource practices: These are the means through which your human resources personnel can develop the leadership of your staff. This occurs through the practice of developing extensive training courses and motivational programs, such as devising systems to direct and assist management in performing ongoing performance appraisals.
Internal control: Internal controls are the mechanisms, rules, and procedures implemented by a company to ensure the integrity of financial and accounting information, promote accountability, and prevent fraud. Besides complying with laws and regulations, and preventing employees from stealing assets or committing fraud, internal controls can help improve operational efficiency by improving the accuracy and timeliness of financial reporting.
Managerial Skills: Managerial skill is a term that refers to the required skills (competencies) of the manager. In particular, the following skills are included: Planning, Organizing, Leadership, Communicating, Decision Making, Problem Solving. The ability to lead people (it is a typical soft skill – to motivate, inspire, coach, etc.
Small Scale Business: This is a privately owned and operated business, characterized by a small number of employees and low turnover.
Technology: This is the collection of techniques, skills, methods, and processes used in the production of goods or services or in the accomplishment of objectives, such as scientific investigation.
1.10 Organization of the Study
This study is divided into 5 chapters.
Chapter one is about the introduction while chapter two talks about the review of relevant literature relating to the study subject. Chapter three discusses the research design and methodology while chapter four focuses on the presentation and analysis of data. Finally, chapter five is about the discussion of findings, conclusion, and recommendation
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