CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Globally, Internal Control system consists of specific policies and procedures designed to provide management with reliable assurance that the goals and objectives it believes important to the entity will be met. Internal control system has been adapted to a higher extent in more developed countries like china and USA compared to the countries of the south Uganda Inclusive (COSO 2017). According to COSO 2004, the reasons to have internal controls is to promote operational effectiveness and efficiency, provide reliable financial and administrative information, safeguard assets and records, encourage adherence to prescribed policies and compliance with regulatory agencies. The AMF Working Group (2007) looked at the components of internal controls as being the control environment, control activities, risk assessment, information and communication, and monitoring and evaluation. These components of internal control apply to all business entities though Microfinance Institutions may apply them differently to large corporations. Micro-finance Institutions’ internal control systems could be less formal and unstructured but at the same time be very effective. Whereas internal controls are thought to be the domain of accountants and auditors, it is actually management that has the primary responsibility for proper controls.

During the 1980s, several high profile audit failures led to the creation of the committee of sponsoring organizations of the tread way commission (COSO) organized for special purpose of redefining internal control and the criteria for determining the effectiveness of internal control (simmons 1997). They studied the causal factors that can lead to fraudulent financial reporting and developed recommendations for public companies, independent auditors, educational institutions the Securities Exchange commission(SEC) and other regulators (C0501985).The product of their work is known as the COSO internal control-Integrated Framework(Simmons 1997). The framework also points out that internal control are the most effective when they are built up into the entity’s infrastructure and further states that built in controls support quality and empowerment initiatives, avoid unnecessary costs and enable  quick response to changing conditions(COSO 1992).

Internal control is a process, effected by an entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of a firm’s objectives in the effectiveness and efficiency of operations, reliability of financial and management reporting, compliance with applicable laws, regulations and protect the organization’s reputation (Kaplan, 2008).There are many controls that an MFI can institute to protect it resources against loss to improve performance. A collection of internal controls put in place by the MFI is what forms internal control system (ICS). An internal control cuts across a number of disciplines including financial accounting and auditing. It can be traced back to ancient times. In Hellenistic Egypt there was dual administration where one side was involved in collection of taxes while the other supervising them. Sacking of Troy was one of the examples of weaknesses of internal controls. Internal controls became apparent at the beginning of 21stcentury following major corporate scandals (PABC 2006).

The reliability of financial reporting is effective to internal control efficiency to ensure that transactions and bookkeeping are appropriate and properly authorized, valid, correctly recorded, complete, and on time. Moreover, it is very important that organizations have fairly summarized accounting information data disclosure Sebbowa (2009). However, in general, a quality reporting is affected by internal control mechanism. There is a general perception that institution and enforcement of proper internal control systems will always lead to improved financial performance. It is also a general belief that properly instituted systems of internal control improve the reporting process and also give rise to reliable reports which enhances the accountability function of management of an entity. According to Dixon et al (1990), appropriate performance measures are those which enable organizations to direct their actions towards achieving their strategic objectives.

Internal control ensures effectiveness and efficiency of operations, reliability of financial reporting and compliance with applicable laws and regulations to which the company is subject. According to Mawanda (2008), a sound internal control system helps the firm to prevent frauds, errors and minimize wastage. The increase of business units has encouraged the use of internal control as it ensures orderly and efficient conduct of business including adherence to internal policies. The completeness and accuracy of accounting records, timely preparation of financial information, can only be achieved if the proper internal control system is in place. The institution’s ability to maximize its profit depends in part on the design and effectiveness of the processes and safeguards it has put in place over accounting and financial reporting (Ndungu, 2013). While no practical control system can absolutely assure financial reports will never contain material errors or misstatements, an effective system of internal control over financial reporting can substantially reduce the risk of such misstatements and inaccuracies in company’s financial statements (Kaplan, 2008).

According to Ledgerwood and White (2006), an internal control adopted by Microfinance Institutions need to be orderly, practical and efficient enough to help them conduct business. Internal controls are most effective when they are directly incorporated in the process that support operations and enable quick response to changing economic conditions. Micro-finance Institutions use internal control mechanisms to make sure the staffs respect its policies and procedures. Everyone in an organization has the responsibility to ensure internal control succeeds to some extent. Virtually all employees produce information used in the internal control system or take other actions needed to affect the control.

Internal control systems including internal audits are intended primarily to enhance the reliability of financial performance, either directly or indirectly by increasing accountability among information providers in an organization (Jenning et al., 2008). Internal control therefore has a much broader purpose in the organization level. Internal controls provide an independent appraisal of the quality of managerial performance in carrying out assigned responsibilities for better revenue generation (Donald & Delno, 2009).

According to Ondieki (2013), fraud is a major enemy of profitability. Control measures are structured in place to avert, detect and eliminate fraudulent occurrence thereby creating an atmosphere for profitability. Effective Internal control system support profitability and growth of an organization by protecting the general assets and resources thereby averting cases of loss. Strong internal control system help to prevent, minimize, transfer or eliminate risks, which may affect a profitable operation (Mugo, 2009).  

Effective internal control system prevents waste and inefficiency in the production line and processes of goods and services. Effective internal control systems assist in the formulation and implementation of quality procurement procedures that helps to factor justification for requisition at proper lead-time, quantity and at lowest prices (Ngechu 2004). This will boost profitability than blind ordering which result to loss and waste. It is very important for every section and department of an organization to have an effective internal control system which is involved in blocking the organization’s income leakages and loop holes thereby supporting a  sustained profitability, growth and other general corporate goals and objectives. 

Many efforts have been made to streamline corporate governance which in turn guarantees accountability and security of resources. Notable regulations are Sarbanes-Oxley Act of 2002(SOX), Committee of sponsoring organization of the Tread Way Commission (COSO 2004), Internal Control Integrated Framework (ICIF March 2013) among others. The widespread accounting scandals that have been witnessed in both public and private sectors have informed this study. Cases of Enron and WorldCom in the U.S.A., Parmalat in Europe and ChuoAoyama in Asia. In Zimbabwe between December 31 2003 and December 31 2004 out of 40 registered financial institutions 29 collapsed representing 27.5 % decline in registered financial institutions. In Nigeria the managing director and the chief finance officer of Cadbury Nigeria plc were dismissed in 2006 for exaggerating profits of the company for several financial years before the company’s foreign partner acquired controlling interest.

However, the perception of internal control is not different like that in Cameroon .Microfinance institutions in Cameroon consist of Banks, microfinance agencies, non -governmental organizations (NGOs), and rural farmers’ scheme and savings societies that provide savings and/or credits facilities to micro and small scale business people who have experience difficulties in obtaining such services from the formal financial institutions. Their range of activities include deposit taking, savings schemes, small scale enterprises, agriculture, real estate, group lending, retail financial services, giving advice on financial matters and training in business management. This study therefore looks at the effect of internal control on the performance of Micro Finance Institutions in Buea Municipality.

1.2 Statement of the Problem

The efficacy of internal control system on financial performance is paramount in every organization. This is because internal controls ensure prevention and detection of errors and frauds. The firm’s economic assets generate income which abets growth and sustainability. It is imperative for MFI’s to establish water tight controls if at all it is to achieve improved financial performance.

A study conducted by Moraa Ondieki (2003) found out that internal controls can have features built into them to ensure that fraudulent transactions are flagged or made difficult if not possible to transact. Setting of internal controls will involve costs and delays in the accounting cycle. Although internal controls have numerous benefits, excessive of these can procrastinate growth and development. On the other hand, inadequate internal controls have led to corruption and collusion leading to organizations failing to achieve their set objectives. Procasur Africa report (2012) stated that poor control systems has led to huge investment loss through fraud and misuse of assets that are used to generate revenue while members and institutions have suffered big losses. Appropriate internal control leads to the effectiveness and efficiency of operations. Effective internal controls should enable MFI to tap new businesses while safeguarding the already existing portfolio. Therefore, MFI should strike a balance between internal control and efficiency in operations.

Also, a study conducted by (Moses Ofeh & Zangue Jeanne, 2017) on the effect of internal controls on financial performance of Microfinance Institutions in Cameroon clearly indicate that MFIs face quite a number of challenges during internal controls in performance like struggles with liquidity problems, financial reports are not made on time, unaccountability for the financial resources, frauds and misuse of institutional resources have been unearthed and a number of decisions made have not yielded the expected results. This clearly indicates that organizational internal control and performance is an understudied area. Therefore, limited studies have been carried out on the effects of internal controls on performance of Microfinance Institutions in Buea Municipality.

Currently, Microfinance Institutions are at par with other financial players in the industry in terms of human resource. The management of Microfinance Institutions is of the highest qualifications, caliber and dedication. Management meets regularly to review and improve its processes to ensure that quality, efficiency, and customer satisfaction is consistently achieved. Micro-finance Institutions have overtime undergone positive transformations in all their departments. Internal controls are in place to safeguard Microfinance Institutions assets; to avoid misappropriation of its assets and to detect against probable frauds. However, despite all the above findings, Micro-finance Institutions struggle with liquidity problems, operating and financial expenses are relatively high for Microfinance Institutions and on average, revenues from Microfinance Institutions remain lower than in other global regions. There are also cases of alleged corruption and financial malpractices. Efficiency in terms of cost per borrower is also low to provide for the potential loss from defaulted loans. This research will therefore attempt to investigate the effect of internal control on the performance of Microfinance institutions in Buea Municipality which has hitherto been ignored.

However, the findings of the various studies carried out were too generalized and did not focus specifically on the effect of Internal Control on performance of Microfinance Institutions in Buea Municipality. Arising from the findings of the above studies, it is clear that, there are many areas about internal control in relation to performance of Microfinance Institutions in Buea Municipality that have not yet been fully addressed. It is for this reason that this study seeks to investigate the effects of internal controls on the performance of Microfinance institutions in Buea Municipality by providing answers to the following research questions:

1.3 Research Questions

The main research question for this study is; “What is the effect of internal control on the performance of microfinance institutions in Buea”?

The specific research questions include;

• What is the effect of risk assessment on the performance of Microfinance Institutions in Buea?
• What is the effect of control environment on the performance of Microfinance Institutions in Buea?
• What is the effect of Control Activities on the performance of Microfinance Institutions in Buea?

1.4 Objectives of the Study

Main Objective

The main objective for this study is to examine the effect of internal control on the performance of Microfinance Institutions in Buea.

Specific Objectives

The specific objectives include;

• To evaluate the effect of risk assessment on the performance of Microfinance Institutions in Buea.
• To assess the effect of control environment on the performance of Microfinance Institutions in Buea.
• To examine the effect of Control Activities on the performance of Microfinance Institutions in Buea.