effects of internal control system on the profits of manufacturing industries

EFFECTS OF INTERNAL CONTROL SYSTEM ON THE PROFITS OF

MANUFACTURING INDUSTRIES

(A CASE STUDY OF UAC OF NIGERIA PLC.)

BY

AROMIRE OLUWABUKUNMI BABATUNDE

(09-08-11-076)

BEING A RESEARCH PROJECT SUBMITTED TO THE

DEPARTMENT OF ACCOUNTING AND FINANCE, FACULTY OF

MANAGEMENT SCIENCES, LAGOS STATE UNIVERSITY, OJO.

IN PARTIAL FUFILMENT OF THE REQUIREMENTS FOR THE

AWARD OF BACHELOR OF SCIENCE DEGREE (B.Sc.) IN

ACCOUNTING

MARCH, 2014

ii

CERTIFICATION

This project written by AROMIRE OLUWABUKUNMI BABATUNDE,

under the guidance and supervision of DR. M. A. ABATA, has been submitted

and accepted by the Department of Accounting and Finance of Lagos State

University in partial fulfilment of the requirements for the degree of Bachelor of

Sciences (Accounting and Finance).

________________________ ___________

DR M. A. ABATA DATE

PROJECT SUPERVISOR

________________________ ___________

DR. B. R. YUSUF DATE

HEAD OF DEPARTMENT

________________________ ___________

EXTERNAL EXAMINER DATE

iii

DEDICATION

This research work is dedicated to ALMIGHTY GOD for the privilege and grace

of completing this study.

iv

ACKNOWLEDGEMENT

I appreciate the work of God on my life for giving me the strength, wisdom, knowledge

and understanding to write and complete this research work successfully. I also

appreciate his guidance and protection over my academics.

I acknowledge the efforts of my supervisor Dr M. A. Abata who did not only sacrifice

his time to supervise this study but also guided me on how to write a good research

work.

I also appreciate the outstanding efforts and contribution of my Head of Department,

Dr B. R. Yusuf; level adviser, Mr Adebayo; and my other able, efficient and effective

lecturers: Dr Kehinde, Dr Agbodu, Dr Okoli, Dr Mrs Idowu, Dr Mrs Bolarinwa, Mr

Sodiq, Mr Matthew, Mr Adisa, and Mrs Osamor – who have all led, guide and directed

my steps in my educational sojourn.

In addition, I acknowledge and appreciate the effort and contribution of Mr Olakunle

Tijani to the success and accomplishment of this research work. I extend my heartily

thanks and appreciation for tutelage and directions in general as regards my personal

development.

Furthermore, I give glory to God on the life of my parents, Mr and Mrs Aromire,

siblings, Aromire Oluwaseun and Adesola Opeyemi, my uncle, Mr Ebinisi Jaiye and

aunt, Mrs Aina Adebola and my cousins for their contribution to my growth and success

of my academics in general.

v

To my friends, especially Oyeniyi Abdulhakeem, Akinbami Rasheed, Orejoko

Temitope Maforikan Elizabeth, Buari Temitope and, from the depth of my heart, I say

a resounding thank you. I appreciate the quota you all contributed to my development

and to the success of my academics

And to all those whose name I did not mention, I say thank you and I appreciate you

all.

vi

ABSTRACT

The study investigated and sought to determine the effect of internal control on profit of UAC

of Nigeria Plc. It also sought to determine the level of the impact of internal control on

corporate profit as being a challenging issue in the organizational financial performance.

Three hypotheses were formulated to justify the effect. It also viewed internal control from the

perspective of control environment, control activities and internal audit, three of the

components of internal control. The study utilized both primary and secondary data in

analyzing the hypotheses. Data was collected through distribution of questionnaires and

extraction of figures from the annual financial report of UAC of Nigeria Plc. They were then

analyzed using chi-square and regression with the aid of some statistical packages and

subsequent conclusions were drawn therefrom. The study found that management is committed

to the control systems, appropriate measures are taken to prevent and detect fraud and error,

the firm has had a sustained increase in its profitability. Also, in terms of the utilization of

asset, the organization’s internal control was not effecting internal control on how the assets

were being used as internal control had a negative impact on asset turnover. However, the

internal control system was found to have an effect on the resource usage, profitability and

effectiveness and efficiency of operations. The study went on to recommend a handful of

measures the organization could adopt to improve its internal control system and how it affects

the operations, use of assets and profitability of the organization.

vii

TABLE OF CONTENT Pages

CERTIFICATION ii

DEDICATION iii

ACKNOWLEDGEMENT iv

ABSTRACT vi

LIST OF FIGURES x

LIST OF TABLES x

CHAPTER ONE 1

1.1 INTRODUCTION 1

1.2 BACKGROUND TO THE STUDY 2

1.3 STATEMENT OF PROBLEMS 3

1.4 RESEARCH OBJECTIVE 4

1.5 RESEARCH HYPOTHESES 4

1.7 SIGNIFICANCE OF STUDY 5

1.8 SCOPE OF STUDY 5

1.9 LIMITATION OF STUDY 6

1.10 OERATIONAL DEFINITION OF TERMS 6

CHAPTER TWO 8

2.1 INTRODUCTION 8

2.2 CONCEPT OF INTERNAL CONTROL 9

2.2.1 TYPES OF INTERNAL CONTROL 9

2.2.2 INTERNAL CONTROL OBJECTIVES 11

2.2.3 ADVANTAGES OF INTERNAL CONTROL 13

2.3 THEORETICAL FRAMEWORK 14

2.3.1 CONTROL ENVIRONMENT 15

2.3.1.1 COMPONENTS OF CONTROL ENVIRONMENT 16

2.3.1.2 SUGGESTIONS FOR EFFECTIVE CONTROL ENVIRONMENT 20

2.3.2 CONTROL ACTIVITIES (CONTROL PROCEDURES) 21

viii

2.3.2.1 NATURE OF CONTROLS 22

2.3.2.2 TYPES OF CONTROL ACTIVITIES 23

2.3.3 INTERNAL AUDIT 31

2.4 INTERNAL CONTROL AND PROFITABILITY 32

2.5 CONCLUSION 33

CHAPTER THREE 34

3.1 INTRODUCTION 34

3.2 RESEARCH DESIGN 34

3.2.1 JUSTIFICATION OF PROXIES 35

3.2.1.1 INDEPENDENT VARIABLE 35

3.2.1.2 DEPENDENT VARIABLE(S) 35

3.3 RESTATEMENT OF QUESTION AND HYPOTHESES 37

3.3 POPULATION OF THE STUDY/SAMPLE AND SAMPLING TECHNIQUES 38

3.4 INSTRUMENTS FOR DATA COLLECTION 39

3.5 DATA ANALYSIS METHODS 40

3.6 LIMITATION OF THE METHODOLOGY 42

CHAPTER FOUR 43

4.1. INTRODUCTION 43

4.2. PRESENTATION OF DATA 44

4.2.1 PRESENTATION OF PRIMARY DATA 44

4.2.2 PRESENTATION OF SECONDARY DATA 50

4.3 TEST OF HYPOTHESES 50

4.4 DISCUSSION OF FINDINGS 61

CHAPTER FIVE 63

5.1 INTRODUCTION 63

5.2 SUMMARY OF THE STUDY AND FINDINGS 63

5.3 CONCLUSION 64

5.4 RECOMMENDATIONS 65

ix

5.5 SUGGESTIONS FOR FURTHER STUDIES 66

REFERENCES 67

APPENDICES 70

x

LIST OF FIGURES

Figure 2.1: Categories of Controls

LIST OF TABLES

Table 3.1: Determination of Information Technology Expenses Figures

Table 4.1: Gender

Table 4.2: Age

Table 4.3: Marital Status

Table 4.4: Educational Qualification

Table 4.5: Working Experience

Table 4.6: Occupational Status

Table 4.7: Management is faithfully committed to the effective and efficient operation of the system

Table 4.8: Management closely monitors implementation of Internal Control Systems, after paying

careful attention to its design to ensure suitability and appropriateness.

Table 4.9: Management gets feedback from the junior officers about the operation of the system

Table 4.10: Management ensures proper training of junior officers about the operation of the internal

control system

Table 4.11: Managers make periodic and systematic reviews of the reporting system to determine if it

is meeting current needs in order to ensure operating effectiveness

Table 4.12: Appropriate and prompt measures are taken to address any malfeasance in the operation of

Accounting & Finance Management System

Table 4.13: Ethical values are followed and upheld in all management decisions

xi

Table 4.14: Implementation of a sound Internal Control System ensures reliability of financial reporting

system

Table 4.15: Management ensures the company complies with applicable laws and regulations

Table 4.16: Appropriate measures are taken to prevent and detect fraud and error

Table 4.17: Presentation of Secondary Data

Table 4.18: Model 1

Table 4.19: Model 2

Table 4.20: Model 3

Table 4.21: Model 4

Table 4.22: Model 5

Table 4.23: Case Processing Summary

Table 4.24: Reliability Statistics

Table 4.25: Chi-square Frequencies

Table 4.26: Test Statistics

Effects of the Internal Control System on the Profits of the Manufacturing Industry P a g e | 1

CHAPTER ONE

INTRODUCTION

1.1 INTRODUCTION

All organizations, whether profit oriented or otherwise, operate within conditions of resources

constraints. As a result, various steps are taken and procedures established to ensure the use of

these resources is maximized in achieving organizational goals.

Apart from the problem of resources, organizations run a high risk of fraud, errors,

misappropriations, and inefficiency and ineffectiveness of operations. Steps are required,

therefore, to minimize, if not eliminate completely, these risks by establishing rules,

regulations, policies and procedures i.e. Internal Control.

IFAC (2012) recognizes that the term “internal control” can have multiple meanings, including:

1. A system or process: the entirety of an organization’s internal control system, i.e., an

organization’s internal control system.

2. An activity or measure: the actual measure to treat risks and to effectuate internal control,

i.e., individual controls.

3. A state or outcome: the outcome of the internal control system or process, i.e., an

organization achieving or sustaining appropriate or effective internal control.

These three meanings are further defined below:

Internal control system or process: based on the definition used by the Committee of

Sponsoring Organizations of the Treadway Commission (COSO) (1992), it is the “process

designed, implemented, and maintained by those charged with governance, management, and

other personnel to provide reasonable assurance about the achievement of an entity’s objectives

with regard to reliability of financial reporting, effectiveness and efficiency of operations, and

compliance with applicable laws and regulations.”


Internal control activity or measure: activities performed to treat risks and effectuate internal

control. Examples of actual control activities include managerial controls, such as executing

the “Plan-Do-Check-Act Cycle,” or transaction controls, such as verifications, reconciliations,

authorizations, physical controls, and supervisory controls that oversee transaction controls.

Internal control as an activity or measure is sometimes simply referred to as “control.”

Internal control as a state or outcome: an organization is “in control,” when it has achieved

its internal control objectives.

It is worth noting that internal controls only provide reasonable but not absolute assurance to

an entity’s management and board of directors that the organization’s objectives will be

achieved. Organizations establish systems of internal control to help them achieve performance

and organizational goals, prevent loss of resources, enable production of reliable reports and

ensure compliance with laws and regulations.

1.2 BACKGROUND TO THE STUDY

There is a general perception that institution and enforcement of proper internal control systems

will always lead to improved financial performance. It is also a general belief that properly

instituted systems of internal control improve the reporting process and also give rise to reliable

reports which enhances the accountability function of management of an entity.

Hayes, Dassen, Schilder, & Wallage, (2005) say the reason a company establishes an internal

control system is to help achieve its performance and profitability goals and prevent loss of

resources by fraud and other means. Internal control can also help to ensure reliable financial

reporting and compliance with laws and regulations which implies that an internal control

system should aid the prevention of the loss of resources that result from irregularities of the

employees of the organization.


In his words, Nwankwo (2006) believes that management seeks to monitor and mitigate the

business risks that an entity’s objectives will not be obtained as the result of all the chiefly

external factors, pressures and forces brought to bear on the entity. Internal control depend on

the risks management perceives to be the greatest.

According to Arens, Elder, & Beasley, (2006), controls within an organization are meant to

encourage efficient and effective use of its resources to optimize the company’s goals. An

important objective of these controls is accurate financial and nonfinancial information about

the entity’s operations for decision making.

1.3 STATEMENT OF PROBLEMS

UAC of Nigeria Plc. has a rich and varied history of successful enterprise that pre-dates the

geographical entity called Nigeria. The company has evolved through a series of mergers and

acquisitions and restructurings as the various entrepreneurs sought to enthrone profitability and

enduring activities. However, the name UAC of Nigeria Plc. was adopted in 1991.

Today, UAC of Nigeria Plc. is a leading diversified company, operating in the food and

beverages, real estate, paint and logistics sectors of the economy.

UAC of Nigeria Plc. is a parent company with chains of subsidiaries with strong influences in

the various markets in which they exist. It, however, remains to be seen how effective and

efficient internal control has been to the assurance of an up-to-standard and innovative system

of operations within the organization.

Also, UAC of Nigeria Plc. is a large firm with chain of assets entrusted with employees in

various parts of the country. Internal control should give reasonable assurance to the firm as to

the safety of the assets and also to avoiding its misuse and misappropriation.

The scarcity of resources has been a major concern for all organizations, be it profit oriented

or otherwise and as such an effective system of internal control should serve as a tool for


safeguarding the resources of the organization in every possible way and ultimately improve

financial performance of the organization.

1.4 RESEARCH OBJECTIVE

The major objective of this study is to establish the relationship between the internal control

system and its effect on the financial performance of UAC of Nigeria Plc. However, the

research will also examine if the internal control system:

1. Help ensure efficiency and effectiveness of operations; and

2. Impacts the maximization the use of resources in UAC of Nigeria.

1.5 RESEARCH QUESTION

1. Does the internal control system have an effect on the financial performance of UAC of

Nigeria Plc.?

2. Does the internal control system help ensure efficiency and effectiveness of operations?

3. Does the internal control system impact maximization of the use of resources in UAC of

Nigeria Plc.?

1.6 RESEARCH HYPOTHESES

HYPOTHESIS 1

H0: Internal control system does not have an effect on the financial performance of UAC of

Nigeria Plc.

H1: Internal control system has an effect on the financial performance of UAC of Nigeria Plc.

HYPOTHESIS 2

H0: Internal control system does not impact the maximization the use of resources in UAC of

Nigeria Plc.


H1: Internal control system impacts the maximization the use of resources in UAC of Nigeria

Plc.

HYPOTHESIS 3

H0: Internal control system does not help ensure efficiency and effectiveness of operations.

H1: Internal control system helps ensure efficiency and effectiveness of operations.

1.7 SIGNIFICANCE OF STUDY

The results of the study will help identify gaps within the systems of internal control in UAC

of Nigeria Plc. It is also the researcher’s belief that invaluable benefits to management and

those charged with governance in UAC of Nigeria Plc. will emerge on how to streamline the

systems of internal controls thus ensuring improved financial performance and ultimately

ensure attainment of the organizational objectives. The study will also add to the existing

knowledge bank regarding internal control.

1.8 SCOPE OF STUDY

The research will focus on the effectiveness internal control systems in UAC of Nigeria Plc.

Although, UAC of Nigeria Plc. has several other offices and factories, the research will,

however, focus on its head office in Lagos alone. This is mainly due to the fact the other

factories are located across the countries and it will be quite difficult to cover them.

1.9 LIMITATION OF STUDY

The major limitation of the study is that a lot of research has been done on Financial

Performance, but the Researcher wanted to deviate from the obvious. There is a general

perception that the study has been around for some time. The curiosity of the Researcher was


to answer the question; do the systems really work as expected? The other limitation was the

belief that the research may never be read, thus people may not get the benefit of the study. It

is therefore the Intention of the Researcher to write papers out of the research and present them

in conferences.

1.10 OERATIONAL DEFINITION OF TERMS

Fraud: The use of dishonest means to obtain an unjust or illegal material advantage.

Error: This is an unintentional misstatement of the financial statement.

Irregularities: This refers to the intentional distortion of financial statement for whatever

purpose.

Risk: The degree of possibility that a loss may be incurred or sustained in any given transaction.

Internal Check: The part of internal control system which deals with organization and

preparation of the book-keeping and other clerical duties in such a way as to ensure that a single

task is executed from its inception to its completion by only one person, and that the work of

each clerk engaged upon is subject to an independent check in the course of another duty.

Management: A collaboration or team of top office holders responsible for directing, on a

daily basis, the activities of the organization.

Auditing: This is a process (carried out by suitably qualified auditors) whereby the account of

a business entity is examined and an opinion is formed as regards the truth and fairness of the

account records and the financial statement.

Effectiveness: This refers to the ability or capability of producing a desired result or level of

outcome.

Efficiency: This is the extent to which time, effort or cost is well used for the intended task or

purpose.


CHAPTER TWO

2.1 INTRODUCTION

“Understanding the concept of internal control is essential for developing an understanding of

its impact on the performance of an organization. The internal control system of an entity is

strictly interrelated to the structure used by management to oversee the activities of the

organisation, or to what is defined as the entity’s corporate governance” (Lembi, 2006).

According to Muraleetharan (2008), management and personnel at all levels have to be

involved in this process to address risks and to provide reasonable assurance of the achievement

of the entity’s mission and general objectives.

Over the last several years, practitioners in public practice have expressed confusion relating

to the concept of internal control and, specifically, internal control over financial reporting. For

example, auditors may no longer default to a maximum control risk. Instead, the auditor should

obtain an understanding of the five components of internal control sufficient to assess the risk

of material misstatement of the financial statements whether due to error or fraud, and to design

the nature, timing, and extent of further audit procedures. The auditor should obtain a sufficient

understanding by performing risk assessment procedures to evaluate the design of controls

relevant to an audit of financial statements and to determine whether they have been

implemented.

Today, organizations are less able to perform many internal accounting controls (e.g., multiple

layers of authorization, cross-checking, supervision, and segregation of duties) because, they

employ less people due to technological advancement and changing management techniques.

However, the revised professional guidance highlights opportunities to strengthen overall

control (Thomas & Charles, 2009).


2.2 CONCEPT OF INTERNAL CONTROL

IFAC (2012) asserts that one of the best defence against business failure, as well as an

important driver of business performance, is having an effective internal control system, which

manages risk and enables the creation and preservation of value. Successful organizations

know how to take advantage of opportunities and counter threats, in many instances through

effective application of controls, and therefore improve their performance. It is an integral part

of an organization’s governance system and ability to manage risk, which is understood,

effected, and actively monitored by the governing body, management, and other personnel to

take advantage of the opportunities and to counter the threats to achieving the organization’s

objectives.

Internal control, according to Badmus & Elegbede (2003) citing from the Auditing Guidelines,

has been defined as the whole system of controls, financial or otherwise, established by the

management in order to carry on the business of the enterprise in an orderly and efficient

manner, ensure adherence to management policy, safeguard the assets and secure as far as

possible, the completeness and accuracy of records in addition to internal check and internal

audit.

2.2.1 TYPES OF INTERNAL CONTROL

Nwankwo (2006) citing from the guidelines issued by the Institute of Chartered Accountants

of England and Wales on Internal Control listed eight types of internal control which an

organization may adopt namely:

Organizational Controls: These are those controls, rules, regulations and procedures which:

1. Specify the organizational plan (structure);

2. Define roles and allocates responsibilities; and

3. Identifying lines of reporting for all aspects of the enterprises’ operations.


Segregation of Duties: they are those types of controls, which ensure that separate individuals

or groups of individuals carry out the main functions of an organization of authorization,

executive, custody and recording. It is believed that the separation of these critical duties will

minimize the inherent risk of fraud or errors and increase the element of checking within the

system.

Physical Controls: These are those procedures and measures set up to secure proper custody

over valuable corporate assets. They prevent unauthorized access to these assets.

Authorizations and Approvals: These are those controls, which specify the persons

responsible for authorizing and approving transactions and the limits of such authority.

Personnel Controls: No matter how well a system is designed, its efficient and effective

functioning will depend on the operators. Controls are therefore necessary to ensure that

personnel have capabilities commensurate with their responsibilities. These controls, known as

personnel controls, provide a framework for ensuring an efficient selection and training

procedure for staff.

Arithmetical and Accounting Controls: These controls, which are predominant in the

recording function, ensure that all transactions occurring during the period have been

authorized and that they have all been correctly and accurately recorded and processed.

Management Controls: These are those controls characteristically executed by the top

management on a periodic basis as against a daily basis. Conceivably, they include periodic

review of management accounts and comparison thereof with budgets and other special

reviews.

Supervisory Controls: These are controls over day-to-day activities of the organizations,

which ensure that the work of less experienced staff are reviewed and controlled by

independent, more senior and experienced staff.


In addition to the above which appears in the guidelines, two other types were added by

Badmus & Elegbede (2003):

Acknowledgement of Performance: Person performing data processing operations should

acknowledge their activities by means of signature, initials, rubber stamps, etc. for example, if

invoice calculations have to be checked, the checker should initial each invoice.

Budgeting: A common technique used in business is the use of budgets, which can be defined

as quantitative plans of action. Budgets having been agreed, can be compared with actual turn-

out and differences investigated.

2.2.2 INTERNAL CONTROL OBJECTIVES

The COSO (2011) framework sets forth three categories of objectives, which allow

organizations to focus on separate aspects of internal control:

Operations Objectives: These pertain to effectiveness and efficiency of the entity’s

operations, including operations and financial performance goals and safeguarding assets

against loss.

Reporting Objectives: These pertain to the reliability of reporting. They include internal

and external financial and non-financial reporting.

Compliance Objectives: These pertain to adherence to laws and regulations to which the

entity is subject.

Arens, et al. (2006) said a system of internal control consists of policies and procedures

designed to provide management with reasonable assurance that the company achieves its

objectives and goals. These policies and procedures are often called controls, and collectively,

they comprise the entity’s internal control. Management typically have three broad objectives

in designing an effective internal control system:


Reliability of Financial Reporting: Management is responsible for preparing financial

statements for investors, creditors and other users. Management has both a legal and

professional responsibility to be sure that the information is fairly presented in accordance with

reporting requirements such as GAAP. The objective of effective internal control over financial

reporting is to fulfil these financial reporting responsibilities.

Efficiency and Effectiveness of Operations: controls within an organization are meant to

encourage efficient and effective use of its resources to optimize the company’s goals. An

important objective of these controls is accurate financial and non-financial information about

the entity’s operations for decision-making.

Compliance with Laws and Regulations: By law, all public companies must issue a report

about the operating effectiveness of internal control over financial reporting. In addition,

public, non-public and non-profit-making organizations are required to follow many laws, such

as environmental protection and some civil rights law. Others are closely related to accounting,

such as income tax regulations and fraud.

The Nova Scotia Municipal Finance Corporation [NSMFC] (2005) stated the following as the

objectives that management should keep in mind in designing an effective internal control

system:

Maintaining Reliable Systems

Management must have reliable systems so that it will have accurate information for carrying

out its operations. Such reliable systems can include information technology systems, a

requirement of multiple signatures on purchase orders and cheques, and a segregation of duties

within the municipality.


Ensuring Timely Preparation of Reliable Information

Information must be reliable and timely if it is to be useful for management decision-making.

Management should provide quarterly financial statements within thirty days of the closing

period.

Safeguarding Assets

To ensure against theft and fraud, adequate controls must be in place. Examples of safeguarding

assets could be the appropriate signatures on cheques or accounts receivable documents. There

should be a system of checks and balances in place.

Optimizing the Use of Resources

Controls within an organization are meant to optimize efficiency. Internal controls are meant

to provide reasonable reassurance that the employees of the municipality are following

established procedures to prevent duplicity and unnecessary tasks. A reduction in the

duplication of tasks will also result in an efficient use of time and resources, which can create

financial savings for the municipality.

Preventing and Detecting Error and Fraud

Internal controls of a government play an important role in the prevention and detection of

error and fraud, or other irregularities. The cost of preventing error should be assessed based

on the likelihood of the error actually occurring, the frequency and/or materiality of error that

could occur, and the costs associated with the error. It is important to realize that not all error

can be addressed and avoided, and concentration should be placed on the most serious errors.

2.2.3 ADVANTAGES OF INTERNAL CONTROL

Application of internal control provides the following benefits to the various parties:

1. Internal control helps to protect the assets of the business from misuse, theft, accident etc.

2. Internal control helps to implement management policies to attain corporate goals.


3. Internal control helps the auditor in his/her work detecting all the errors and frauds which

are committed in the books of accounts.

4. Internal control helps to increase the accuracy and reliability of financial statement and

books of accounts.

5. Internal control helps to regulate the work of staffs through division of work among the

staffs in a scientific manner which helps to make the daily works of staffs effective.

6. Internal control helps the management to prepare and implement effective plans by

providing correct and fact information.

7. Internal control helps to put moral pressure on staffs. (“Concept of Internal Control”,

[2012])

2.3 THEORETICAL FRAMEWORK

The research was intended to assess the effect of internal controls on financial performance

with emphasis on UAC of Nigeria Plc. The review of available literature therefore attempted

to establish whether there is a correlation between Internal Control systems as an independent

variable and financial performance as a dependent variable.

Thomas & Charles (2009) asserted that a system of internal control is put in place to keep the

organization on course toward profitability goals and achievement of its mission and to

minimize surprises along the way. An effective system of internal control enables management

to deal with rapidly changing economic and competitive environments, shifting customer

demands and priorities, and restructuring for future growth. Internal control promotes

efficiency, reduces risks of asset loss, and helps ensure the reliability of financial statements

and compliance with laws and regulations.

Five components of internal control were listed in the internal control-integrated framework

issued by the Committee of Sponsoring Organizations of the Treadway Commission [COSO]


(1992) which are: Control Environment; Risk Assessment; Control Activities; Information and

Communication; and Monitoring. All five internal control components must be present to have

effective internal controls. Also, when considering the five components of internal control,

certain components relate more to the organization as a whole, while other components relate

to specific financial reporting areas or transaction classes.

In order to understand the relationship between the internal control system and the financial

performance of an organization we shall review the assertions by various authors on two of the

components of internal control system given by COSO (Control Environment and Control

Activities) as they relate directly to the topic at hand. Also, we shall be discussing a topic that

is not estranged from internal control and although not mentioned in the integrated framework,

has been argued by various authors as being a part of internal control component. The other

components of the internal control systems will be held constant.

2.3.1 Control Environment

According to Hayes, et al (2005), the control environment means the overall attitude,

awareness, and actions of directors and management regarding the internal control system and

its importance in the entity. The control environment has a pervasive influence on the way

business activities are structured, the way objectives are established, and the way risks are

assessed. It is influenced by the entity’s history and culture.

COSO (1992) believes that the control environment sets the tone of an organization,

influencing the control consciousness of its people. It is the foundation for all other components

of internal control, providing discipline and structure. Developing a strong culture of control

consciousness within an organization is one of the most cost-effective and efficient ways that

internal control over financial reporting can be implemented. Its effect can permeate throughout


the organization, directly impacting each of the other components of internal control

(Understanding Internal Control, n.d.).

Control environment factors include the integrity and ethical values, competence of the entity's

people; management's philosophy and operating style; the way management assigns authority

and responsibility, and organizes and develops its people; and the attention and direction

provided by the board of directors (COSO, 1992).

2.3.1.1 Components of Control Environment

Integrity and Ethical Value

The integrity and ethical value of the people who create, administer, and monitor controls

determines their effectiveness. Company’s integrity and ethical value are the products of the

entity’s ethical and behavioral standards, and its communication to employees and

reinforcement in practice affects the way in which employees view their work. Setting a good

example is not enough, top management should verbally communicate the entity’s values and

behavioral standards to employees (Hayes, et al., 2005; & Arens, et al., 2006).

Hayes, et al. (2005) is of the opinion that management should, through its attitudes and actions,

demonstrates character, integrity, and ethical values. Sound integrity and ethical values,

particularly of top management, are developed and set the standard of conduct for the

organization and financial reporting. Management should also provide employees code of

conduct, method for reporting violations through whistle-blower provisions.

Management can act to maximize control integrity and reduce misstatement by removing

incentives and temptations that prompt personnel to engage in fraudulent or unethical behavior.

Incentives for unethical behavior include pressure to meet unrealistic performance targets, high

performance-dependent rewards, and upper and lower cut-offs on bonus plans. Temptations

for employees to engage in improper acts include: non-existent or ineffective controls; top


management who are unaware of actions taken at lower organizational levels; ineffective board

of directors; and insignificant penalties for improper behavior.

Commitment to Competence

A company’s control environment will be more effective if its culture is one in which quality

and competence are openly valued. Competence is the knowledge and skills necessary to

accomplish tasks that define and individual’s job. Commitment to competence includes

management’s consideration of the competence levels for specific jobs and how those levels

translate into requisite skills and knowledge (Hayes, et al., 2005; & Arens, et al., 2006).

NSMFC (2005) believes these skills can be acquired through organization of employee training

programmes and evaluation.

Board of Directors and Audit Committee Participation

The participation of the entity’s board of directors and the audit committee significantly

influences the control environment and “tone at the top”, the entity’s internal control

environment and its financial reporting (Hayes, et al., 2005). The board is an independent group

of elected officials that deal with difficult questions regarding plans and performance (NSMFC,

2005). Arens, et al., (2006) opined that an effective board of director should be independent of

management, and its members stay involved in and scrutinize management’s activities.

Although the board delegates responsibility of internal control to management, it should be

charged with providing regular independent assessments of management-established internal

control. NSMFC (2005) also opined that the board should deal with internal and external

auditors (where applicable). To assist the board in its over-sight, also, the board creates an audit

committee that is charged with over-sight responsibility for the financial reporting process.

The audit committee must be separate from management in order to objectively and effectively

evaluate management’s practices, strategies, financial positions, and operating results


(NSMFC, 2005). The audit committee’s independence from management and knowledge of

financial reporting issues are important determinants of their ability to effectively evaluate

internal controls and financial statements prepared by management. The audit committee is

also responsible for maintaining ongoing communication with both external and internal

auditors, including the approval of audit and non-audit services performed by auditors for

public companies (Arens, et al., 2006).

Management’s Philosophy and Operating Style

Hayes, et al. (2005) believes that management’s philosophy and operating style is their attitude

about, and approach to financial reporting, accounting functions, safeguarding of assets, data

processing, and taking and managing business risks. Management’s philosophy and operating

style are consistent with a sound control environment and have a pervasive effect on the entity.

Management should analyze the risks and benefits of new ventures, assess turnover among

employees, investigate and resolve improper business practices, view accounting as a means

to monitor and control the various activities of the organization, and adopt accounting policies

that reflect the economic realities of the business. A personal example set by top management

and the board provides a clear signal to employees about the company’s culture and about the

importance of control.

Organizational Structure

According to Arens, et al. (2006), the entity’s organizational structure defines the existing lines

of responsibility and authority. It provides the framework within which business activities are

planned, executed, controlled, and monitored. Important considerations are clarity of lines of

authorities and responsibility; the level at which policies and procedures are established;

adherence to these policies and procedures; adequacy of supervision and monitoring of

decentralized operations; and appropriations of organizational structure for size and complexity


of the entity appropriate reporting lines, and free flow of information across the organization.

All of these provide unfettered influence to effectively run the entity and support effective

financial reporting. The organizational structure determines an organization’s ability to provide

necessary information to managers, managers responsibilities, the adaptability of an

organization to change, and if there are a sufficient number of employees within the

organization (Hayes, et al., 2005, & NSMFC, 2005).

Assignment of Authority and Responsibility

According to NSMFC (2005), this involves the framework for which activities for achieving

objectives is planned, executed, controlled, and monitored. It also establishes areas of authority

and responsibilities by identifying appropriate lines of reporting. Hayes, et al. (2005) is of the

opinion that how authority and responsibility are assigned throughout the organization and the

associated lines of reporting has an impact on control.

This assesses the delegation of authority to deal with entity goals and objectives, operating

functions, and regulatory requirements (NSMFC, 2005). The entity assigns authority and

responsibility to provide a basis for accountability and control (Understanding Internal

Controls, n.d.). How responsibility is distributed is usually spelled out in formal company

manuals.

Human Resource Policies and Practices

The most important element of the control environment (and internal control) is personnel,

which is why human resource policies and practices are essential (Hayes, et al., 2005). If

employees are competent and trustworthy, other controls can be absent, and reliable financial

statements will result. Incompetent or dishonest people can reduce the system to a shambles-

even if there are numerous controls in place (Arens, et al., 2006).


Human resource policies and practices involves the procedures for hiring, promotion, and

compensation; the extent to which employees are aware of their responsibilities; remedial

actions taken in response to disobedience of policies and practices; adherence to moral and

ethical standards, and adequacy of employee retention and promotion criteria (NSMFC, 2005).

2.3.1.2 Suggestions for Effective Control Environment

Listed below are some suggestions to enhance a department/business unit's control

environment. This list is not intended to be all-inclusive, or applicable for all departments,

however, it should be helpful in promoting an effective control environment.

Make sure that the following policies and procedures are available in your department (hard

copy or Internet access):

Business Procedures Manual;

Employees Purchasing Manual; and

Policies and Procedures Manual.

Make sure that departments have well-written departmental policies and procedures which

address its significant activities and unique issues. Employee responsibilities, limits to

authority, performance standards, control procedures, and reporting relationships should be

clear.

Make sure that employees are well acquainted with the organization’s policies and procedures

that pertain to their job responsibilities.

Discuss ethical issues with employees. If any employees need additional guidance, make sure

that it is provided.

Make sure that employees comply with the Conflict of Interest policy and disclose potential

conflicts of interest.


Make sure that job descriptions exist, clearly state responsibility for internal control, and

correctly translate desired competence levels into requisite knowledge, skills, and experience;

make sure that hiring practices result in hiring qualified individuals.

Make sure that the department has an adequate training program for employees.

Make sure that employee performance evaluations are conducted periodically. Good

performance should be valued highly and recognized in a positive manner.

Make sure that appropriate disciplinary action is taken when an employee does not comply

with policies and procedures or behavioral standards (Understanding Internal Controls, n.d.).

2.3.2 Control Activities (Control Procedures)

According to COSO (2011), control activities are the policies and procedures that help ensure

management directives are carried out. Control activities occur throughout the organization, at

all levels and in all functions. These are those actions that are taken to address risks that threaten

the entity’s ability to achieve its objectives, one of which is reliable financial reporting

(Understanding Internal Controls, n.d.). Control activities are not performed simply for their

own sake or because it seems the "right thing to do", but rather serve as mechanisms for

managing the achievement of business objectives (The International Standards of Supreme

Audit Institutions [ISSAI], 2004).

Control procedures are divided into two elements: a policy establishing what should be done

and procedures to effect that policy. A policy, for example, might be that a securities dealer

retail branch manager must monitor customer trades. The control procedure is a review of a

computer printout of daily trade activities by the customer, performed in a timely manner and

with attention given to the nature and volume of securities traded. Control procedures

implement the control policies by specific routine tasks, performed at particular times by the


designated people, held accountable by adequate supervision and evidence of performance

(Hayes, et al., 2005).

2.3.2.1 Nature of Controls

There are potentially many control activities in an entity, including both manual and automated

controls (Arens, et al., 2006). These two can be broken down further as follows:

FIGURE 2.1: Categories of Controls

Understanding Internal Controls, n.d.

Manual Controls are controls that are manually performed by individuals. They may be solely

manual where no IT generated reports are used or they may be IT Dependent whereby an

employee is using a system generated report to test the validity of a particular control.

Application controls are performed entirely by the computer system.

These controls are discussed in more detail below:


Preventive controls attempt to deter or prevent undesirable events from occurring. They are

proactive controls that help to prevent a loss. Examples of preventive controls are separation

of duties, proper authorization, adequate documentation, and physical control over assets.

Detective controls, on the other hand, attempt to detect undesirable acts. They provide

evidence that a loss has occurred but do not prevent a loss from occurring. Examples of

detective controls are reviews, analyses, variance analyses, reconciliations, physical

inventories, and audits.

Both types of controls are essential to an effective internal control system. From a quality

standpoint, preventive controls are essential because they are proactive and emphasize quality.

However, detective controls play a critical role providing evidence that the preventive controls

are functioning and preventing losses (Understanding Internal Controls, n.d.).

2.3.2.2 Types of Control Activities

Hayes, et al. (2005), citing from the International Standards on Auditing [ISA] categorized

control activities into five (5). However six types of control activities will be listed below:

1. Performance Reviews;

2. Information Processing;

3. Physical Controls;

4. Segregation of Duties;

5. Approvals, Authorizations, and Verifications; and

6. Reconciliations (Understanding Internal Controls, n.d.).

Performance Reviews


Performance reviews are independent checks on performance by a third party not directly

involved in the activity (Hayes, et al., 2005). Management compares information about current

performance to budgets, forecasts, prior period results, or other benchmarks to measure the

extent to which goals and objectives are being achieved and to identify unexpected results or

unusual conditions that require follow-up. This control activity also includes management’s

review of reconciliations, reports and other information generated from reconciliations (which

will be discussed below) (Understanding Internal Controls, n.d.).

The need for independent checks arises because internal control tends to change over time

unless there is a mechanism for frequent review. Personnel are likely to forget or intentionally

fail to follow procedures, or they may become careless unless someone observes and evaluate

their performance. Regardless of the quality of the controls, personnel can make both

fraudulent actions and unintentional mistakes. An essential characteristic of the person

performing internal verification procedures is independence from the individuals originally

responsible for preparing the data (Arens, et al., 2006).

Information Processing

The purpose of an entity’s information and communication systems is to initiate, record,

process, and report the entity’s transactions and to maintain accountability for the related assets

(Arens, et al., 2006).

Generally speaking there are 4 types of IT controls: General controls, IT dependent manual

controls, Application controls, and End-User Computing controls.

General Controls: General controls are policies and procedures that relate to many

applications and support the effective functioning of application controls and IT Dependent

Manual Controls by helping to ensure the continued proper operation of information systems.

These commonly include controls over data centre operations, system software acquisition and


maintenance, access security, and application system development and maintenance (Hayes, et

al., 2005; “Understanding Internal Controls”, n.d.).

General controls assure that access to the computer system is limited to people who have a

right to the information. Appropriate delegation of authority sets limits on what level of risk

are acceptable and these limits determine the discretion of the employees delegated to authorize

the main types of business transactions (Hayes, et al., 2005).

IT Dependent Manual Controls: These are processes that are manually performed by

individuals, but rely on computer generated information. To ensure the effectiveness of IT

Dependent Manual Controls, one must validate the accuracy and completeness of the system-

generated report and the effectiveness of the manual portion of the control (Understanding

Internal Controls, n.d.).

Application Controls: There are several standard application controls. The chart of accounts

is an important application control because it provides the framework for determining the

information presented on to financial statement (Hayes, et al., 2005).

These are “computer controls” based on the organization’s business rules (system settings).

These controls determine how transactions will be input, processed and output by the computer

system:

Input controls ensure the complete and accurate recording of authorized transactions by only

authorized users; identify rejected, suspended, and duplicate items; and ensure resubmission of

rejected and suspended items. Examples of input controls are error listings, field checks, limit

checks, self-checking digits, sequence checks, validity checks, key verification, matching, and

completeness checks.


Processing controls ensure the complete and accurate processing of authorized transactions.

Examples of processing controls are run-to-run control totals, posting checks, end-of-file

procedures, concurrency controls, control files, and audit trails.

Output controls ensure that a complete and accurate audit trail of the results of processing is

reported to appropriate individuals for review. Examples of output controls are listings of

master file changes, error listings, distribution registers, and reviews of output (Understanding


End-User Computing Controls – This type of IT control comes into play when using

departmentally developed spreadsheets or data bases as tools for performing work which

extends to the information reported in the financial statements. Important control elements

would be employee access, accuracy and process integrity, backup and review.

Control activities must be implemented thoughtfully, conscientiously, and consistently. A

procedure will not be useful if performed mechanically without a sharp continuing focus on

conditions to which the policy is directed. Further, it is essential that unusual conditions

identified as a result of performing control activities be investigated and appropriate corrective

action be taken (Understanding Internal Controls, n.d.).

Physical Controls

Physical controls are procedures to ensure the physical security of assets. Assets and records

that are not adequately protected can be stolen, damaged, or lost. In highly computerized

companies, damaged data files could be costly or even impossible to replace (Hayes, et al.,

2005). For this reason, access to equipment, inventories, securities, cash and other assets should

be restricted. Also, assets should be periodically counted and compared to amounts shown on

control records.


This Control Activity is critical because liquid assets, vital documents, critical systems and

confidential information must be safeguarded against unauthorized acquisition, use or

disposition. Generally limiting access to these assets is the best way to protect them whether

by physical controls such as locked doors or alarm systems or by IT controls such as passwords,

data encryption, etc. Periodic inventory counts should be made and perpetual inventory records

should be maintained.

Segregation of Duties

This seeks to prevent persons with access readily realizable assets from being able to adjust the

records that record and thereby control those assets (Hayes, et al., 2005). When selecting and

developing control activities management should consider whether duties are divided or

segregated among different people to reduce the risk of error or inappropriate or fraudulent

actions (COSO, 2011). Normally, responsibilities for authorizing transactions, recording

transactions (accounting), and handling the related asset (custody) are divided. Segregation of

duties is one of the best fraud deterrents and if the size the staff prevents adequate segregation

of duties, then a compensation control activity such as supervisory reviews must be

implemented (Understanding Internal Controls, n.d.). Thomas A. R., & Charles E. L., (2009)

argues that in practice, three types of functions are considered to be mutually incompatible:

authorization, record keeping, and custody. Thus, no single individual should be able to (1)

authorize a transaction, (2) record the transaction in the accounting records, and (3) maintain

custody of the assets resulting from the transaction.

Separation of the Custody of Assets from Accounting: To protect a company against

defalcation, a person who has temporary or permanent custody of asset should not account for

that asset. Allowing one person to perform both functions increases the risk of that person


disposing off the asset for personal gain and adjusting the records to cover up the theft (Arens,

et al., 2006).

The basic control imposed by the double-entry bookkeeping means that, to conceal the theft or

fraudulent use of an asset, the perpetrator must be able to prevent the asset being recorded in

the first place or to write it off. If the theft cannot be permanently written off, it may still be

temporarily concealed by being carried forward in preparing stock sheets, in performing the

bank reconciliation, or in reconciling the debtor creditor control accounts (Hayes, et al., 2005).

Separation of the Authorization of Transactions from the Custody of Related Assets: If

possible, it is desirable to prevent persons who authorize transactions from having control over

the related asset, as this raises the possibility of defalcation. For example, the same person

should not authorize the payment of a vendor’s invoice and also sign the check in payment of

the bill.

Separation of Operational Responsibility from Record-Keeping Responsibility: To ensure

unbiased information, record-keeping is typically included in separate department under the

controller. For example, if a department or division prepares its own records and reports, it

might bias the results to improve its reported performance (Arens, et al., 2006).

When these functions cannot be separated, due to limited personnel, a detailed supervisory

review of related activities may be used as a compensating control activity (Thomas & Charles,

2009).

Information Technology (IT) Segregation of Duties

As the level of complexity of IT systems increase, the separation of authorization, record-

keeping, and custody often becomes blurred (Hayes, et al., 2005). Operations responsibility

and record-keeping and the IT duties should be separate. Information systems are crucially

important to control, so it is suggested that those duties be segregated for programmer,


computer operator, librarian and data reviewer. A programmer configured the software. Giving

him access to input data creates temptation. The computer operator (who inputs the accounting

data) should not be able to modify the program. A librarian maintains and is custodian of the

records and files that should only be released to authorize personnel. The person who tests the

efficiency of all aspects of the system should be independent of the other computer jobs (Arens,

et al., 2006).

Approvals, Authorizations, and Verifications

An authorization affirms that a transaction is valid (i.e., it represents an actual economic event).

An authorization typically takes the form of an approval by a higher level of management or

of verification and a determination if the transaction is valid (COSO, 2011). Every transaction

must be properly authorized if controls are to be satisfactory (Arens, et al., 2006). Management

authorizes employees to perform certain activities and to execute certain transactions within

limited parameters. If any person in an organization could acquire or expend assets at will,

complete chaos would result. In addition, management specifies those activities or transactions

that need supervisory approval before they are performed or executed by employees. A

supervisor’s approval (manual or electronic) implies that he or she has verified and validated

that the activity or transaction conforms to established policies and procedures (Understanding


Authorization can either be general or specific:

Under general authorization, management establishes policies for the organization to follow;

and subordinates are instructed to implement these general authorizations by approving all

transactions within the limits set by the policy.


Specific generalization applies to individual transactions. For certain transactions,

management is often unwilling to establish a general policy of authorization. Instead,

management prefers to make authorization on a case-by-case basis.

As a general rule, authorization controls do both of the following:

Require advance approval; and

Require written documentation of approval (Thomas & Charles, 2009).

The distinction between authorization and approval also, is important. Authorization is a policy

decision for either a general class of transaction or specific transactions. Approval is the

implementation of management’s general authorization decisions.

Verifications compare two or more items with each other or compare an item with a policy,

and perform a follow-up action when the two items do not match or the item is not consistent

with policy. Examples include computer matching or a reasonableness check. Verifications

generally address the completeness, accuracy, or validity of processing transactions (Arens, et

al., 2006).

Reconciliations

An employee relates different sets of data to one another, identifies and investigates

differences, and takes corrective action, when necessary (Understanding Internal Controls,

n.d.). Reconciliations generally address the completeness and/or accuracy of processing

transactions (COSO, 2011). To ensure proper segregation of duties, the person who approves

transactions or handles cash receipts should not be the person who performs the reconciliation.

A critical element of the reconciliation process is to resolve differences. It does no good to note

differences and do nothing about them. Differences should be identified, investigated, and

explained—corrective action must be taken. Reconciliations should be documented and

approved by management (Thomas & Charles, 2009).


2.3.3 Internal Audit

This is a part of the internal control system. Internal audit is one of those management controls,

which are exercised periodically by top management (Nwankwo, 2006). Internal audit is a

long-standing function and an effective tool of management in many organizations. It has been

a recognized component of organizations in both the public and private sectors and in most

industries for many years. Internal auditing is often seen as an overall monitoring activity with

responsibility to management for assessing the effectiveness of control procedures which arc

the responsibility of other functional managers. The internal audit function is not limited to the

operation of any particular function within an organization. Rather, it is all-embracing and

accordingly is structured in the organization as a separate entity responsible only to a high level

of management (Kiabel, 2012).

According to the Institute of Internal Audit (IIA), internal auditing is an independent, objective

assurance and consulting activity designed to add value and improve an organization’s

operations. It helps an organization accomplish its objectives by bringing a systematic,

disciplined approach to evaluate and improve the effectiveness of risk management, control,

and governance processes (IIA, 2013). Internal auditing activity is primarily directed at

evaluating internal control (Wikpedia). It involves the periodic review of the accounting,

operational processes and internal control systems as well as the results of operations in order

to:

Report on the efficiency and effectiveness of the internal controls and accounting

systems, and to suggest improvements where necessary;

Report on results of operations, variations from plans and the reasons thereof; and

Report on the compliance with applicable legislations, rules and regulations

(Nwankwo, 2006).


However, it could be deduced that internal audit is a management tool which should be put in

place according to the size and circumstances of each organization. Initially, an internal auditor

was seen as to be checking the arithmetical accuracy of the accounting records and prevention

or detection of fraud (Nwankwo, 2006).

According to KPMG (n.d.), the following are the roles played by an internal auditor in an

organization:

Assessing the scope and effectiveness of the systems established by management to

identify, assess, manage and monitor the various risks arising from the organization’s

activities.

Ensuring senior management establishes and maintains adequate and effective internal

controls.

Satisfying itself that appropriate controls are in place for monitoring compliance with

laws, regulations, supervisory requirements and relevant internal policies.

Monitoring and reviewing the effectiveness of the internal audit function.

Reviewing and assessing the internal audit plan and its progress.

Ensuring that the internal audit function is adequately resourced and enjoys appropriate

standing within the organization.

Considering management’s response to major internal audit recommendations and

progress in their implementation.

Approving the appointment or dismissal of the head of internal audit.

2.4 INTERNAL CONTROL AND PROFITABILITY

The research work carried out by Hollis, David and Daniel (2012) revealed that there is an

association between internal control over financial reporting effectiveness and trading

profitability present in the years leading up to the material weakness disclosure, but disappears


after remediation. Also, in the paper written by Muraleetharan (2008) which was carried out to

find out the impact of internal control on performance of the private and public organizations,

also found that internal control (if implemented effectively) the internal control system has a

significant impact on the financial performance of an organization. In the work published by

William (2000), he concluded that the internal control function are extremely important to a

meaningful and manageable fixed assets policy. He also suggested that other areas should be

considered when constructing a fixed assets policy, including the use of only capital accounts

to purchase fixed assets and the offering of annual training in the management of fixed assets.

Furthermore, the research by Beng and Jae (2013), which examined examine whether effective

internal control over financial reporting has implications beyond that of financial reporting to

firm operational efficiency using sample of firms gave the conclusion that operational

efficiency is significantly lower in firms disclosing material weaknesses in internal control

relative to firms with effective control. However, this result only held in the years in which

these disclosures were made, but disappears after remediation of the internal control problems,

suggesting that the remediation of material weaknesses in internal control over financial

reporting improves operational efficiency.

2.5 CONCLUSION

The study examines the relationship between internal control and the profit of an organization.

We examine all the components of internal control that have direct impact on the profitability

of an organization, with other components held as being constant. It is with respect to this that

we shall carry out an empirical study which we shall look at in subsequent chapters.


CHAPTER THREE

RESEARCH METHODS

3.1 INTRODUCTION

The first two chapters dealt with justifying the study, studying the available literature and

defining the research questions and research problems. We should bear in mind that conducting

any research would require a well-defined methodology, which consists of a series of steps.

Research methodology is the set of methods, plans or guide used for detailed study of a subject

that would assist the researcher in carrying out the research work in order to achieve his

research objectives. This chapter attempts to explain the way the research was carried out. This

include: research design, population of the study, sample and sampling techniques, research

instrument, data collection and data analysis.

3.2 RESEARCH DESIGN

Asika (2000) defined research design as “the structuring of investigation aimed at identifying

variables and their relationship with another”. It could also be seen as a framework or plan that

is used as a guide in collecting and analyzing the data for the study. A research design is used

to demonstrate how the variables of a proposed research will be collected, controlled or

manipulated to generate the necessary secondary data for the study. The casual, survey and

case study research design was adopted in the study.

Furthermore, the secondary data used are extracted from the financial statement of UAC of

Nigeria Plc. with an attempt to proxy the dependent and independent variables for each

hypothesis. Internal Control, as a variable, cannot be quantitatively gleaned from the financial

statement. However, a proxy (a representative) is assigned to stand in its place, ensuring that

the proxy largely measures the same thing as the variable of interest.


3.2.1 JUSTIFICATION OF PROXIES

3.2.1.1 INDEPENDENT VARIABLE

Internal Control as defined by COSO (1992), is the “process designed, implemented, and

maintained by those charged with governance, management, and other personnel to provide

reasonable assurance about the achievement of an entity’s objectives with regard to reliability

of financial reporting, effectiveness and efficiency of operations, and compliance with

applicable laws and regulations.” In modern times and as a result of the rapid growth of

Information Technology and its widespread adoption, most organizations today spend huge

amount of funds in its acquisition and installation with the aim of increasing the efficiency and

effectiveness of their operations as well as reduce errors and fraud committed by employees.

Arguably, if information technology, as a variable, helps, among other things, to drive

effective and efficient running of an organisation’s operations, reduce errors and frauds and

internal controls, as another variable, focuses on smooth, effective and efficient operations as

well as ensure minimisation of errors and prevention and detection of frauds, then the two

variables can be said to measure largely the same construct. The forgoing premises have

therefore, informed the decision to extract and use the expenses on Information Technology as

a proxy for Internal Control in this study.

3.2.1.2 DEPENDENT VARIABLE(S)

Financial Performance Metrics

Gross profit margin is a financial metric used to assess a firm's financial health by revealing

the proportion of money left over from revenues after accounting for the cost of goods sold.

Gross profit margin serves as the source for paying additional expenses and future savings. The

gross margin is not an exact estimate of the company's pricing strategy but it does give a good


indication of financial health. Without an adequate gross margin, a company will be unable to

pay its operating and other expenses and build for the future. In general, a company's gross

profit margin should be stable. It should not fluctuate much from one period to another, unless

the industry it is in has been undergoing drastic changes which will affect the costs of goods

sold or pricing policies.

Operating profit margin ratio measures the relationship between net profit before tax, interest,

finance income and finance cost. It measures what percentage of revenue is left (after deducting

cost of sales, selling and distribution expenses, and administrative expenses.) It is used to

determine a company’s pricing strategy and operating efficiency.

Both gross profit margin and operating profit ratio were used as proxies for financial

performance since both measure how cost of sales and operating expenses are managed to attain

profitability.

Maximisation of Resources Metrics

Asset turnover ratio is a financial ratio that measures the efficiency of a company’s use of its

asset in generating sales revenue. It aims at describing how effectively the asset resources of

the company are optimized and combined to attain higher profit. Companies with a low profit

margin tend to have a higher asset turnover and vice versa, and the higher the asset turnover

ratio the more the revenue generated with them.

Debtors’ turnover ratio measures the number times debtors are turnover during a period. It is

an accounting measure used to quantify a firm’s effectiveness in extending credit as well as

collecting debt. It is also an activity ratio, which measures how efficiently an organization

manages its debtors in order to maintain an optimal level of liquidity. The higher the ratio, the

lesser the credit period extended to customers and vice-versa.


Creditors’ Turnover Ratio measures the number of times trade creditors are turned over during

the period. In other words, it establishes the relationship between the net credit purchases and

the average trade creditors. Creditor's turnover ratio indicates the number of times with which

the payment is made to the supplier in respect of credit purchases. The lower the ratio, the more

the credit period extended to the organization and vice-versa

Asset turnover ratio, creditors’ and debtors’ turnover ratio were used as proxies for

maximization of resources they measure how efficiently and effectively assets resources

(tangible and intangible, and cash)are combined and used to meet organizational objectives as

well as liabilities of the organization are managed to control their burden on such assets.

3.3 RESTATEMENT OF QUESTION AND HYPOTHESES

RESEARCH QUESTION

Does the internal control system have an effect on the financial performance of UAC of Nigeria

Plc.?

Does the internal control system help ensure efficiency and effectiveness of operations?

Does the internal control system impact maximization of the use of resources in UAC of

Nigeria Plc.?

RESEARCH HYPOTHESES

HYPOTHESIS 1

H0: Internal system does not have an effect on the financial performance of UAC of Nigeria

Plc.

H1: Internal system has an effect on the financial performance of UAC of Nigeria Plc.

HYPOTHESIS 2



Nigeria Plc.


Plc.

HYPOTHESIS 3



3.3 POPULATION OF THE STUDY/SAMPLE AND SAMPLING TECHNIQUES

For the purpose of testing hypothesis three, primary data were collected from samples selected

from a finite population. A population is the total number of objects or items in a target universe

under study (Farinde, 2004). The study’s population sets the limit within which the research’s

findings would be applicable.

The population used for the study constitutes the staff and managers of UAC of Nigeria Plc.

The staff strength is over 2,293 (Annual Report, 2012). Since the population of the study is too

large, administration of questionnaire to the whole lot is extremely difficult. This therefore calls

for the need to represent population in form of simple thought. The random sampling technique

was applied in carrying out this research.

In the case of the secondary data, however, a total of 10 years financial statement will be

collected and used, from which the data needed will be extracted.

UAC of Nigeria Plc. only presented, in its annual reports, these figures for years 2011 and

2012. However, in order to derive the figures for previous years, this study expediently had to

use the average of the ratios of information technology expenses to operating expenses of 2011


and 2012. This average ratio was then applied on the operating expenses of years 2003 to 2010

to derive the required data. This is illustrated below:

Table 3.1: Determination of Information Technology Expenses Figures

Years Operating Expenses Information Technology Expenses

2012 58,277,742 227,568

2011 53,199,604 193,034

Average Ratio as applied (0.0038)

2010 44,080,851 166,039

2009 48,206,722 181,580

2008 44,986,523 169,450

2007 33,009,744 124,337

2006 25,853,644 97,383

2005 24,602,084 92,668

2004 22,860,384 86,108

2003 18,881,379 71,120

Source: UACN of Nigeria Plc Annual Financial Reports

Derivation of Ratio of Information Technology Expenses to Revenue

2012 2011

227,568

58,277,742=0.0038

193,034

53,199,604=0.0036

Average Ratio=0.0038+0.0036

2=0.0038

3.4 INSTRUMENTS FOR DATA COLLECTION

As stated above, the data required for the secondary data analysis was extracted from the

financial statement of UAC of Nigeria Plc.


The primary data was used for testing hypothesis three. In order to gather such data the

following instrument was used:

Questionnaire

A questionnaire is a written down set of question which aimed at getting, collecting fact

[information] about something from a respondents who will give an answer in a written form.

It is a medium through which data and information can be collected from the source.

A total of 50 questionnaires were distributed with focus being on finance and finance related

departments, targeting particularly Finance and Accounts personnel and Heads of Units and

Departments. The questionnaires were used in the analysis and presentation of hypothesis

three.

3.5 DATA ANALYSIS METHODS

Tools for Data Analysis

The data collected was fed into the computer and analysed with E-views and SPSS (a computer

programme meant specifically for analysing data) for easy analysis and interpretation of results.

Methods of Data Analysis

Regression analysis was used in analysing the data gathered from the annual reports while the

primary data was analysed using chi square. The primary data to be used for the third

hypothesis will be analyzed using chi-square.

The formula is:

X2 = (Oi – Ei)2

Ei

Where: X2 = Chi-Square

Oi= Observed frequencies

Ei= Expected frequencies


Degree of freedom (DF) is calculated as (r-1) (c-1)

r= number of rows

c= number of columns

Model Development

The regression model to be used will be y= β0+β1X+ut;

Where: y is the dependent variable

β0 is the intercept/autonomous

β1 is the slope

x is the independent variable

ut is Stochastic error term

The information technology expenses will serve as the independent variable for all models

where applicable. Equally, the independent variables for each hypothesis will be discussed

below:

Hypothesis 1:

Model 1: GPM= β0+β1(ITEX)+ut……………………………………………………….(i)

Model 2: OPM= β0+β1(ITEX)+ut……………………………………………………….(ii)

Hypothesis 2:

Model 3: ATR= β0+β1(ITEX)+ut……………………………………………………….(iii)

Model 5: DTR= β0+β1(ITEX)+ut……………………………………………………….(iv)

Model 4: CTR= β0+β1(ITEX)+ut………………………………………………………..(v)

Where: GPM represents Gross Profit Margin

ITEX represents Expenses on Information Technology

OPM represents Operating Profit Margin


ATR represents Asset Turnover Ratio

CTR represents Creditors’ Turnover Ratio

DTR represents Debtors’ Turnover Ratio

3.6 LIMITATION OF THE METHODOLOGY

While embarking on this study, some difficulties and limitations were encountered; this

impeded the extension or otherwise success of the achievement of a comprehensive research.

Among these limitations are:

1. Financial short-handedness.

2. Time constraint.

3. Reliability of figures extracted from the annual financial report.

4. Unwillingness of some respondents to supply information.


CHAPTER FOUR

DATA PRESENTATION, ANALYSIS AND PRESENTATION

4.1. INTRODUCTION

This chapter is based on the presentation, analysis and interpretation of both primary and

secondary data. The analysis of primary data is presented on the basis of method used in

collecting data for the research work, which are personal interview, questionnaire and

observation while that of the secondary data was through UAC of Nigeria (UACN) Plc. Annual

Reports.

The respondents are required in the questionnaire to indicate their choice by ticking in the

appropriate box provided against each of the alternative provided. A total number of fifty (50)

copies questionnaires were distributed however, forty-eight (48) were returned at the time of

writing this research work.

The secondary data used for this research work was retrieved from UACN Plc. Annual Reports

and the data was on several variables as they relate to their various hypotheses. The period

covered was from 2003 to 2012.

The data gathered from the questionnaire were used to test hypothesis three, while both

hypotheses one and two were tested using secondary data.

Regression analysis was used to analysis the secondary data (through Eviews statistical

package), while chi square was use in analyzing the primary data (through Statistical Packages

of Social-Science {SPSS}).


4.2. PRESENTATION OF DATA

4.2.1 PRESENTATION OF PRIMARY DATA

Below is the presentation of data gathered through the use of questionnaires:

Frequencies

Table 4.1: Gender

Frequency Percent Valid Percent Cumulative

Percent

Valid

Male 25 52.1 52.1 52.1

Female 23 47.9 47.9 100.0

Total 48 100.0 100.0

Source: Field Survey, 2014

We can deduce that majority of the respondents to the questionnaires of this study were males

as indicated by the fifty-two percent (52%) in the table above.

Table 4.2: Age


Percent

Valid

20-30 years 25 52.1 52.1 52.1

31-40 years 15 31.3 31.3 83.3

41-50 years 6 12.5 12.5 95.8

51 years and above 2 4.2 4.2 100.0

Total 48 100.0 100.0


We can observe that, of all the forty-eight respondents, 25 (or 52.1%) were between the ages

of 20 and30 years, 15 (or 31.3%) were between the ages of 31 and 40 years, 6 (or 12.5%) were

between the ages of 41 and 50 years, while only 2 (or 4.2%) were 51 years and above.

Table 4.3: Marital Status

Frequency Percent Valid Percent Cumulative Percent

Valid

Single 24 50.0 50.0 50.0

Married 24 50.0 50.0 100.0

Total 48 100.0 100.0


The marital status of the respondents was evenly distributed as 50% (or 24 people) were

married and the other 50% (or 24 people) were single.


Table 4.4: Educational Qualification


Percent

Valid

O' Level 3 6.3 6.3 6.3

OND/NCE 8 16.7 16.7 22.9

B.Sc./HND 31 64.6 64.6 87.5

PhD 6 12.5 12.5 100.0

Total 48 100.0 100.0


From the table above, we can deduce that majority of the respondents were B.Sc. degree holders

(64%) while the others were either OND/NCE (16.7%), PhD (15.5%), or O’ Level (6.3%)

holders.

Table 4.5: Working Experience


Percent

Valid

1-5 years 23 47.9 47.9 47.9

6-10 years 13 27.1 27.1 75.0

11-15 years 10 20.8 20.8 95.8

16 years and above 2 4.2 4.2 100.0

Total 48 100.0 100.0


Majority of the respondents to the questionnaires had 1-5 years’ work experience (47.9%),

while 27.1% had 6-10 years’ experience, 20.8% had 11-15 years’ experience and only 4.2%

have had 16 years and above experience of work.

Table 4.6: Occupational Status


Percent

Valid

Level 1-7 30 62.5 62.5 62.5

Level 8-14 14 29.2 29.2 91.7

Level 15 and above 4 8.3 8.3 100.0

Total 48 100.0 100.0


From the table above, 30 (or 62.5%) of the respondents were between level 1 and 7, 14 (or

29%) were between level 8 and 14, while 4 (or 8.3%) were either are level 15 or higher.


Table 4.7: Management is faithfully committed to the effective and efficient operation of

the system


Percent

Valid

Undecided 2 4.2 4.2 4.2

Agree 12 25.0 25.0 29.2

Strongly Agree 34 70.8 70.8 100.0

Total 48 100.0 100.0


Based on the analysis in the table above, the respondents agree (strongly) that the management

is faithfully committed to the effective and efficient operation of the system.

Table 4.8: Management closely monitors implementation of Internal Control Systems,

after paying careful attention to its design to ensure suitability and appropriateness.


Percent

Valid

Undecided 3 6.3 6.3 6.3

Agree 15 31.3 31.3 37.5

Strongly Agree 30 62.5 62.5 100.0

Total 48 100.0 100.0



closely monitors implementation of internal control systems, after paying careful attention to

its design to ensure suitability and appropriateness.

Table 4.9: Management gets feedback from the junior officers about the operation of

the system


Percent

Valid

Strongly Disagree 2 4.2 4.2 4.2

Disagree 2 4.2 4.2 8.3

Agree 20 41.7 41.7 50.0

Strongly Agree 24 50.0 50.0 100.0

Total 48 100.0 100.0


Based on the analysis in the table above, the respondents agree (strongly) that management

gets feedback from the junior officers about the operation of the system.


Table 4.10: Management ensures proper training of junior officers about the operation

of the internal control system


Percent

Valid

Disagree 1 2.1 2.1 2.1

Undecided 2 4.2 4.2 6.3

Agree 17 35.4 35.4 41.7

Strongly Agree 28 58.3 58.3 100.0

Total 48 100.0 100.0



ensures proper training of junior officers about the operation of the internal control system.

Table 4.11: Managers make periodic and systematic reviews of the reporting system to

determine if it is meeting current needs in order to ensure operating effectiveness


Percent

Valid


Disagree 1 2.1 2.1 4.2

Undecided 3 6.3 6.3 10.4

Agree 22 45.8 45.8 56.3

Strongly Agree 21 43.8 43.8 100.0

Total 48 100.0 100.0


Based on the analysis in the table above, the respondents agree that managers make periodic

and systematic reviews of the reporting system to determine if it is meeting current needs in

order to ensure operating effectiveness.

Table 4.12: Appropriate and prompt measures are taken to address any malfeasance in

the operation of Accounting & Finance Management System


Percent

Valid


Disagree 3 6.3 6.3 8.3

Undecided 2 4.2 4.2 12.5

Agree 18 37.5 37.5 50.0

Strongly Agree 24 50.0 50.0 100.0

Total 48 100.0 100.0



Based on the analysis in the table above, the respondents agree (strongly) that appropriate and

prompt measures are taken to address any malfeasance in the operation of accounting & finance

management system

Table 4.13: Ethical values are followed and upheld in all management decisions


Percent

Valid


Disagree 2 4.2 4.2 6.3

Undecided 4 8.3 8.3 14.6

Agree 19 39.6 39.6 54.2

Strongly Agree 22 45.8 45.8 100.0

Total 48 100.0 100.0


Based on the analysis in the table above, the respondents agree (strongly) that ethical values

are followed and upheld in all management decisions.

Table 4.14: Implementation of a sound Internal Control System ensures reliability of

financial reporting system


Percent

Valid


Disagree 2 4.2 4.2 6.3

Undecided 3 6.3 6.3 12.5

Agree 18 37.5 37.5 50.0

Strongly Agree 24 50.0 50.0 100.0

Total 48 100.0 100.0


Based on the analysis in the table above, the respondents agree (strongly) that implementation

of a sound internal control system ensures reliability of financial reporting system.


Table 4.15: Management ensures the company complies with applicable laws and

regulations


Percent

Valid


Disagree 1 2.1 2.1 4.2

Undecided 3 6.3 6.3 10.4

Agree 19 39.6 39.6 50.0

Strongly Agree 24 50.0 50.0 100.0

Total 48 100.0 100.0



ensures the company complies with applicable laws and regulations.

Table 4.16: Appropriate measures are taken to prevent and detect fraud and error


Percent

Valid

Disagree 4 8.3 8.3 8.3

Undecided 3 6.3 6.3 14.6

Agree 16 33.3 33.3 47.9

Strongly Agree 25 52.1 52.1 100.0

Total 48 100.0 100.0


Based on the analysis in the table above, the respondents agree (strongly) that appropriate

measures are taken to prevent and detect fraud and error.

4.2.2 PRESENTATION OF SECONDARY DATA

The secondary data was used to test the effect of internal control system on financial

performance and maximization resource usage (i.e. hypotheses one and two). The time series

data used for this study in estimating and analysis for both hypotheses is presented in the table

below:


Table 4.17: Presentation of Secondary Data Years Information

Technology

Expenses

Gross

Profit

Operating

Profit

Capital

Employed

Turnover Debtors Creditors Cost of

Sales

2003 71,120 5,270,649 2,195,863 9,904,864 20,947,146 385,176 1,177,998 15,676,497

2004 86,108 6,204,928 2,404,462 13,745,392 25,116,384 958,893 1,561,581 18,911,456

2005 92,668 7,028,644 2,677,116 16,834,685 27,118,696 1,391,975 1,921,267 20,090,052

2006 97,383 7,131,469 2,748,306 18,586,514 28,403,237 1,690,443 1,692,935 21,271,768

2007 124,337 9,746,293 4,145,427 50,644,584 37,155,171 3,735,836 4,519,458 27,408,878

2008 169,450 14,618,888 8,665,676 50,622,138 53,652,199 4,705,272 11,979,081 39,033,311

2009 181,580 16,504,077 8,398,236 49,111,843 56,604,958 3,796,545 7,688,728 40,100,881

2010 166,039 16,450,207 8,232,831 62,965,530 52,313,682 5,373,620 7,707,450 35,863,475

2011 193,034 15,860,750 7,715,139 58,775,397 59,637,822 5,421,800 5,222,045 43,777,072

2012 227,568 19,049,760 11,526,022 55,530,968 69,632,321 4,538,651 5,167,653 50,582,561

Source: UACN Annual Financial Reports 2003-2012

4.3 TEST OF HYPOTHESES

HYPOTHESIS 1:

H0: Internal system does not have an effect on the financial performance of UAC of Nigeria

Plc.

H1: Internal system has an effect on the financial performance of UAC of Nigeria Plc.

Table 4.18: Model 1 Dependent Variable: GPM

Sample: 2003 2012

Included observations: 10

Variable Coefficient Std. Error t-Statistic Prob.

C 1.797317 0.567057 3.169550 0.0132

ITEX 0.126584 0.048086 2.632466 0.0301

R-squared 0.464162 Mean dependent var 3.289301

Adjusted R-squared 0.397182 S.D. dependent var 0.074419

S.E. of regression 0.057780 Akaike info criterion -2.687506

Sum squared resid 0.026708 Schwarz criterion -2.626989

Log likelihood 15.43753 Hannan-Quinn criter. -2.753893

F-statistic 6.929876 Durbin-Watson stat 1.902661

Prob(F-statistic) 0.030063

Source: Computation using E-Views Statistical Package, Version 7.0

Model 1:

GPM = 1.80 + 0.13 (ITEX)

Std. Error = 0.57 0.05

t-Statistic = 3.17 2.63

p-value = 0.01 0.03

R2 = 0.46 Prob(F-statistic)= 0.03


Interpretation of Result

From the analysis above, we can deduce that the coefficient of that intercept of the model (1.78)

and that of the independent variable (i.e. internal control) (0.13) came up with positive signs,

which are in conformity to expectation indicating that there is a positive relationship between

the internal control system and gross profit.

The individual statistical significance of the parameter estimate of the model evaluated by

examining the probability value of the coefficients shows that both the intercept (β= 1.797317:

p-value= 0.01) and slope (β= 0.126584: p-value= 0.03) are statistically significant at five

percent (5%) level of significance.

Furthermore, the coefficient of determination, measured by square of correlation coefficient

(R2), is about 0.464162 which translates, approximately, to forty-six percent (46%). This

implies that about 46% of the variation in gross profit is as a result of the changes in expenses

on information technology over the observed period and that the other fifty-four percent (54%)

of the variation can be attributed to other factors.

Again, the overall statistical significance of the model evaluated by examining the probability

of F-statistic (0.03) suggests that at 5% significance level, the regression model passed the

overall goodness of fit test which indicates that none of the estimated coefficient is equal to

zero and that there is a linear relationship between the gross profit and the internal control

system and, by extension, the latter variable, therefore, affects the former.


Table 4.19: Model 2

Dependent Variable: OPM

Sample: 2003 2012



C -3.426120 1.078792 -3.175886 0.0131

ITEX 0.504332 0.091480 5.513016 0.0006









Model 2:

OPM = -3.43 + 0.50 (ITEX)

Std. Error = 1.08 0.09

t-Statistic = -3.17 5.51

p-value = 0.01 0.00



We can deduce, from the analysis above, that the coefficient of the intercept of the model (-

3.43) and that of the independent variable (0.50) came up with negative and positive signs

respectively. However, it is still in conformity with expectations of the study as it indicates that

there is a positive relationship between the internal control system and operating profit.


examining the probability value of estimates shows that both the intercept (β= -3.426120: p-

value= 0.01) and slope (β= 0.504332: p-value= 0.00) are statistically significant at five percent

(5%) level of significance.

Furthermore, the coefficient determination, measured by square of correlation coefficient (R2),

is about 0.791631 which translates, approximately, to seventy-nine percent (79%). This implies

that about 79% of the variation in operating profit is as a result of the changes in expenses on


information technology over the observed period and that the other twenty-one percent (21%)

can be ascribed to other factors.

Again, the overall statistically significance of the model evaluated by examining the probability

of F-statistic (0.00), suggests that at 5% significance level, the regression model passed the


zero and that there is a linear relationship between the operating profit and the internal control

system and, by extension, the latter variable, therefore, significantly affects the former.

HYPOTHESIS 2:


Nigeria Plc.


Plc.

Table 4.20: Model 3 Dependent Variable: ATR

Sample: 2003 2012



C 11.29089 3.021107 3.737334 0.0057

ITEX -1.949324 0.589891 -3.304552 0.0108



S.E. of regression 0.307832 Akaike info criterion 0.658330

Sum squared resid 0.758083 Schwarz criterion 0.718847

Log likelihood -1.291650 Hannan-Quinn criter. 0.591943




Model 3:

DTR = 11.29 + -1.95 (ITEX)

Std. Error = 3.02 0.59

t-Statistic = 3.74 -3.30

p-value = 0.01 0.01




As can be observed above, the coefficient of the intercept of the model (11.29) and that of

information technology expenses (ITEX) (-1.95) came up with positive and negative signs

respectively; this is a deviation from our expectations as it is an indication that there is a

negative relationship between internal control and asset turnover.


examining the probability value of estimates, however, shows that both the intercept (β=

11.29089: p-value= 0.01) and slope (β= -1.949324: p-value= 0.01) are statistically significant

at five percent (5%) level of significance.


(R2), is about 0.577168 which translates to approximately fifty-seven percent (57%). This

implies that about 57% of the variation in asset turnover is as a result of changes in the expenses

on information technology over the observed period and that the other forty-three percent

(43%) of the variation in is due to other factors.

Again, the overall statistically significance of the function evaluated by examining the

probability of F-statistic (0.01) suggests that at 5% significance level, the regression model

passed the overall goodness of fit test which indicates that none of the estimated coefficient is

equal to zero and that there is a linear relationship between asset turnover and the internal

control system and, by extension, the latter variable, therefore, significantly affects the former.


Table 4.21: Model 4

Dependent Variable: DTR

Sample: 2003 2012



C 0.818503 0.271310 3.016861 0.0166

ITEX -0.149775 0.052975 -2.827276 0.0222









Model 4:

DTR = 0.82 + -0.15 (ITEX)

Std. Error = 0.27 0.05


p-value = 0.02 0.02



The coefficient intercept of the model above (β= 0.82) and that of the independent variable

(internal control) (-0.15) came up with positive and negative signs, which deviates from our

expectations as it is an indication that there is a negative relationship between internal control

and debtors turnover.


examining the probability value of estimates, however, shows that both the intercept of the

model (β= 0.818503: p-value= 0.02) and slope (β= -0.149775: p-value= 0.02) are statistically

significant at five percent (5%) level of significance.


(R2), is about 0.499797 which translates to approximately fifty percent (50%). This implies that

about 50% of the variation in debtors’ turnover is as a result of the changes in expenses on


information technology over the observed period and that the other 50% can be attributed to

other factors.

Again, the overall statistically significance of the model evaluated by examining the probability

of F-statistic (0.02) suggesting that at 5% significance level, the regression model passed the


zero and that there is a linear relationship between the debtors’ turnover and internal control

and, by extension, the latter variable, therefore, significantly affects the former.

Table 4.22: Model 5

Dependent Variable: CTR

Sample: 2003 2012



C 0.222049 0.075168 2.954024 0.0183

ITEX -0.038787 0.014677 -2.642662 0.0296









Model 5:

CTR = 0.22 + -0.04 (ITEX)

Std. Error = 0.08 0.01


p-value = 0.02 0.03



It can be deduced, from the analysis above, that the coefficient of the intercept (0.22) and that

of information technology expenses (ITEX) (-0.04) came up with positive and negative signs,

which is in conformity with our expectations and it indicates that there is a negative relationship

between the internal control system and creditors’ turnover.



examining the probability value of estimates shows that both the intercept of the model (β=

0.222049: p-value= 0.02) and its slope (β= -0.038787: p-value= 0.03) are statistically

significant at five percent (5%) level of significance.


(R2), is about 0.466085 which translates to approximately forty-seven percent (47%). This

implies that about 47% of the variation in creditors’ turnover is as a result of the changes in

expenses on information technology and that the other fifty-three percent (53%) of the variation

in is due to other factors.

Again, the overall statistical significance of the model evaluated by examining the probability

of F-statistic (0.03) suggests that at 5% significance level, the regression model passed the


zero and that there is a linear relationship between the creditors’ turnover and internal control

and, by extension, the latter variable, therefore, affects the former.

HYPOTHESIS 3:



Table 4.23: Case Processing Summary

N %

Cases

Valid 48 100.0

Excludeda 0 .0

Total 48 100.0

a. Listwise deletion based on all variables in the

procedure.



Table 4.24: Reliability Statistics

Cronbach's Alpha N of Items

.906 10


The reliability statistics table reports the value of Cronbach’s alpha. It tests the reliability of an

approach used in determining the ability of a study to measure accurately and dependably a

research construct.

The Cronbach’s alpha coefficient gave a value of 0.906 (which is in line with the

recommendation of 0.70 and above) is acceptable. The value was due to a relatively sample

size that has been used. Therefore this can be interpreted that the instrument used is reliable

given that the highest coefficient of reliability is a maximum of one (1). In conclusion, the

coefficient of 0.906 reported for these items is an estimate of the true alpha, which in turn is a

lower bound for the true reliability.

Chi-Square Test

Table 4.25: Chi-square Frequencies

Internal Control and Effectiveness and Efficiency of Operations

Observed N Expected N Residual

Disagree 2 12.0 -10.0

Undecided 1 12.0 -11.0

Agree 12 12.0 .0

Strongly Agree 33 12.0 21.0

Total 48


Table 4.26: Test Statistics

Internal Control

and Effectiveness

and Efficiency of

Operations

Chi-Square 55.167a

Df 3

Asymp. Sig. .000

a. 0 cells (0.0%) have expected

frequencies less than 5. The

minimum expected cell frequency is

12.0.




The statistical analysis above shows that the asymptotic significance (0.000) of the tested

variable is less than 0.05 decision criterion. This is an indication that the result of the chi square

calculated above is significant.

The calculated chi-square value (55.167) at 95% confidence interval with 3 degree of freedom

is greater than the table value of 7.815 (0.05), which makes the chi-square calculated to fall at

the critical or rejection region. Hence, the Null hypothesis is rejected, while the alternative

hypothesis is accepted.

Detailed Interpretation of Results

Hypothesis 1:

The analyses (presented in tables 2 and 3) above disclose that there is a positive relationship

between the Internal Control System put in place by UAC of Nigeria Plc. and its profitability

as indicated by the positive slopes of both gross and operating profit, above. The trend analysis

also informs us that the Internal Control System has an impact on the profitability of the

organization.

It is a general assumption that when an organization expends more on the internal control

system, it should have a positive effect on the financial performance of such an organization

(Muraleetharan, n.d.). Hence, the alternative hypothesis was accepted.

Hypothesis 2:

The three regression analysis (presented in tables 4, 5 and 6) above tested the impact of internal

control on maximization of resources. From the analysis above, it is confirmed that the internal

control system has a significant influence on the use of resources in UAC of Nigeria; however,

based on the models above this influence contrasts.


Considering the impact of the internal control system on the asset turnover ratio (how effective

utilization of asset to generate revenue), based on the relationship indicated by the slope (-

1.949324) calculated in the model above, it means that there is a negative relationship between

internal control system and asset turnover. But according to COSO (1992), an internal control

system is instated by an organization with the aim of achieving its objectives, and amongst the

means of achieving its objectives is the generation of maximum revenue. However, the motive

of this research is to determine if there is a relationship between internal control and asset

turnover, hence, on that bases we accept the alternative hypothesis.

From the analysis above, the internal control system instituted by UAC of Nigeria Plc. has an

impact on the debtors’ turnover (effectiveness in extending credit as well as collecting debt

which translate into optimum cash management). However, the negative relationship between

them (-0.149775) varies from our expectations. The implementation of internal control should

aid the increase of the number of times debtors are turned over which, judging by the negative

relationship is not the case. This research, on the other hand, is testing if there is a relationship

between internal control and debtors’ turnover which is achieved from the calculations above

and confirmed by the significance of the model (0.022243).

Creditors’ turnover (the lower the ratio the more the credit period extended to the organization)

is the opposite of debtors’ turnover, hence, should reduce as more expenses are spent on

internal control. The analysis above indicates that there is a relationship between internal

control and creditors’ turnover ratio and the more UAC of Nigeria Plc. expends on internal

control the lower the creditors’ turnover ratio which translates into more credit period extended

to the organization.


In conclusion the alternative hypothesis (H1) was accepted because all variables tested showed

that there is a relationship between internal control and maximization of resources of the

organization.

Hypothesis 3:

The analysis above indicated that the respondents were in support of the fact that the internal

control system put in place by UAC of Nigeria Plc. did not only have a strong impact on its

efficiency and effectiveness of the operations, but also aided its success. The respondents also

acknowledged the properly instituted internal control system of the organization which was

noticed by the researcher during the observation as there was smoothness in the operations of

the firm.

4.4 DISCUSSION OF FINDINGS

In light of the analyses above, the findings above were pitched against the decision of previous

literatures on works related to internal control and the following discoveries were made:

The research work carried out by Hollis, David and Daniel (2012) on Internal Control over

Financial Reporting and Managerial Rent Extraction: Evidence from the Profitability of

Insider Trading” revealed that there is an association between internal control over financial

reporting effectiveness and trading profitability is present in the years leading up to the material

weakness disclosure, but disappears after remediation. Also, in the paper written by

Muraleetharan (2008) titled Internal Control and Impact of Financial Performance of The

Organizations which was carried out to find out the impact of internal control on performance

of the private and public organizations, also found that internal control (if implemented

effectively) the internal control system has a significant impact on the financial performance

of an organization. The decisions from both papers are in consonance with the results of the


first hypothesis which indicated that there is a positive relationship between internal control

and profitability of an organization.

In the work published by William (2000) titled “Managing and Accounting for Fixed Asset”,

concluded that the internal control function are extremely important to a meaningful and

manageable fixed assets policy. He also suggested that other areas should be considered when

constructing a fixed assets policy, including the use of only capital accounts to purchase fixed

assets and the offering of annual training in the management of fixed assets. This is in

consonance, expediently, with the finding of hypothesis two which suggests there is a

relationship between implementation of an internal control system and maximization of the

utilization of resources.

Furthermore, the research by Beng and Jae (2013) titled “Internal Control and Operational

Efficiency” which examined examine whether effective internal control over financial reporting

has implications beyond that of financial reporting to firm operational efficiency using sample

of firms gave the conclusion that operational efficiency is significantly lower in firms

disclosing material weaknesses in internal control relative to firms with effective control.

However, this result only held in the years in which these disclosures were made, but disappears

after remediation of the internal control problems, suggesting that the remediation of material

weaknesses in internal control over financial reporting improves operational efficiency. This

aligns with findings in the analysis of the third hypothesis which acknowledges that the internal

control system put in place by UAC of Nigeria Plc. does not only have an impact on the

effectiveness and efficiency of its operations but guarantees its success.


CHAPTER FIVE

SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATIONS

5.1 INTRODUCTION

The first four chapters have been all about the introduction, literature review, methodology and

data presentation, analysis and interpretation; the aim of this chapter, however, is to discuss the

summary of previous chapters as well as conclude generally on the study and give

recommendations based on the findings of the study.

5.2 SUMMARY OF THE STUDY AND FINDINGS

The primary objective of the study was to determine the effect of internal control system on

financial performance of the organization. Based on the analyses carried out in chapter four of

this study, it was found that the system was significant, to some degree, in determine how

profitable UAC of Nigeria Plc. was.

Furthermore, two other objectives were included in the study to determine if internal control

had an impact on the use of resources, as well as efficiency and effectiveness of operations.

The analyses also revealed that the internal control system put in place by UAC of Nigeria Plc.

was significant and had tremendous effect in determining how effective and efficient the

operations of the organization was as well as the maximization of its resources.

Also, based on the analyses the following could be said of UAC of Nigeria Plc:

1. The company has had a sustained increase in its gross profit over time and the relation of its

gross profit to the internal control system is positive indicating a good cost control system

as well as an excellent pricing system.


2. The relationship between the internal control system and operating profit came up positive

indicating a low-cost operating model (i.e. the company can deliver merchandise and/or

services to customers at cheaper prices)

3. The asset turnover had a negative relation to the internal control system which implies that

it could be have a poor inventory management system or a high cash balance.

4. The debtors’ turnover also had a negative relation to the internal control system which could

translate to a either a lax or non-existing credit policy or an inadequate collection system.

The creditors’ payment period in relation to the internal control system also gave a negative

result but this is expected as this is an indication UAC is able to persuade its creditors into

extending their credit limits and/or period.

5. The management pays attention to the achievement of an efficient internal control system to

achieve the objectives of the firm through a satisfactory operation in its manufacturing

process.

5.3 CONCLUSION

Based on the findings revealed above, the management of UAC of Nigeria Plc. can improve

the profitability of the firm by paying attention to the effective functioning of internal control

of the firm especially as it had major impact on its operations. The use of internal control with

an efficient cost reduction and control system could go a mile in improving the profits of the

organization.

Internal control system can be used to improve how an organization manages its inventory

system and cash balances as well as manage the credit it extends to customers. Internal control

can also guide the firm in the management of its credits owed to creditors so prompt and due

payment can be made to disrepute of the firm.


In addition, the internal control can aid the efficiency and effectiveness of the operations of

the firm through a proper implementation of the system and its careful configuration, ensure

compliance of, not only the personnel, but of other resources.

5.4 RECOMMENDATIONS

In view of the findings of the study, and in other to develop a sound internal control system in

relation to profitability, efficiency and effectiveness of operations as well as maximisation of

use of resources, the following are recommended:

1. The management of the organization should create, if already in existence, review the

policies and procedures for inventory planning and control. Managers and employees must

follow these polies and procedures when handling the company’s inventory. Policies and

procedures outline may include: segregation of duty on inventory handling, how inventory

flows through the company, accounting policies for valuing inventory and procedures for

dealing with obsolete goods.

2. In the case where the organization has a high cash balance, the organization should invest

more with the cash in its till in order to reduce and maintain an optimum level of liquidity.

3. The organization should also, in addition to reviewing its current credit policy, implement

a more flexible collection system in order that its debtors may pay up their debt in due time.

In addition to improving the aforementioned recommendations, the organization may also

implement its internal control system to:

4. Be capable of responding quickly to evolving risks arising from factors within the company

and from the ever dynamic business environment.

5. Include procedures for reporting immediately to appropriate level of management any

significant control failings or weaknesses that are identified.


5.5 SUGGESTIONS FOR FURTHER STUDIES

The secondary data used in the analysis of hypothesis one and two on covered a total of ten

years of the annual financial report of UAC of Nigeria. It is therefore suggested that the sample

size for the secondary data (i.e. the number of years the annual financial report covered) be

increased to a span of twenty (20) years compared the ten (10) years used for this study.

This study also, has been carried out with certain limitations which include the fact that it only

studied the performance of a particular company and industry against the internal control

system. Further studies can be equally carried out to span across a number of other companies

within the same industry or could be extended to be an industry-wide research.

Also, this study was also limited to the use of a single proxy for the internal control system, as

well as few financial ratios in other to determine the performance of the organization. It is

recommended that other proxies and financial ratios be used to elucidate the effect of the

internal control system on the performance of UAC of Nigeria or other organization or

industries as well.

In addition the following topics could also be researched upon:

1. The effect of internal control system on the output of an organization

2. The influence of internal control system on the decisions of the management of an

organization.

3. The impact of internal control system on the pricing decision of an organization.


REFERENCES

Abdulwahab O., I, (2004). Practical Guides to Project Writing, The Federal Polytechnic, Offa,

Kwara State. Nigeria.

Aren, A., Elder, R, & Beasley M. (2006), Auditing and Assurance Services (11th ed.). Pearson

Education Limited, New Jersey.

Asika, N. (2006). Research methodology in the behavioural science, Lagos: Longman Nigeria.

Badmus O., & Elegbde D., (2003), Auditing & Investigation “Theory & Practice” (1st Ed.).

Bayus Prints.

Beng W. G., Jae B. K., (2013) Internal Control and Operational Efficiency available at

papers.ssrn.com/sol3/papers.cfm?abstract_id=2275753

Committee of Sponsoring Organizations of the Treadway Commission (1992), Internal

Control—Integrated Framework available at http://www.coso.org.

Committee of Sponsoring Organizations of the Treadway Commission (2011), Internal

Control—Integrated Framework available at http://www.coso.org.

Farinde D. (2004). Descriptive Statistics, 1st Edition, Akure Nigeria: Sugaf Venture.

Hayes, R., Dassen, R., Arnold, S., & Wallage, P. (2005), Principles of Auditing (2nd ed.).

Pearson Education Limited, New Jersey.

Hollis A. S., David V., Daniel W., (2012) Internal Control over Financial Reporting and

Managerial Rent Extraction: Evidence from the Profitability of Insider Trading available

at paper,ssrn.com/sol3/paper.cfm?abstract_1928557

International Federation of Accountants (2012), Evaluation and Improving Internal Control in

Organizations, retrieved from www.ifac.org/publications-resources/evaluating-and-

evaluating-and-improving-internal-control-in-organizations-0.

Institute of Internal Audit, (2013), available at www.theiia.org/guidance/standards-and-

guidance/ippf/definition-of-internal-auditing/?search%C2%BCdefinition

Kiabel B. D. (2012), Internal Audit and Performance of Government of Government

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www.kpmg.com.cn

Lembi N. (2006), Evaluation of the Effectiveness of Internal Control over Financial Reporting,

University of Tartu.

Muraleetharan P., (n.d.), Internal Control and Impact of Financial Performance of the

Organizations (Special Reference Public and Private Organizations in Jaffna District) http://www.kln.ac.lk/uokr/ICBI2011/A&F%20128.pdf

Nova Scotia Municipal Finance Corporation, (2005), Enhancing Management Involvement

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http://www.coso.org/

http://www.coso.org/


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budgeting

http://www.wikipedia.org/


APPENDIX I

Department of Accounting and Finance,

Accounting Unit,

Faculty of Management Sciences,

Lagos State University, Ojo.

Dear Sir/Ma,

RESEARCH QUESTIONNAIRE

I am a final year student of Accounting and Finance department, accounting programme of

Lagos State University, Ojo.

I am required to carry out a research/project in the relevant field of study. The research topic is

“THE EFFECT OF INTERNAL CONTROL SYSTEM ON THE PROFITS OF

MANUFACTURING INDUSTRIES.”

I will be pleased and immensely grateful if you could grant part of your valued time to respond

to the questions in the following questionnaire. All the information you provided will be treated

in the strictest confidence.

Thank you for your cooperation

_______________________________

AROMIRE, OLUWABUKUNMI B.

RESEARCHER


SECTION A

PERSONAL DATA

Please tick () where appropriate

1. Sex: Male [ ] Female [ ]

2. Age: 20- 30 [ ] 30-40 [ ] 40-50 [ ] 50-60 [ ]

3. Marital status: Single [ ] Married [ ]

4. Educational Qualification: O’ level [ ] OND/NCE [ ] B.SC/HND [ ] PHD [ ]

5. Working Experience: 1-5 years [ ] 6-10 years [ ] 11-15 [ ] 16 years and above [ ]

6. Occupational Status: Level 1-7 [ ] Level 8-14 [ ] Level 15 and above [ ]

SECTION B

INSTRUCTIONS

Please indicate by marking “√” in the appropriate box whether: Strongly Agree [SA]; Agree [A];

Undecided [U]; Disagree [D]; & Strongly Disagree [SD]

INTERNAL CONTROL AND EFFICIENCY AND EFFECTIVENESS

S/N QUESTIONS SA A U D SD

Q1 Management is faithfully committed to the effective and efficient

operation of the system

Q2 Management closely monitors implementation of Internal Control

Systems, after paying careful attention to its design to ensure

suitability and appropriateness.

Q3 Management gets feedback from the junior officers about the

operation of the system

Q4 Management ensures proper training of junior officers about the

operation of the internal control system

Q5 Managers make periodic and systematic reviews of the reporting

system to determine if it is meeting current needs in order to ensure

operating effectiveness

Q6 Appropriate and prompt measures are taken to address any

malfeasance in the operation of Accounting & Finance Management

System

Q7 Ethical values are followed and upheld in all management decisions

Q8 Implementation of a sound Internal Control System ensures

reliability of financial reporting system

Q9 Management ensures the company complies with applicable laws

and regulations

Q10 Appropriate measures are taken to prevent and detect fraud and error


APPENDIX II


Respondents Sex Age

Marital

Status

Educational

Qualification

Working

Experience

Occupational

Status Q1 Q2 Q3 Q4 Q5 Q6 Q7 Q8 Q9 Q10

1 1 1 1 3 2 2 4 4 5 4 4 5 4 5 4 4

2 2 1 1 2 1 1 5 4 5 5 4 5 4 5 4 5

3 1 1 1 3 1 1 5 4 5 5 4 5 4 5 4 5

4 1 3 2 4 3 2 5 5 5 4 4 5 5 5 5 4

5 1 1 2 3 1 1 5 4 4 5 5 5 4 5 4 4

6 1 4 2 4 3 3 5 5 5 5 4 4 4 5 5 5

7 2 1 1 3 1 1 5 5 5 4 5 4 5 5 5 5

8 2 2 2 3 2 2 5 5 4 5 5 4 5 4 5 5

9 1 1 1 3 1 1 4 5 4 5 5 4 3 5 4 3

10 2 2 2 3 2 2 5 5 4 4 5 5 5 5 4 3

11 1 2 2 3 2 1 5 5 4 4 5 4 4 5 5 5

12 2 1 2 3 1 1 5 5 4 5 4 4 5 5 5 5

13 2 1 2 4 2 2 4 5 4 5 4 5 4 5 5 4

14 2 1 1 3 2 1 4 5 5 5 5 4 5 5 5 5

15 2 1 1 3 1 1 5 5 5 5 5 4 4 4 5 5

16 2 1 1 3 1 1 5 5 5 5 5 4 4 4 5 5

17 2 1 1 3 1 1 5 5 4 4 4 3 3 4 4 4

18 1 3 2 4 1 2 5 4 4 5 4 4 5 4 5 5

19 2 2 2 3 3 2 5 4 4 5 5 4 5 4 4 5

20 2 1 2 3 3 2 5 4 5 4 5 5 5 4 4 5

21 1 1 1 3 1 1 5 5 5 5 4 4 4 4 4 5

22 1 1 1 3 1 1 4 5 5 5 5 4 5 4 5 4

23 1 1 1 2 1 1 5 5 4 4 4 5 5 4 5 4

24 1 2 2 3 3 2 5 5 4 4 4 5 5 5 4 4

25 1 2 2 3 3 2 5 5 4 4 4 5 5 4 4 4

26 1 2 2 3 2 1 5 5 4 5 4 5 4 4 5 5

27 1 1 1 3 1 1 5 5 5 5 4 5 4 5 5 5

28 2 2 1 3 2 2 4 5 5 5 4 5 5 5 5 4

29 1 1 1 3 1 1 5 5 5 4 5 4 5 5 5 5

30 2 3 2 3 3 3 5 4 5 5 5 4 5 5 5 4

31 2 3 2 4 3 2 4 5 4 5 3 5 5 4 5 5

32 1 2 1 3 1 1 4 4 4 4 5 5 5 5 1 2

33 1 1 1 2 1 1 5 5 4 4 5 5 5 5 5 4

34 2 1 2 2 1 1 5 5 5 5 5 5 4 5 4 4

35 2 2 2 3 2 1 5 5 4 4 4 5 5 4 4 4

36 1 3 2 3 4 3 5 5 5 5 5 4 4 4 3 2

37 1 1 1 3 2 1 5 4 5 5 4 2 5 5 4 5

38 2 2 2 2 3 2 5 4 5 5 4 2 5 5 4 5

39 1 2 2 3 2 1 4 5 5 4 5 4 4 5 5 5


40 2 1 1 3 1 1 5 5 5 5 4 5 4 4 4 5

41 2 4 2 4 4 3 5 5 5 5 5 5 4 4 5 5

42 1 3 2 3 3 2 5 4 5 5 5 5 4 4 5 5

43 2 1 1 2 1 1 5 4 4 5 4 5 4 3 5 5

44 1 2 1 2 2 1 4 4 4 4 4 5 3 3 4 4

45 1 1 1 1 1 1 4 4 2 4 3 4 3 3 4 4

46 1 1 1 2 1 1 4 3 2 3 3 3 2 2 3 3

47 2 2 2 1 2 1 3 3 1 3 2 2 2 2 3 2

48 2 2 1 1 1 1 3 3 1 2 1 1 1 1 2 2

effects of internal control system on the profits of manufacturing industries

Documents