CHAPTER ONE

                                                                    INTRODUCTION

1.1.  Background of the Study

Quality financial statements are to provide high-quality financial reporting information concerning economic entities, primarily financial in nature, useful for economic decision making (FASB, 1999; IASB, 2008). Providing high quality financial reporting information is important because it will positively influence capital providers and other stakeholders in making investment, credit, and similar resource allocation decisions enhancing overall market efficiency (IASB, 2006; IASB, 2008).

Although, both the FASB and IASB stress the importance of high-quality financial reports, one of the key problems found in prior literature is how to operationalize and measure this quality. Because of its context-specificity, an empirical assessment of financial reporting quality inevitably includes preferences among a myriad of constituents. This problem of quality measurement should be looked at from two perspectives. The first perspective is, if it meets standards of preparation and the second, its content. In this study we will concentrate on its content and by so doing need internal control for proper investigation and follow-up.

Internal Controls are therefore, processes designed and effected by those charged with governance, management, and other personnel to provide reasonable assurance about the achievement of an entity’s objectives with regard to quality of the financial reporting, effectiveness and efficiency of operations and compliance with applicable laws and regulations (Mwindi, 2008).

Brink (2009) contents that internal control concept has existed as early as there have been substantive relationships. Brink (2009) added 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 the proper accounting and collection of these taxes, an elaborate system of checks and counterchecks was established.

Such early internal control systems were designed primarily to minimize errors, and safeguard state property from dishonest tax collectors. Internal control is a process effected by the entity’s board of director, management and other personnel’s, design to provide reasonable assurance regarding the achievement of objective in categories; quality and financial reporting effectiveness and efficiency of operations and compliance with applicable laws and   regulations (Ray and Kurt, (2001).

According to Mercer University (2010) the United States of America and somewhere else in Europe have supported countries and corporate associations to place more emphasis on their internal control frameworks and internal auditing functions and risk management. 

In the United States for example in 1992, a gathering of organizations supported the development of the tread path commission to study and write about how to enhance the adequacy of internal control system, and in 2002 the US Congress passed the Sarbanes Oxley act giving new orders   on how companies are to report on the effectiveness or otherwise of their internal control systems are to cover the viability or generally of their interior control frameworks (spring, 2005).

In Kenya, a study conducted by Simiyu (2011) on effectiveness of internal control system in higher institutions of learning in Kenya clearly indicate that Institutions of higher learning face quiet a number of challenges during internal controls in performance like struggles with liquidity problems, financial reports are not made timely, accountability for the financial resources is still wanting, frauds and misuse of institutional resources.

Njui (2012) investigated the effectiveness of internal control and audit in promoting good governance in the public sector in Kenya and found that internal control has the greatest effect on corporate governance within Kenya government ministries followed by risk management while compliance and consulting had the least effect.

Kakucha (2009) evaluated the level of effectiveness of internal controls operating in Nairobi and established that there are deficiencies in the systems of internal controls, with the degree of deficiencies varying from one enterprise to another.

Kateeba (2010) that indicates a strong positive relationship between the quality of financial statements with financial accountability. One of the tools to facilitate the creation of transparency and accountability is through a comprehensive presentation of the financial statements.

The financial statements are an essential component to create accountability and is one measure of financial performance (Bandary, 2011). The same is expressed in the research by Siti Aliyah (2012) that the preparation of financial statements in full area in accordance with Government accounting Standards and easily accessed by all interested parties allow the control and supervision of the financial management can work well.

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).

Cameroon has about 7.3 million living below the national poverty line (IMF reports, 2009, 2010). This rural population greatly relies on the microfinance institutions to provide them with credit which could enable them finance their micro enterprises as well as sustain their consumption patterns. 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.

The aim of this study was therefore to investigate the effect of internal control on the quality of financial statement of selected Microfinance institutions in Cameroon.

Statement of the Problem

According to Kirsty (2008) efficient internal controls creates an organization’s confidence in its ability to perform or undertake a particular task and prevents errors and losses through monitoring and enhancing organizational and financial reporting processes as well as ensuring compliance with pertinent laws and regulations.

However, despite the importance of internal control on the quality of financial statements, Molem and Ngwa (2016) carried out a study Incidence of Fraud in Microfinance Institutions in the Southwest Region of Cameroon and reported that the problem of fraud and internal control weaknesses in microfinance institutions still exists and requires specific attention from the management or the stakeholders of these institutions. However, these are just some of the factors which have affected the authenticity of financial statements of micro finance institutions in Cameroon.

Several studies have been carried out on internal controls globally, regionally and locally on the effect on internal control system on profitability of diverse firms.

For example; globally studies by Abu-Musa (2004); Chunlan (2009); Wittayapoom (2011); and regionally Kakucha (2009) and Nyakundi & Nyamita (2014) have established there exist a relationship between effective internal control and financial performance of the firm. However, majority of these studies have concentrated on different industries, while others have concentrated on a mix of listed firms in their localities. In addition, the studies employed different methodologies hence such studies may not be generalized to the study context

This study is therefore aimed at assessing the effect of internal control on the quality of financial statement of Microfinance institutions in Cameroon with the case study being three selected micro finance institutions with names, Buea Police Credit Union, Ntarikon and Nkwenccul.. This is in order to provide meaningful recommendations which will go a long way to influence the research gap and hence increase the quality of financial statements in micro finance institutions in Cameroon.

1.3.  Research Questions

This study seeks to answer the following research questions

1.3.1.  Main Research Questions

What is the effect of internal control on the quality of financial statements inthree selected microfinance institutions in Cameroon?

1.3.2.  Specific Research Questions

1. What is the effect of the control environment on the quality of financial statements inthree selected micro finance institutions in Cameroon?
2. What is the effect of the internal control activities on the quality of financial statements in three selected micro finance institutions in Cameroon?
3. What is the extent to which information and communication affect the quality of financial statements in three selected micro finance institutions in Cameroon?
4. What is the effect of the risk assessment on the quality of financial statements in three selected micro finance institutions in Cameroon?
5. What is the extent to which monitoring of controls affect the quality of financial statements in three selected micro finance institutions in Cameroon?

1.4. Research Objectives

This study seeks to fulfill the following objectives

1.4.1. Main Objective

The effect of internal control on the quality of financial statements of three selected micro finance institutions in Cameroon.

1.4.2. Specific Research Objectives

1. To assess the effect of control environments on the quality of financial statements of three selected micro finance institutions in Cameroon.
2. To investigate the effect of the internal control activities on the quality of financial statements of three selected micro finance institutions in Cameroon.
3. To assess the effect of information and communication on the quality of financial statements of three selected micro finance institutions in Cameroon.
4. To access the effect of the risk assessment on the quality of financial statements of three selected micro finance institutions in Cameroon.
5. To investigate the effect of monitoring of controls on the quality of financial statements of three selected micro finance institutions in Cameroon

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