THE ROLE OF INTERNAL CONTROL ON THE PERFORMANCE OF MICROFINANCE INSTITUTIONS. CASE STUDY: CDC HOCCU LIMBE

ABSTRACT

The term internal control as defined by the American Institute of Certified Public Accountants (AICPA) comprises those procedures, rules, policies and regulations which are set out by the organization to ensure that the use of its resources is maximized and potential risk of intentional and unintentional irregularities are reduced to a minimum.
The objective of this paper is to identify the role of internal control on the performance of MFIs. Data was collected using the primary source through the use of questionnaires. 15 questionnaires were administered at the CDC Head Office cooperative credit union (HOCCU) using the stratified random sampling method. The questionnaires were presented using tables while chi-square was used in analyzing the data. It was found out from the data analysis that the majority of our respondents do keep adequate internal control to improve on the performance and therefore proves that internal control plays a role in the organisation. The researcher concludes internal control is very important in an organisation. It’s therefore recommended that MFIs should keep up with an accurate internal control system.

CHAPTER ONE

INTRODUCTION

1.1 Background to Study

Internal controls refer to the measures instituted by an organization to ensure the attainment of the entity’s objectives, goals and missions. They are a set of policies and procedures adopted by an entity in ensuring that an organization’s transactions are processed appropriately to avoid waste, theft and misuse of organization resources. Internal control, according to the Committee of Sponsoring Organizations of the TTreadwayCommission (COSO), is a process, effected by an entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the following categories: effectiveness and efficiency of operations, reliability of financial reporting, compliance with applicable laws and regulations, and afeguarding of assets against unauthorized acquisition, use or disposition. It is worth noting that internal controls only provide reasonable but a not absolute assurance to an entity’s management and board of directors that the organization’s objectives will be achieved. “The likelihood of achievement is affected by limitations inherent in all systems of internal control” (Hayes et al., 2005).  Internal control will ensure that errors and irregularities are avoided or made apparent. Internal control as a system comprises the control environment and procedures. It includes all the policies and procedures adopted by the directors and management of an entity to assist in achieving their objectives of ensuring as far as practicable the orderly and efficient conduct of its business to safeguard assets, prevent and detect fraud and error to ensure accuracy and completeness of accounting records and the timely preparation of reliable financial information (SAS 300.1). During the period from approximately 1905 to 2004, the definitions, meaning, and use of internal controls in auditing as well as their impact on audit engagements have developed and transformed. These changes were often a reaction to a major change in the economic situation of the country as a whole or to the actions of individual firms within the economy.

 In 1892, Lawrence Dicksee made it clear that the object and scope of an audit were threefold. Dicksee also stated that the “whole duty of the auditor is to ascertain the exact state of the client’s affairs upon a certain given date” The author then explained that this duty may be accomplished by “testing” the accounts, but he never discussed the concept of internal control n any fashion as it relates to those tests. According to Montgomery the purpose of an audit had moved from just the detection of both fraud and errors to the primary purpose to “ascertain the actual condition and earnings of an enterprise for its proprietors, its executives, bankers and investors who are considering the purchase of securities.

The practice within the United States Industrial setting moved Auditing from protecting the assets of single business proprietors to protecting the numerous stakeholders in an American economy where ownership and management of companies had become divorced from each other. Regardless of the changing nature of the audit for Montgomery, a large portion of the audit focus was still on the possible fraudulent actions of clerical employees, with no mention of potential problems within the ranks of the management of the company itself.  Thus, nearly 100 years before the problems at Enron and other early twenty-first-century audit failures, the seeds of discussion existed regarding not only the necessity of internal control reviews during an audit, which should be investigated and reported for the protection of stakeholders but also the corporate administrator’s role in financial reporting.

As a reaction to the stock market crash in the fall of 1929, Congress passed two acts to stabilize the market and ensure proper reporting to investors. The first was the Securities Act of 1933, which required publicly held companies to register their market securities and make regular financial disclosures. The second was the Securities Exchange Act 1934, which created the Securities and Exchange Commission (SEC), an organization tasked with regulating exchanges and brokers as well as monitoring the financial disclosures of publicly held companies

In 1934, Victor H. Stumpf proceeded to discuss the fact that it is the responsibility of the company, not the independent auditor, to detect fraud within the company. He stressed fraud and defalcation investigations would be a duplication of the work done by the company’s internal audit staff. Stumpff made these very pointed comments even though the 1931 Ultramares case had ruled that professional liability could attach to auditors in the case of fraud and negligence. The concept of independent auditor responsibilities was to evolve through litigation and authoritative pronouncements over the next 70 years culminating with SAS 99 in 2001, which finally placed an affirmative responsibility on auditors to detect fraud

With the coming of the war in 1941, the major focus of internal control measures from 1941 to 1945 was to identify and reduce fraud and abuse among defence contractors. This type of contract auditing was the responsibility of the internal audit staffs of many of the large corporations

In November 1949, the Committee on Auditing Procedure of the AIA now known as AICPA issued a report entitled Special Report on Internal Control, which included a definition of internal control. The report indicated that “Internal control comprises the plan of organization and all of the coordinate methods and measures adopted within a business to safeguard its assets, check the accuracy and reliability of its accounting data, promote operational efficiency, and encourage adherence to prescribed managerial policies”. The problems led to Congressional hearings in February 2002, but they did little to calm the fears of investors. To assuage the public outrage over the Enron debacle and other high-profile financial scandals at the turn of the twenty-first century, as well as mute the criticisms over the weak regulatory oversight by the government, the Congress of the US passed a sweeping market reform act that became known as Sarbanes-Oxley Act 31st July 2002.

 The Supreme State Audit (SAI) was established to fight against the practice of corruption, embezzlement and all the malfunctions in the public sector of Cameroon. Supreme State Audit incriminates SODECOTON General Manager, Iya Mohamed which was found guilty of 20 managerial lapses that cost the state 9 billion. The SAI in Cameroon has also undertaken to encourage transparency in the management of public affairs measures for management in corporations to establish controls and check their effectivenesstoo to increase the reliabilityofn audited financial statements following the collapse ofmicro-financiall institutions like FIFF,National corporate fund (NCF), Global Business Financial (GBF), Compagnie Financière de l’estuaire du Cameroun (CO-FINEST).

The Supreme State Audit (SAI) appointed by the Head of State has also got jurisdiction over businesses in Cameroon. To this effect, the SAI has the power to take punitive actions. One of the major roles played by the SAI to control corruption in the Public sector is by carrying out punitive actions against government officials for poor management, fraud and corrupt practices. This task is done by the Budget and Finance Disciplinary Board headed by Henri Eyebe.

‘‘Operation Sparrow Hawk’’ is also a corrective measure taken by the Head of State to fight against corruption and the misuse of public funds. In this respect the discrepancies in the Higher Education sector and weaknesses in secondary education can also be attributed to embezzlement for this, we can notice the removal of the former vice-chancellor of the University of Buea and Douala. Minister of Secondary Education Louis Bapes Bapes sentenced to 20 years of jail due to misuse and embezzlement of funds. Another scandal is the case of Marafa Hamidou Yaya, former minister of territorial administration and Yves Michel Fotso, former Director of defunct state air transport company CAMAIR who were held guilty of misappropriation and sentenced to 25 years of jail. This led to the closure of Yves Fotso’s corporations such as FGH-SA and Clean OIL.

Equally, the National AAnti-CorruptionCommission (CONAC), is an institutional body established by the Head of State to fight against corruption in the country.

1.2 Problem Statement and Justification of Study

The absence of adequate internal controls as set by the SOX ACT and other regulatory bodies generally leads to the collapse of companies. Enron was ranked by Chief Executive Magazine as having one of the nation’s five best boards in 2000. The Enron Board of Directors failed to safeguard Enron shareholders and contributed to the collapse of the seventh-largest public company in the United States. Also, we witness the fall of WorldCom due to poor corporate ethics.  Parmalat in Europe, and Chou Aoyama in Asia.

The override of internal controls such as authorization, segregation of duties, passwords, physical checks and supervision or lack of these controls in commercial enterprises usually leads to fraud, pilferage, theft, and embezzlement and hence reduces performance. This reflects the practices in the public sector of Cameroon and can be seen through embezzlement in the Health Ministry by former minister Owona Olanguena, fraud by Marafa Hamidou Yaya, Louis Bapes Bapes found guilty of misappropriation of funds in the Ministry of secondary education and mismanagement in public universities. This goes a long way to reduce performance. Performance is viewed in terms of profitability, liquidity, customer satisfaction, employee and managerial performance, strategic performance and reputation.

 Due to corruption and malpractices in administration and weak internal controls can be traced to the collapse of companies in Cameroon such as FIFFA, COFINEST, NCF, CECO, FGH-SA, and Clean OIL. However,r the government instituted regulatory agencies such as the National Anti-Corruption Commission CONAC, MDPRSS, and Supreme State Audit which have taken corrective measures to discourage corruption, embezzlement and misuse of funds. Weak controls will lead to reduced performance.  From this perspective; the following research questions shall guide this study. The main research question is;

What are the roles of internal control on the performance of Microfinance institutions? This is subdivided into the following specific questions.

1. What are the various internal control techniques practised by MFIs?

2. What are the problems associated with internal control on the performance of MFIs?

3. Can the management of MFIs be guided by internal controls?

1.3 Objectives of Study

1. To determine the various internal control techniques practised by MFIs.

2. To identify the problems associated with internal control on the performance of MFIs.

3. To examine if internal control can guide the management of MFIs to attain an effective performance.

4. To make necessary recommendations based on the findings on how MFIs can properly use internal control to improve their management.

1.4 Hypothesis

H0: internal control does not significantly affect the performance of microfinance institutions.