CHAPTER ONE

INTRODUCTION

• Background to the Study

The concept of internal control is said to trace its history back to the beginning of the 20^th century when the audit on financial statements came into being. Its present-day interpretation differs from early days owning to changes in the business environment. An earlier victory in the Spanish-American war brought about an expansion of the overall economy and the scale of enterprises in the U. S after the turn of the century. Until those days, detailed audit was undertaken on all the target items as an audit of financial statements. But a rapid growth in corporate scale made it impossible to continue the practice. Consequently a “sampling test “was introduced involving examination of samples taken from targets assuming that companies conduct their own inspection (system of checks and balances) whereby potential frauds and errors in operations are mutually checked within organization. This internal checks and balances effectively marked the birth of the concept of internal control.

The research of internal control in china began in 1980 (Chen Xiao fang, Nie Huili school of management) due to the collapse of so many companies.

In the wake of the great depression in 1929, the security Act of 1933 and the Security Exchange Act of 1934 were enacted, mandatory audit on financial statements was imposed on listed companies. The role of auditors then was to inspect financial statements to see if they comply with accounting principles. As corporations became even bigger and more complex, it became impossible to ignore the aspect of business management which is the prerequisite of auditing the reliability of financial reporting.

Consequently, the American Institute of Certified Public Accountants (AICPA) published a report on internal control in 1949 defining it. It was followed by further clarifications in 1958 and 1972. In 1977, publicly held companies came under legislation to adequately protect their financial information by putting in place an internal control mechanism. When a break in the relationship of accountability occurs, investor confidence in the reliability of financial signals also, starts to erode, shaking the foundation of the capitalist economy.

This was made painfully obvious after the accounting scandals in early 2000s involving some of the biggest names in the financial and corporate world: Enron, WorldCom, Tyco, and Arthur Anderson. Henry Paulson rightly emphasized that capital markets reply on trust and trust is based on financial information presumed to be accurate and reflect the economic reality (Cohen et al, 2005).  Thus, in 2002 the US congress passed the Sarbanes Oxley Act (SOX) (Goh, 2013). President Bush signed the act into legislation and it became effective on July 30, 2002 (Fuerman, 2012).

Following the recommendation of Sir Andrian Cadbury of the United Kingdom, the king committee came into being in South Africa in 1992. Sir Cadbury pointed out the evolutionary nature of corporate governance. Various commissions were held in England under people other than Sir Cadbury after the Cadbury report was issued. This report as followed by the Greenbury, Hampel, Turnbull and many others. These were combined to become the UK governance code now known as the combined code (financial reporting council, June 2006), laying down principles for proper financial reporting and the role of internal controls in the reporting process.

Per the Turnbull review group (October 2005) for the combined code, boards should review whether they can make more of the communication opportunity of the internal control statement in the annual report. Investors consider the board’s attitude towards risk management and internal control to be an important factor when making investment decisions about a company. Taken together with the operating and financial review, the internal control statement provides an opportunity for the board to help shareholders understand the risk and internal control issues facing the company, and to explain how the company maintains a framework of internal controls to address these issues and how the board has reviewed the effectiveness of that framework.

It is in this light that directors need to exercise their responsibility to review on a continuing basis their revised guidance. Internal control became apparent in Egypt at the beginning of the 21^st century following major corporate scandals (PABC 2006). In Hellenistic Egypt, there was dual administration where one side was involved in collection of taxes and while the other supervises them. This then marked the beginning of internal control in Egypt.                                                                                                

As far as regulation is concerned, the microfinance sector of Cameroon has as its main regulators, the Central African Banking Commission (COBAC) and the ministry of Finance (MINFI). These bodies set the rules and regulations that are to be implemented by the institutions. Nevertheless, one of the most peculiar issues on the microfinance sector in Cameroon is that contrary to expectations this sector has become one of the most regulation needing industry. This increase regulation comes from the fact that the MFIs have considerably grown in size which can be seen from their increase deposits and loans and capital base.

As these institutions become bigger and more complex their internal control processes are also becoming more complex and complicated. This view is held by Anita (2010), who explains that, microfinance institutions are not immune to the dangers of weak internal controls. She further argues that weak internal controls can also allow operational errors to remain uncorrected and that human or systems errors can result to the posting of figures of interest and other financial transactions into wrong accounts which can accumulate into a serious loss in the future.

• Statement of the Problem

 When companies collapse, the often resound question is “what went wrong?” A breakdown in the internal control system is the usual cause. Today accounting systems and the internal control (further – IC) concepts are subjects of constant changes. And, the current economic environment and financial pressure to improve margins and earnings performance are challenging many financial institutions, causing them to downsize, employ new technologies or offer new products or services in attempts to maintain a competitive edge. Because of all these, there is a potential belief that the internal control environment may not always evolve in kind. Failure to maintain an internal control environment which commensurate with the size and activities of an institution can create issues including opportunities for fraud and gross material misstatement in financial reports.  The increase pressure in the scrutiny of financial reports has been prompted by the collapse of major firms in the world like Enron and WorldCom in the USA.The collapse of such firms has been because of a weak or lack of internal control systems.AS such, fraudulent financial statements were issued which do not show a true picture of such companies. In South Africa and Nigeria, cases of accounting scandals have been recorded because of weak internal control systems. Cameroon is yet to register a prominent collapse in its economy resulting from weaknesses in internal control. These scandals recorded so far in the world and some in Africa emphasize the need to put in place a strong system of internal control. This includes the need to evaluate, scrutinize and formulate a system of checks and balances to guide corporate executives in decision making and financial reporting. These executives are legally and morally oblige to produce honest, reliable, timely, accurate and informative financial reports periodically. In order to achieve such, effective internal control must become very necessary for proper identification, summarization, processing and communication of information to the stake holders of the company. Management needs to provide all necessary financial and material information to stake holders, who are users of the annual financial statements. As part of it, internal control detail should be disseminated to the stakeholders to facilitate their decision-making process.

• Research Questions

This study seeks to answer the following research question

1.3.1 Main Research Questions

What is the Impact of Internal Control Systems on the Reliability of Financial Statements in Selected Micro-Finance Institutions in Buea?

1.3.2 Specific Research Questions

1. What is the impact of the internal control activities on the qualities of financial Statements in selected micro-financial institutions in Buea?
2. What is the extent to which information and communication affect the quality of financial Statements in micro-financial institutions in Buea?
3. What is the impact of risk assessment on the quality of financial Statements in selected micro-financial institutions in Buea?

1.4 Objectives of the Study

This study seeks to fulfill the following objectives

• Main Objective

To examine the impact of internal control systems on the quality of financial Statements in selected micro-financial institutions in Buea.

1.4.2 Specific Objectives

1. To assess the impact of internal control systems on the reliability of financial Statements in selected micro-financial institutions in Buea.
2. To investigate the impact of internal control actives on the reliability of financial Statements in selected micro-financial institutions in Buea.
3. To assess the impact of information and communication on the reliability of financial Statements in selected micro-financial institutions in Buea.
4. To assess the impact of risk assessment on the reliability of financial Statements in selected micro-financial institutions in Buea.