ABSTRACT
Internal control systems are primarily established to
enhance the reliability of financial performance directly or indirectly by
increasing accountability among information providers in an organisation. As
the credit unions in Ghana has existed over the past twenty years but their
activities have not witnessed significant growth as compared to banks and
financial services within the country. It therefore calls for a systematic
approach to analyse the internal control system within credit unions and how it
has affected their financial performance over the years.This study sought to
determine the effect of internal control system on the financial performance of
Credit Unions in the Sekondi-Takoradi Metropolis. There were sixteen credit
unions in the Metropolis. All sixteen were used for this study. Quantitative
analysis was employed for this study. Some of the findings from the study
revealed that Credit unions in Sekondi-Takoradi Metropolis have structured
control environment which included the presence of policies that guided work
process and roles and responsibilities that highlights each employee’s role and
responsibility. It was therefore recommended that the management of credit
unions should exert collective efforts in identifying the ideal mix of effective
and efficient internal control systems that match their business needs and
invest in them, and future researchers should consider replicating this study
in the all financial institutions in Sekondi-Takoradi order to establish the
role of internal audit in financial institutions.
CHAPTER ONE
INTRODUCTION
Any organisation of whichever form or size must put in place
its own system of controls to achieve desired objectives. This is because critical
components of management involve systems of effective internal controls of
company and thus a foundation for the safe and sound operation of every
organisation. This research evaluates effect of internal control on financial
performance of credit unions in Sekondi-Takoradi Metropolis. The chapter is
divided into five main sectionsnamely the background of the study, the
statement of the problem, objectives, research questions and significance of
the study.
Background to the Study
Internal controls are put in place so that organisation can
achieve profitable goals and mission and to minimize undesirable risks along
the way. They help organisational management to effectively deal with economic
and competitive environment which is rapidly changing, shifting customer
priorities and demands and restructuring for future growth. Internal controls
reduce risks of asset loss, promote efficiency, and help to ensure the
reliability of financial statements and compliance with laws and regulations
(Mwindi, 2008).
The concept of internal control has existed as early as there
have been substantive work relationships. Gupta (1991) sited that its origin
can be documented and traced back to civilized communities that existed around
5000 B.C. The governments of these empires imposed a number of taxes on
individuals and business for proper accounting and collection of taxes and an elaborate system of checks and
counterchecks. Such systems of internal control in early times were designed
basically to protect state properties and minimize errors done by dishonest tax
collectors (Gupta, 1991). According to Gupta (1991), the Mesopotamian
civilizations which existed about 3000 B.C. used comprehensive systems of internal
controls and their transaction summaries were prepared by scribes but these
scribes did not provide valid records of receipts and payments.
In 1985, organizations sponsored the National Commission on
Fraudulent Financial Reporting, (Treadway Commission). In 1987, Treadway
Commission suggested committee to be formed to study internal controls. In
1992, Committee of Sponsoring Organizations (COSO) issued “internal Control
Integrated Framework” Then the Real Finance Journal, (2005), and concluded with
the history of internal controls in the United Kingdom (UK) as follows: 1992:
The Cadbury Code, the UK’s first corporate governance code, which included
principles on reporting the effectiveness of a company’s system of internal
controls. In 1994, the Rutteman Report on Internal Control on Financial
Reporting expanded the principles specifying minimum disclosures but it
admitted a system of control can provide only “reasonable and not absolute”
assurance against misstatement.
This led to the first Combined Code which broadens the debate
from internal financial control to internal control in 1998. In 1999 The
Turnbull Report suggested boards of organisations should adopt a risk-based
approach to establishing a sound system of internal control and conduct an ongoing
review of its effectiveness. The Sarbanes-Oxley Act was therefore passed in the
United States (US) in year 2002. All directors of organisations were required under Section 404 of the act
make statements on the effectiveness of internal controls. In 2003, ‘The Smith
Report’ advised on the roles and responsibilities of audit committees.
The Combined Code was further revised to reflect both this
and the Higgs Report. In 2005, a group led by Douglas Flint, Financial Director
of HSBC reviewed the Turnbull Guidance. Flint stated that “the overwhelming view
was that the Turnbull Guidance continued to provide an appropriate framework
for risk management and internal control. Its relative lack of prescription is
considered to have been a major factor contributing to the successful way it
has been implemented,”(Flint, 2005).
To ensure the effective and efficient managements of credit
delivery and recovery of all facilities granted at expiry, internal controls
are normally put in place. In the financial sector, to enhance the efficiency
and effectiveness of internal control in organisations, various legislations
have been designed by Central Bank of the nation which includes but not limited
to 1992 Fourth Republican constitution, the financial Administration Act (act
654), the Criminal Code of 1960 (Act 29), Internal audit Agency Act (Act 658)
and the Public Procurement Act (Act 663). Nonetheless, internal control only
provides reasonable assurance, not absolute assurance for organisations. This
is because it is humanly operated therefore human error, management override,
breakdowns, deliberate circumvention, improper collusion among people who are
supposed to act independently can cause failures of the internal control to
achieve objectives.
As part of improving their internal control systems, internal
auditing function, and financial performance, most credit unions in the country
have put in place mechanisms to ensure
internal control and compliance in credit delivery. These include setting up an
internal audit unit, a monitoring unit and issuing the Accounting, Treasury and
Financial Reporting Rules (ATE Rules). It is therefore in this light that this
dissertation is undertakento assess the effect of internal control system and
how it affects the financial performances of credit unions.
The growth and development of the financial institutions are
dependent on the effective and efficient management of its credits. Under the
COSO Framework, objective setting is seen as a precondition for internal
control. By setting objectives, management is able to identify potential risks
to the achievement of set objectives. To address these risks, management of
organizations may implement specific internal controls. The effectiveness of
internal control can then be measured by how effectively the risks are
addressed and how well the objectives are achieved.
More generally, budgets, plans, setting objectives, and other
expectations establish criteria for control. Control itself exists to keep a
state of affairs within what is allowed and expected. Control built within a
process is internal in nature. It evolves having combination components that
are interrelated and these includesnecessary information, social environment
effecting behaviour of employees, as well as policies and procedures. Internal
control as a structure is a plan which predicts how internal control is made up
of these interrelated components.
Corporate governance as a concept heavily relies on the
necessity of internal controls because internal controls ensure operation of
processes as designed and risk management carried out. Further, it is necessary
to establish strategies that ensure that
aforementioned procedures will be performed as intended: integrity and
competence, right attitudes, and monitoring by managers.
Internal control is an organisation’s plan and all it
coordinated methods and measures adopted to protect the assets of the
organisation, check the accuracy and reliability of accounting data, promote
operational efficiency of the machinery and human resource and adherence to
prescribed managerial policies. This definition of internal control can be
divided into two; financial and non-financial (administrative) internal control
respectively. Financial internal control involves financial activities
including controls over company’s cash receipts and payments financing operations
and company’s management of receipts and payments. Non-financial internal
control on the other hand deals with activities that are indirectly financial
in nature that is, controls over organisation’s personnel and operations,
control of fixed assets controls and controls of laid down procedures (Reid
&Ashelby, 2002).
The French Institute of Chartered Accountants defines
internal control as a set of security measures which contribute to the control
of a company. It ensures the security and safety of assets and information.
Internal control further plays an important function of preventing and
detecting fraud as well as protecting resources of an organisation both
physical (which includes machinery and property) and intangible (that is,
reputation or intellectual property). Internal controls are policies,
practices, procedures, and organisational structures undertaken to provide
assurance that an organisation’s business objectives will be achieved and
undesired risk events prevented or detected and corrected,
based on either compliance or management initiated concerns (Awe, 2005).
Despite been expensive, internal control system installs and
maintain, it gradually evolved over the years with the greatest development
occurring at the beginning of 1940’s. Not only have the complexities of the
business techniques contributed to this development but also the increased size
of business units which have encouraged the adoption of methods which while
increasing efficiency of business, acts as a safeguard against errors and
frauds. Mawanda (2008) posits that there is a generally, people perceive that
instituting and enforcement of proper internal control systems will always lead
to improved financial performance. Another general belief is that effectively
established system of internal control improves reporting process and gives
rise to reliable reports enhancing accountability function of management of
organisations. Preparing reliable financial information is thus a key
responsibility of the management. The ability to effectively manage the firm’s
business requires access to timely and accurate information.
Credit Unions are important contributors to the economy of
Ghana. Apart from creating employment opportunities, they have also led the
establishment and growth of many micro enterprises, training of entrepreneurs,
generation of income as well as sources of livelihood for the majority of low
and middle income earners/households by financing their businesses or ventures.
Credit Unions traditionally have become the main source of funding for micro
enterprises in Africa and in other developing regions of which Ghana is not
exception (Anthony, 2004). CUs were initially established as institution-based
organizations or aimed towards people on regular incomes. However, in recent
times CUs have opened up to a wider variety of clients in the community where
they are based (Darko, 2007).
The Ghanaian credit union industry has evolved from a highly
regulated sector into a largely market driven one. The regulatory and
institutional framework has improved considerably yet still credit unions in
Ghana are facing some challenges as the world deals with one of the deepest
financial crisis in the history of the planet (Beacon, 2010). The recent demise
of Ghana Co-operative Credit union Ltd is test case of how gaps in internal
controls can easily cause collapse of financial institutions. Internal controls
and risk managements has a purpose to ensure the efficiency and effectiveness
of operational activities, reliability of financial information, compliance
with applicable rules and regulations and sustainable business growth have been
incorporated into the mundane activities of credit unions in Ghana.
Most credit unions go through difficulties in recovering
facilities given to customers after expiry. Issues of default of credit
facilities by credit unions are gradually destroying most gains and weakening
business opportunities. Internal controls and risk managements and sustainable
business growth have been incorporated into the mundane activities of credit
unions in Ghana.The Ghana Cooperative Credit Union Association (CUA), which is
the governing body of all credit unions in Ghana regulates the interest rates
that Credit Unions have to pay on members’ savings and charge on loans, perhaps
reflecting the initial welfare nature of credit unions.
Credit Unions operate a Central Finance Facility into which
member CUs contribute and source funds to lend to their members (Darko,
2007).The Bank of Ghana, which plays the regulatory role of financial
institutions in the nation has instituted some measures
to make sure financial institutions function to improve on the effectiveness of
their internal control systems and financial performance. These various
legislations have been passed to reduce fraud, the risk of misstatements, and
mismanagement of both government and corporate resources.
The Office of accountability at the Presidency was created
among the Commission on Human Rights and Administrative Justice (CHRAJ) and the
Serious Fraud Office. With support from the UNDP in 2005, the Securities and
Exchange Commission (SEC) was also created carried out a country assessment of
corporate governance standards in Ghana, which led to issuing of new corporate
governance standards in the same year (ACCA, 2005).
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