THE EFFECT OF INTERNAL CONTROL AS A BASIC TOOL FOR FRAUD DETECTION AND PREVENTION


Content

ABSTRACT

 

Fraud has been one of the major threats to the existence of an organization in the modern day business and if it is not adequately prevented it might lead to the collapse of the business within a very short period of time. This research work look into the way fraud can be detected and prevented in the corporate organization through the use of internal control as a mechanism for it prevention.

The objectives of the study were to determine whether the internal control system adopted is maintained and complied with in most organization within our economy in which the focus is on the banking sector; to acquire more knowledge on internal control system and evaluate the effort to which it helps in a sector if adopted and strictly complied with; to also ensure that there are adequate records on transactions are properly done. Two null hypotheses were stated to guide the study as follows:

§  Effective internal control does not in any way reduce the incidence of fraud

§  It is not the sole responsibility of the management to ensure the establishment of sound internal control system.

The research method and the instrument used were survey and questionnaire respectively. Also the responses to the questionnaire were analyzed and the results used to test the hypotheses. Chi square test of the hypotheses revealed that:

§  Effective internal controls reduce the incidence of fraud

§  It is the sole responsibility of the management to ensure the establishment of sound internal control system.

It was concluded on the basis of the findings that,

§  Before payment are made they are duly authorized by the management;

§  Segregation of duties enhance performance of operations of an organisation

§  Irregular recording of cash and cheques lead to the omission of important transactions.

Therefore it is important to note that, internal control system can be used for fraud prevention and detection in an organization.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

TABLE OF CONTENTS

                                                                                                            Page No

Title page                                                                                                    i

Certification                                                                                                ii

Dedication                                                                                                  iii

Acknowledgement                                                                                                iv

Abstract                                                                                                      v

Table of contents                                                                                    vi

CHAPTER ONE: INTRODUCTION

1.0 INTRODUCTION                                                                                1-6

1.1 STATEMENT OF PROBLEM                                                             6-8

1.2 OBJECTIVE OF THE STUDY                                                            8

1.3 SIGNIFICANCE OF STUDY                                                              8-9

1.4 RESEARCH METHODOLOGY                                                          9-11

1.5 SCOPE AND LIMITATION OF STUDY                                            12

1.6   HISTORICAL BACKGROUND OF SKYE BANK PLC                            12-14

1.7 DEFINITION OF TERMS                                                                   14-17

 

CHAPTER TWO:

2.0 LITERATURE REVIEW                                                                     19

2.1 FRAUD DEFINITIONS                                                                        19-21

2.2 CATEGORIES OF FRAUD                                                                 21-24

2.3 FRAUD DETECTION AND PREVENTION:

     TRANSACTIONAL ANALYSIS FOR EFFECTIVE

      FRAUD DETECTION                                                                       25-29

2.4 HOW FRAUDSTERS EXPLOIT COMPLEX SYSTEMS                              29-32

2.5 REPORTING FRAUD AND COMMUNICATING

      WITH MANAGEMENT                                                                      32-39

2.6 CONTROLS IN ORGANISATIONS                                                   39-52

2.7 CO N C L U S I O N                                                                                      52-55

CHAPTER THREE

3.0     RESEARCH METHODOLOGY                                                                58

3.1     RESEARCH DESIGN                                                                      58-59

3.2     POPULATION /SAMPLE                                                                          59-60

3.3     DATA ANALYSIS                                                                                    60

3.4     LIMITATION OF STUDY                                                                         60

CHAPTER FOUR: PRESENTATION AND ANALYSIS

 4.1 INTRODUCTION                                                                                          62

4.2ANALYSIS OF THE RESPONDENTS’ CHARACTERISTICS               62-66

4.3 ANALYSIS OF RESEARCH QUESTIONS                                          66-73

4.4 HYPOTHESES TESTING                                                                             74-85

CHAPTER FIVE: DISCUSSION, SUMMARY, CONCLUSION AND   RECOMMENDATION  

        5.1 DISCUSSION                                                                                                87-88

5.2 SUMMARY                                                                                         88-89

5.3 CONCLUSION                                                                                    89

5.4 RECOMMENDATION                                                                        89-91

BIBLIOGRAPHY                                                                                                92-93

APPENDIX                                                                                                93-96


CHAPTER ONE

1.0   INTRODUCTION

Internal control is an important tool in the prevention of fraud and detection. It   should be emphasised that if fraud is not taken care of, it can cause serious problem which may invariably lead to liquidation of the company.  The prevention of fraud through internal controls would contribute positively to the development of the organisation and ensure continuity of the firm as well as portraying the good corporate image of the firm in the outside world.

Fraud comes in all sizes ranging from dollar cases of corporate fraud to thousand dollar cases of employee embezzlement to employees overcharging their expense reports. Therefore, an effective fraud prevention strategy must be multi-dimensional, considering senior management, employees and even outside parties such as the customers and vendors. An effective fraud prevention strategy must also be adapted to the ever-changing schemes as internal controls and technology change the operative environments of most companies.

The inventors of the concept and practice of control will definitely be restless in their grave. The system, which they introduced to ensure that finance are properly managed and utilized as stipulated, has been abused and manipulated by those who are supposed to be the custodians.

Consequently, all over the world, financial controls are in discharge; creative accounting is the new ‘god’ and auditors whether internal or external are agonizing over the present and future of auditing practices.

First it was Enron, a firm ranked 7th on the fortune 500 chart in 2000 which suddenly crumbled like a pack of cards as a result of indigenous account doctoring to the tune of $1.21 billion (Asein, 2002). Then came the shocking disclosure of the “fund book of record” grade  world accounting fraud which was originally put at $3.7billion  but eventually hit $7biilion following the discovery of $3.7billion earning errors. This happened at the time global crossing was reeling under $12.4billion debt and over 60 shareholders lawsuit.

Consequently, we are not immune from the corporate ‘419’ that is shaking corporate America, the bastion of capitalism and due process to its foundation. Long before now, Nigeria suffered from a devastated and rampant bank distress epidemic at the end of which 31 banks with deposit of 1,744,080 deposits, about N90billion in deposit were closed. There is also the case of African petroleum PLC where about N29billion was concealed in the records and where the Federal Government has been forced to set up probe of erstwhile management. But the financial record of the same Federal Government is in mess as funds were released without budgeting.

Over the years, particularly during the era of military, when the economy was been handled by those trained in the warfare, the zeal and the productive sector of the national Economy was killed and buried. During this era, while the consumption attitudes of the populace was being developed, the ethical and cultural background, the social fabrics, religious belief assaulted from all fronts. While these were going on, the education of the ‘child’ which hitherto is known to be the all round development of the child mentally, physically, socially, morally, religiously, culturally, where dignity of labour as a foundation was abandoned for man literacy programme. The resultant effects of these were:

§  The collapse of the national economy.

§  Breakdown of social, cultural and ethnic background of the people.

§  Mass unemployment of energetic, vibrant and intelligent youths.

§  The total eradication of the middle class which resulted to the do or die syndrome of lower class to ‘reach the top’.

However, the reduction or prevention of flow of illegal act can be achieved through internal checks in every organisation or work field and it could be divided into three units; work environment, control system and fraud specific procedures. Through these, fraud commitment will be reduced to a lower level and then have a positive effect in organisations and the nation as a whole.

According to the Deputy Manager and chief inspector of Intercontinental Bank PLC, Remi Adewunmi, he observed that reasons for upsurge in bank fraud have the same factors as in why people steal, which are ; temptation, opportunity and kleptomania syndrome.

According to him, in the Nigerian context, people perpetrate fraud in order to: Satisfy the materialistic pen

chant of the society, put an end to the scourge of poverty in the face of worsening economic conditions as well as an unbridled greed to acquire wealth for no legitimate course.

Concerning reported cases of fraud and forgeries in Nigeria banks for years 2003 to 2006, Adewumi stated that the Nigerian banking sector witnessed a high rate of fraud and forgery both in number and amounts of attempted and successful fraud during the years prior to consolidation.

According to him, from figures made available by the CBN, the banking sector witnessed a total of 1,036 frauds in 2003. This figure rose in 2004 by 11.8 per cent 1,175 and by 4.59 per cent in 2006 to a figure of 1,229.

It however declined by 2.9 per cent in 2006 to a figure of 1,193 to which Adewumi said that this current figure is still considered very high for the 25 surviving banks.

"The threat posed to depositors' funds and shareholders' funds by the fraudsters cannot be over emphasised," he said.

Talking about fraud prevention and the role of control, the deputy general manager explained that the first line of defence against fraud is a strong and tested internal controls.

According to him, while a lack of internal control does not guarantee that fraud will take place, it does open the door a bit wider for whoever cares to come in.

"If people intent on committing fraud think they may be blocked or exposed by strong internal controls, they will be deterred," he said.

Consequently, he said, it is incumbent on the internal auditor to guarantee strong internal control through institutionalization of the following basic internal control measures; segregating duties, dual controls, joint custody, rotating duties and specific internal checks and balances.

Other fraud prevention control, he stated, include, strong physical control over inventory, marketable securities and blank chequebooks, adequate documentation for cash movement, presence of robust and reliable software as well as independent spot check to monitor and sanction deviation.

Still, other fraud prevention controls include: Regular process review (at least once a year) to assess adequacy or otherwise of the control mechanism in-built in the system, acquire robust audit tool that will facilitate fraud detection as well as appropriate deterrent perception and presence of fraud policy or ethical policy that will spell out issues regarding employee awareness on fraud, investigation, whistle blowing, sanction code and others.

Strong internal controls, proactive auditing of records and analysis of key financial trends are effective tools in the battle against fraud. Clear policies and zero tolerance toward fraud, along with employee support programs, help create the proper control environment.

1.1 STATEMENT OF PROBLEM

Fraud can be catastrophic to any organisation if it is not adequately identified and monitored. The result otherwise can be devastating to the organisation’s financial position, reputation, citizen’s confidence level and success in achieving its goals and objectives.

The existence of fraud within an organisation has the potential to be viewed as a failure to fulfil its governance obligation. The major reason for the rising incidences of fraud has been attributed to the increased hardship caused by the hostile economic condition. Another reason for the proliferation of fraud is the confidence built up by the fraudsters who take advantage of the decays in the nation’s legal system. As a result, fraud has become a cankerworm increasing in number, magnitude and sophistication daily.

In modern day business, segregation of duties and physical control system of internal control serves as prominent, reliable and effective control put in place to avoid fraud and manipulation.  This however has brought some problems which could be detrimental to the business. For instance, deterioration of working capital could be detrimental to business organisation and may cause serious problem which may result in the winding up of the business organisation.

The first line of defence against fraud is a strong system of internal controls. While a lack of internal control does not guarantee fraud will take place, it does open the door a bit wider. People’s intention of committing fraud can be blocked via the awareness of the existence of strong internal control system put in place by the management.

Internal control becomes a problem to an organisation when there is:

§  Lack of segregation of duties, such as an individual making bank deposits, posting them to the accounts receivable system and performing monthly bank reconciliation;


§  Poor physical controls over inventory, marketable securities or blank check stock;

§  Inadequate documentation and support for cash disbursements;

§  Inadequate or obsolete accounting software; and

§  Failing to perform independent verification, such as spot checks of physical inventory

1.2 OBJECTIVE OF THE STUDY

The objectives of this study include:

§  To ensure that internal control system adopted is maintained and complied with in most organisation within our economy in which the focus is on the banking sector.

§  To acquire more knowledge on internal control system and evaluate the effort to which it helps in a sector if adopted and strictly complied with.

§  To also ensure that adequate records on transactions are properly done.

1.3   SIGNIFICANCE OF STUDY

In consideration of financial services section (such as banking, insurance, building societies, customer credit, purchase business, leasing, factory, business ventures etc). Banking represents probably the most important unit of financial sector.

This is not just in terms of turnover, profit and employment of labour, but also in its paramount impact on the other sector of the economy.  Any problem in banking sector would invariably have strong effect on the economy. That is why this research work tries to study the internal control in relative to fraud prevention and detection in the banking sector with respect to SKYE BANK PLC and its effectiveness and reliability.

This work will also serve as a basis of broaden the researcher knowledge on internal control and its uses. To customers and investors, they would be confident that controls in place can be relied upon for safeguarding their deposits. Management will also be able to reduce losses and improve on the internal control system. Finally, the academic would use this research work as a basis for further study.

1.4.0 RESEARCH METHODOLOGY

1.4.1 RESEACH QUESTIONS

§ Is Internal control System Requirement Necessary?

§  Is ineffective internal control breed Fraud in an organisation?

§  Are records kept of all cheques received?

§  Is bank reconciliation prepared regularly?

§  Is there segregation of duties?

§  Are invoices authorized before payments are made?

§  Are accounting policies adopted by the company consistent?

§  Are registers of fixed assets maintained showing details for all material assets?

§  Are claims refund made on special forms?

§  Are regular physical inspections made to ensure existence and condition of asset?

§  Has there been any restriction as to information or scope of work carried out?

§  Could corporate re-organisation strategy be responsible for fraud in an organisation?

1.4.2  STATEMENT OF HYPOTHESIS

The hypotheses to be tested in this study are stated as follows:

Hypothesis 1

Ho: Effective internal control does not in any way reduce the incidence of fraud

Hi: Effective internal controls reduce the incidence of fraud

 

Hypothesis 2

Ho: It is not the sole responsibility of the management to ensure the establishment of sound internal control system.

Hi: It is the sole responsibility of the management to ensure the establishment of sound internal control system.

1.4.3 POPULATION /SAMPLE

A research population is the totality of all pertinent observation in a given research problem situation. In other words, a population is made up of all conceivable element subjects or observations relating to a particular phenomenon of interest to the researcher (Asika, 1991).

This research study is focused on SKYE BANK PLC.  The sampling method adopted is based on probability i.e. every population has equal chance of been selected. Out of population size of 50, 40 were taken out as sample sizes on which questionnaire will be distributed so as to generate responses from the chosen sample size. The population will be divided into strata i.e. top management and the lower level management. 

 

 

1.5 SCOPE AND LIMITATION OF STUDY

Since it will be too tedious to look at the system of internal controls of all the banks in the country, this research work will be limited to the internal control system and incidence of fraud in SKYE BANK PLC with special references to internal control questionnaire as a means of evaluating the system. The data will be gathered from their various departments but results and conclusion are envisaged to be relevant to banks and allied institution with internal control system at any point in time.

1.6   HISTORICAL BACKGROUND OF SKYE BANK PLC

Skye Bank was made up of five banks in which Prudent Bank has the upper hand in it formation. These banks are as follows:

(a)                Prudent Bank

(b)               Bond Bank

(c)                Reliance Bank

(d)               Eko International Bank

(e)                Co-operative Bank

Skye Bank started it operation under the new identity in January 2006 subsequent to the completion of the various legal and regulatory processes required to form a valid merger. As at January 1, 2006, Skye Bank’s shareholder’s fund stood at over N34billion and this puts the bank amongst the first top five banks in Nigeria. With this capitalization, the bank is better positioned to conduct in business and deliver value to all stakeholders.

The bank also deposit base in excess of N17bn and a balance sheet size of over N114bn while the branch network is currently spread over 160 locations across the major cities and local government areas of the country.

A few more branches are in various stages opening at various locations across the country. Skye Bank is owned by a large number of institutions and individual investors and the shares are quoted on the Nigeria Stock Exchange. This diverse ownership base allows professional and seamless operation and   the executive management is free from any undue interference in managing the bank.

The vision of Skye Bank is to continuously challenge itself to provide limitation possibilities to its customers and it mission is to provide innovative and convenient banking services by a dedicated team to the benefit of its stakeholders. Its core values are: integrity, accessibility, mutual respect and continuous learning.

INVESTMENT BANKING

The investment Banking Group Provide Specialist services to skye Bank’s customers in the areas of capital raising (Equity and Debt), project and specialized finance. It also applies technical, financial and managerial skills to provide advising services for the proper evaluation of business/ project concepts. The services may come in form of feasibility studies, locating appropriate technology and venture partners. The bank is registered with the Securities and Exchange Commission (SEC) as issuing House and Financial Adviser.

The Head Quarter is located at 3, Akin Adesola Street, Victoria Island, Lagos, Nigeria. Its chairman is Musili Smith with managing Director in the person of Akinsola Akinfemiwa.

1.7 DEFINITION OF TERMS

AUDIT: - An audit is a process carried out by a suitable qualified auditor whereby account of business enterprise, is subject to forming opinion as to its accuracy, truth and fairness.

FRAUD: - It involves the use of dishonest or deceitful conduct in order to obtain some unjust advantage over someone else. The United Kingdom financial services act 1986, defined fraud as “a regulation involving the use of criminal deception to obtain an unjust or illegal advantage. The term ‘fraud’ refers to an intentional act by one or more individuals among management, those charged with governance, employees or third parties, involving the use of deception to obtain an unjust or illegal advantage. International Auditing Standards (ISAs)

INTERNAL CONTROL SYSTEM: - The Auditing Practices Committee (APC) defines internal control system as the whole system of controls, financial and other methods, established by the management in order to carry on the enterprises in an orderly and efficient operations to secure its assets, ensure compliance with management policies and secure as far as possible the competence and accuracy of the records.

INTERNAL AUDIT: - This is an independent appraisal activity within an organisation for the review of operations as a service to management.

COMPLIANCE TESTS: - These are tests which seek to provide audit evidence that internal control are been applied as prescribed.

SUBSTANTIVE TESTS: - These are test of transactions and balances and other procedures such as analytical review which seeks to provide audit evidence as to the consistence, accuracy, validity, and reliability of the information contained in the accounting records or financial statement.

WHISTLE-BLOWING:-These are internal processes put in place to support staff to draw attention to anything they think is of concern. They provide guidance for employees and managers in dealing with business conduct and helping them learn how to identify and to avoid dishonest and unethical business practices as well as providing guidance on how to respond t o conduct which may appear to be of concern.

INDEPTH TESTS: - These are generally cradle to grave tests which involve tracing transactions through the system from the point of origination to the point of conclusion.

WALK THROUGH TESTS: - This is a test carried out for the confirmation of what has been documented if it already exists, the way it ought to have existed.

VERIFICATION: - This is the establishment of existence, ownership and valuation of assets at balance sheet date and correction liabilities as shown at that date and ensuring that presentation of assets and liabilities in the accounts is correct.

AUDIT EVIDENCE:- This is the information obtained by the auditor in arriving at the conclusion on which he base his opinion on the financial statements.

ADMINISTRATIVE CONTROL: - This is the plan of an organisation i.e all methods and procedures that facilitates management planning and control and control of operations.

 

 

REFERENCES

Adrian Stern (2005); Focus on Fraud: internals, audit policies- and a tough

         Stance-  an help deter fraud California CPA. 

Asika N (1991) “Research Methodology in the Behavioural Science”           

         Longman Nigeria Plc, Lagos.

Ernst &Young (2003); Fraud the Unmanaged Risk”. 8th Global Survey

European Federation of Accountants (FEE), “How SMEs Can reduce the Risk

       of Fraud Limiting Fraud Risk- What SMEs can do”  (November 2005)  

Olajide B (2006) “Solution to itchy fingers in banks”. Guardian Newspaper 

       Limited, Lagos.

 

 

 

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