CHAPTER ONE

GENERAL INTRODUCTION

1.0 INTODUCTION

This chapter is going to be talking about the background of the study by reviewing the explanatory variable which is internal is internal control and it’s also elaborated on the independent variable which is profitability of financial institutions in Buea. It also presents the problem to the statement, research questions, objectives, hypothesis, and significance of the study, scope and limitation of the study.

1.1 BACKGROUND OF THE STUDY

Internal control is a crucial mechanism that sets the tone of an entity, influences the control consciousness of the individuals within that organization, and serves as the cornerstone for all other financial performance components. The board of directors, financial managers, and audit committees are in charge of handling banking institution affairs. In these institutions, the management team is responsible for establishing the regulatory framework for controlling the liquidity levels. Internal controls, according to Tunji(2013) and Dhillon (2001), are a set of regulations guidelines, practices that a company uses to give itself a reasonable level of assurance that its financial reports are accurate, its business operations are successful and efficient, and its operations are compliant with all relevant laws and regulations.

According to Beyanga (2011), an effective internal control service can particularly help in reducing overhead, identify ways to  improve efficiency and maximize exposure to possible losses from inadequately safeguarded company assets all of which can have a significant effect on the financial performance of an organization. He further stated that internal audit is an invaluable tool of management for improving performance. Fadzil et al(2005) also concluded that internal controls help run a company more efficiently and effectively to increase shareholders value. Hermanson and Rittenberg (2005) argued that the existence of an effective internal control function is associated with superior organisational profitability.

The five primary internal control system components that should be compared during the evaluation are listed in the COSO framework (2013). The control environment, risk assessment, control procedures, information and communication, and monitoring are some of these. There is a prevalent belief that implementing and maintaining effective internal control systems will always results in increased financial performance. According to the COSO (2013) framework, correctly implemented internal controls are set up to guarantee the secure custody of all corporate assets, prevent misuse or misappropriation of assets, and to identify and protect firm resources from likely frauds.

Furthermore, these determinants of internal control include control environment, the entity’s risk assessment process, information communication technology, control activities and the monitoring of controls (Chukwu. 2012).  Control environment is the foundation on which an effective system of internal control is built and operated in an organization that strives to achieve its strategic objectives, provide reliable financial reporting to internal and external stakeholders, and to operate its business efficiently and effectively(Armstrong, 2003).

Additionally, it has lately come to light that risk assessment is fundamentally more crucial to be conducted in the financial industry than in any other area of the economy. Knowing that the primary goal of financial institutions is to increase revenues and provide the most value to shareholders by enabling them with a variety of financial services, particularly by managing risk, makes it more comprehensible ( AL-Tamimi&AL-Mazrooei,2007). To prevent future failures that are likely, risk assessment methods should be adopted. However, risk assessment is unquestionable not free, in actual terms. In actuality, it cost a lot in terms of resources and institutional upheaval. However, the price of postponing or ignoring appropriate risk management can have unfavourable outcomes.

Monitoring is an ongoing activity which involves performing procedures periodically and reviewing banks documentation to confirm that all procedures have been performed as required (Muhota, 2005). Monitoring is one of the most important aspects of internal control in any financial institution used internally, while externally, financial institutions use regulatory and supervisory measures. The tools used in monitoring by many organizations are reconciliations, internal checks and audits to ensure the accuracy of transactions being reported in financial statements (Diamond, 1984).

In the world context, there have been a  number of financial scandals involving quoted corporations on the local and global stage. Among other financial fraudulent activities affecting publicly traded companies, investors in America los $180 billion in the world Com scandal of 2002, $1.4 billion in the health south scandal of 2003, and $3.9 billion in the America International Group (AIG) scandal of 2005. A number of high-profile corporate accountingscandals in the early 2000s caused some investors, employees and other stakeholders to suffer large losses. Demands for s stronger focus on corporate governance were raised as a result of these crises. In july 2002, the united states congress passed the Sarbanes-Oxley act (SOX) in an effort to reduce public concern over a number of high profile corporate failures in the US (COSO, 2013).

In South Africa, accounting scandals have been documented at the firm Randgoldand Exploration. The managing director and chief financial officer of Cadbury Nigeria in Nigeria were fired in 2006 for exaggerating the company’s profits in the years prior to the foreign partner’s acquisition of a controlling stake. The necessity to assess, examines, and creates systems of checks and balances to direct corporate executives in decision-making are highlighted by these crisis. These executives are required by law and morality to periodically produce truthful, dependable, accurate, and illuminating business financial reports. (Hayes, Dassen, Schilder&Wallage, 2009).

In kenya, according to statistics from CMA (2014), a significant proportion of businesses, particularly publicly traded enterprises, have experienced dimishing financial performance in recent years. For instance, Kenya Airways reported a loss of Ksh10 billion, Mumias Sugar company reported a loss of Ksh3.4 billion, Uchumi Super markets reported a loss of Ksh226 million, Eveready East Africa Limited reported a loss of Ksh248 million, and CMC Holding was suspending from the NSE, among other companies. According to Rezaee and Zabihollah (2002), financial reporting is ineffective as a results in publicly traded enterprises. Due to mega company scandals, Kenya was ranked 106^th out of 144 countries in 2013 by the world economic forum. CMC and Centum Ltd were two of the businesses mentioned in the study for having subpar corporate governance.

In the context of Cameroon, Cameroonian financial institutions such as banks that sustained big losses failed to recognize and evaluate the risks of novel products and activities or to update their risk assessment when material alterations in the external environment or market conditions occurred. The vast majority of recent incidents demonstrate how control systems that work effectively for conventional or simple products cannot handle more advanced or complicated items. Banks engage in risk taking activities (Karagiorgos et al., 2009). Due to its extensive exposure to uncertainty and weighty issues, banking is a sector that is primarily connected with risk. For assurance regarding the dependability of the operations and processes being followed, risk assessment is one of the most crucial techniques to be implemented, especially in banks. In today’s dynamic climate, all banks are susceptible to a wide range of risk, market risk, and interest rate risk, among others, which could represent a threat to a bank’s survival and prosperity.