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Internal Control in Manufacturing Organization

The Impact of Internal Control in Manufacturing Organization (A Case Study of Nigeria Bottling Company Plc, Onitsha Anambra State)

 CHAPTER TWO

LITERATURE REVIEW

2.1     RESEARCH QUESTION

  1. What constitute the internal control system of the organization ?

2        How effective is the internal control system of the organization and to what extent is the organization’s staff complying to it?

  1. Does reliability of accounting information depends on internal control?
  2. Does internal control assist the external auditor in auditing the organization?

5        Does installation of internal control system serve as a check on the activities of the staff of the organization?

6        Does installation of internal control prevent the occurrence of fraud in the organization?

2.2     CURRENT LITERATURE ON THEORIES MODELS AND RESEARCH QUESTION

2.2.1  MEANSING OF INTERNAL CONTROL

The statement number one of the institute of chattered accountants of England and wales, defined internal control as one consisting of not only internal check and internal audit but the whole system of controls financial or otherwise, established by management in order to carry on the business in an orderly manner.

According to Okonkwo (2003) internal control can simply mean all measure used by management to regulate and control affairs of the business.

According to Mrs Dupe Aquaisua F. (2004) internal control can be referred to as te necessary and adequate procedures that can be put in place through which the asset of the organization can be safeguarded. The American Institute of certified Public Accountants (AICPA) has defined internal control as “the policies and procedures established to provide reasonable assurance that an entity’s established objectives will be met”

According to I.E. Okonkwo (2015) internal control is recommended that there should be installation of good internal control system, financial and administrative. Example of these will include among others, sound control mechanism; qualified, honest and sincere personnel; clear definition of functions; effective check; proper authorization; adequate recording; physical security; rotation of duty; internal auditing and bonding.

internal control system therefore are those procedures and methods which the management of an entity adopted to aid them achieve their objective of ensuring that the business of the entity is properly in an orderly and efficient manner.

Statement of Auditing standards (SAS N0 1) defined internal control system as one comprising the plan of organization and all of the coordinate methods and measures adopted within a business to safeguard it’s assets, check the accuracy and reliability of it’s accounting data, promote operational efficiency and encourage adherence to prescribed managerial policies.

According to Okozie B.N. (2004) internal control system as the set of accounting and administrative controls and practice that help to ensure that approved and appropriate decisions are made in an organizations. They further stated that internal controls include both accounting control and administrative controls.

According to Aguolu O. (2002) defined internal controls as the whole system of controls, financial or otherwise, establish by management in order to secure as far as possible the accuracy and reliability f the records run the business in an orderly manner and safeguard the compay’s assets it’s objective being the prevention or early detection of fraud and errors.

2.2.2  TYPES OF INTERNAL CONTROL

According to statement on Auditing Standard (SAS N0 1), we have two types of internal control

  1. Internal Accounting control
  2. Administrative or operational control

INTERNAL ACCOUNTING CONTROL

Internal accounting control is defined in SAS N0 1 (paragraph 320.28) as the plan of organizations and the procedures and records that are concerned with the safeguarding of assets and reliability of financial records and consequently are designed to provide reasonable assurance that:

  1. Transaction are execute in accordance with management general or specific authorization.

b        Transaction are recorded as necessary

*        To permit preparation of financial statement in conformity with generally accept accounting principles or any other criteria application to such statement and

*        To maintain accountability for assets

c        Access to assets is permitted only in accordance with managements authority.

d        The recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to differences.

The responsibility for the installation and maintained of internal accounting control is that if an entity’s management ordinarily the task is delegated in turn with the accounting (or financial) department. Internal accounting control also includes those accounting procedures or physical, statistical or other controls designed to safeguard assets against fraudulent conversion or against avoidable loss from other causes. Some forms of internal accounting control of a physical nature such as fences, gates, security guards and inspection of outing materials or personnel are ordinary the responsibility of operating departments failure to achieve the objectives of internal accounting controls lead to risk of loss or errors.

This is the plan of organization and the procedures and records that are concened with the decisions processes leading to management authorization of transactions scuh authorization is a management function directly associated with the responsibility for achieving the objectives of the organization and is the starting point for establishing accounting control of transaction. It can also be seen as plan of organizations and all of the co-ordinate methods and measures adopted within a business to promote operational efficiency and encourage adherence to prescribed managerial policies.

2.2.3  SPECIFIC METHOD OF ACHIEVING INTERNAL CONTROL

Among the important internal control devices are the following:

  1. Internal Auditing: Virtually very large organizations has an internal auditing staff. The internal auditors study both administrative and accounting controls in all units of the organizations and prepare reports to top management on their findings.
  2. Financial forecast: A plan of operations is prepared each year setting goals for each division of the business as for example the expected volume of sales, amount of expenses and future cash balances. Actual results are compared with forecast amounts month by month. This comparison strengthens actual controls because variations from planned results are investigated properly and many reveal accounting errors or other breakdowns in company policies.
  3. Serially Numbered Documents: The printed should include serial numbers on such document as cheque, purchase orders and sales invoices. If a document is misplaced or concealed the break in the sequence.

4        Competent Personnel: Even best designed system of internal control will not work well unless the people using it are competent. Competence and integrity of employees, but they also are related to the policies for selection of personnel, the adequacy of supervision and the complexity of the system.

2.2.4  ESSENTIAL FEATURES OF INTERNAL CONTROL

According to Dupe Aquaisua f. (2004) internal control system is an important system for the survivals of any business enterprise. It becomes imperative that the internal control should be kept alive and under close watch. The strategies essential for effective functions of internal control system are summarized as follows:

  1. Segregation of Duties: This relates to internal check, separate persons should perform different functions in executing a transaction. For instance the following function should be separately performed.

a        Initiation and authorization of a transaction

b        The custody of the assets involved

c        The document and recording of the transaction.

2        Specific Organization Structures: The structures should specify clear authority will enhance the performance of duties by responsible officers. Responsibility must be given along ith authority.

  1. Proof measures: These include total accountant trial balances, prelists etc independent persons should be made to ascertain and compare records so as to ensure that no error or fraud occurred.

4        Acknowledgement of Performance: Person performing data processing operations should acknowledge their activities by means of signatures, initial, rubber stamps etc. If invoice calculations have to be closed the checker should initial each invoice. Acknowledgment of performance will not only allow blame to be ascribed but will also have powerful psychological effects on persons that are handling the assignment.

5        Protective Devices: These include safe, locked cash registers and secure premises. They are used not only to safeguard assets physically but also to secure reliable records. He use of safe and the like must be accompanied by procedures for the use of keys.

  1. Formal Transfer of Responsibilities for Goods: When goods pass from one department to another it is essential that the transfer be acknowledge by the use of documents which can be signed e.g goods received notes and stores requisition note.

7        Per-Review: Before an action involving the company’s property is taken, the person concerned should review the documentation made available and make sure that they are adequate. For instance, before a signatory signs a cheque, he should ensure that the authority to effect payment had be given and relevant documents such as invoice, copy order form or L.P.O (local purchase order). Goods received note, are attached to the payment voucher.

8        Post-Review: Completed transaction must be reviewed after they have occurred. This makes it possible to correct any possible error and defect fraud if any.

a        Verification, Review and amendment of the system: All internal control system should incorporate procedures to:

a        Verify that the system is working

b        Review the system to evaluate it’s continued adequacy and appropriateness

c        Amend the system to accommodate new circumstances e.g new production methods, expansion, contraction, new government regulations

2.2.5  MANAGEMENT DUTIES REGARDING INTERNAL CONTROL SYSTEM

The primary responsibility for the maintenance of effective internal control system rests with the management of any enterprises. In addition to their business responsibilities to manage and direct the business affair of any enterprises, management has the fiduciary role in safeguarding the assets of the organization. The management is expected by law to be acting in stewardship capacity concerning the property of the enterprises, which is under their care, custody and controls. The management owns the duty of care, skill and diligence in the discharge of their legally assigned duties. The management has the responsibility to ensure that operations of the enterprises are carried out within the confines of legal provisions and obligations. Management responsibilities are normally discharged by:

2.2.6  THE OBJECTIVES OF INTERNAL CONTROL SYSTEM

Objectives of internal control system according to J.C. Eze (2010) are as follows:

  1. To carry on the business in an orderly and efficient manger.

2        To safeguard assets against fraud and waste

3        To ensure adherence to management policies, safeguards it’s assets, and secure the accuracy and reliability of records.

4        To promote coherency and efficiency in the day to day administration of the business.

5        To ensure orderliness in the execution of duties in the business

2.2.7  INTERNAL AUDIT AS PART OF THE INTERNAL CONTROLS SYSTEM

It will be observed from the definitions of internal control discussed earlier that it encompasses internal audit.

According I.E. Okonkwo (2014) defined internal audit as the independent appraisal of the functions and particularly, the examination of the books of account and other records and the quality of performance of an organization by a special staff of the same organization as integral part of the internal control system.

He went on to state that internal audit should function eeffectively and efficiently to in other to satisfy it’s employee in the area of internal control function for which they are employed.

The APC guideline on internal audit has it as an element of the internal control system set up by the management of an enterprise to examine and evaluate and report on accounting and other controls on operations. It exist either at the instances of the management or in certain circumstance as a result of statutory requirements. The objectives of internal auditor and external auditor are similar except that internal auditors are employees of the organization and are responsible to it’s management. The consequently lack the independence with which the external auditors position is (or should be). The internal audit will increasingly concentrate on its functions as instrument of management while still allowing the annual accounts to be verified before they are accepted by the statutory auditors. Thus, the internal auditor.

  1. Verifies all the multifarious accounting statement produced for management.

b        Examine the accounting methods and principles adopted to prepare them.

c        Investigate the administrative system upon which they are based.

According to Adam R.A. (2005) in this book public sector accounting and finance defined internal audit as an independent appraisal activity within an organization for the review of operations as a service to management; it is a managerial control which function by measuring and evaluating the effectives of the other controls.

2.2.8  INTERNAL CHECK AS PART OF INTERNAL CONTOL SYSTEM

This is component of the internal controls system as earlier mentioned. Ti is defined as the procedure of placing checks on the day to day transactions which is a routine operation whereby the work of the one person is proved independently or is complementary to the work of another the aim being prevention and early detection of errors and fraud. Internal checks advocates that no single person should be allowed to carry out all the operations involve in a transactions from beginning to the end so that no single person would have an executive control over any one transaction or a group of transactions.

2.2.9  INTERNAL CONTROL IN SPECIFIC AREAS FO BUSINESS

According to Mrs F. Dupe Aquaisua (2004) describes the practical application of internal control in specific areas of business in the following areas:

  1. Receipt and payment fo cash

2        Sales

3        Purchases

4        Wages

5        Stock and stores

6        Petty cash transactiosn

Fixed assets

8        Investments

RECEIPT AND PAYMENT FOR CASH

Here should be formal authorizations by board of directors of all new banks accounts and transfer between bank accounts. Incoming letters should be opened by or in the presence of a responsible official. All cheque must be crossed to the company’s bankers and marked ‘not negotiable’ and account payee only. All cheque should be restrictively endorsed upon receipt. Amounts received by cheque where no receipts are issued should be retained and made available to the auditor. All receipts of cash must be banked daily, books containing printed receipts forms must be kept in a safe place by a responsible official

SALES:

The following should be regarded as separate functions:

a        Authorizations of sales by a responsible officials e.g the sales manager.

b        Invoices and debtors statement should not be prepared by those who keep sales ledger they should not also have access to cash books or to stock records.

c        Dispatch of goods to customers should also be separate function.

d        Recording sales and returns

e        Maintaining customers ledger.

There should be adequate control over discounts, writtingoff of bad debts, returns, allowances and price adjustments, collection of over due accounts, verifying control accounts with debtors ledger balances.

PURCHASES:

Officials who authorize the purchase of goods should not be allow to perform physical inspection when the goods arrive, neigher should they authorize the payment for the goods.

Incoming invoices should be checked with the goods received note, and independently with official order. Payment for the goods should be authorized by a responsible official on the basis of the initialed verifictations on the invoice. Those who authorized payment should not be allowed to make entries in the purchase ledger.

WAGES:

Those who pay wages to workers should be different from those who prepare and check wages sheets. Wages sheets should be inspected and signed as correct by managers and foremen, and these officials should attend and watch the actual paying of the wages. After the wages have been paid, the wages sheet should be signed by those actually handle the money to the workers. Any packet not collected should be returned to a responsible officials and not back to the cashier.

STOCK AND STORES:

Accounts should be kept showing the quantities of stocks and stores purchase and the quantities used to enable quantity at hand to be compared with the quantity which is shown to be written up by a person other than the storekeeper and the accounts should not be written up from evidence supplied by the storekeeper. The actual stock taking should be carried out by an independent person.

FIXED ASSETS:

Highly placed officials preferably the board of directors, should be responsible for acquiring fixed assets, there should be a fixed assets register maintained by a responsible officials who should have no access to accounting records of fixed assets. Accounting records should be maintained to control fully depreciated assets. The custody of documents of titles should be separated from those having control of assets. Here should be a periodic. Physical inspection of assets, assets should be properly safeguarded against theft and weather.

 PETTY CASH TRANSACTION

The balance at hand of the petty cashier as shown by his books should be counted at frequent but irregular intervals. Petty cash should be kept on the impress system, under as the cash float. When this amount is spent, the petty cashier is given a cheque or cash to reimburse him for the exact amount he spent, thus bringing his balance at hand to the original round sum.

All monies spent must be dully backed by receipts and payment vouchers. This is to ensure that money spent is properly accounted for.

INVESTMENTS

Investments are very valuable assets and so every precaution should be taken over their safekeeping. The necessary segregation of duties is as follows:

a        Authorization of purchases and sales: This function should be performed by a very senior level of management, possibly the board directors. The responsible should have no concern with cash or the custody of document of title.

b        Maintenance of Investment Register: This should be performed by a clerk who has no access to the documents of title and no responsibility for authorizing purchase or sales. This register should periodically be reconciled with the investment account in the general ledger and the document of title should periodically be vouched. The internal auditors should carry out this work.

C       Maintenance of Records: An independent clerk should be responsible for comparing contract notes with purchase and sales authorization and or ensuring that charge have been correctly calculate. Arrangements should be made for dealing with share transfers, ensuring that share certificates are received / delivered and that bonuses, right issues, capital repayments and dividends or interests are received and properly accounted for.

2.3     SUMMARY OF THE LITERATURE REVIEW

From the current literature review the research was able to find out meaning of internal control which is the measure taken by the management to control and regulate the affairs of the business. The two types of internal control, which includes internal accounting control and administrative or operational control.

The research equally ascertains the essential features of internal control which includes segregation of duties, specific organizational structures, proof measures and acknowledgement of performance. Objectives of internal control was also ascertained. internal audit and internal checks as part of internal control were also discussed.

Finally, internal control which is applied in the specific areas were also discussed such as receipt and payment of cash, sales, purchases, wages, stock and stores, petty cash transactions, fixed assets and investment etc.

THE THEORETICAL FRAME WORK

The theoretical frame work of this research work best discus on the assumption or proposition of the two variable, which is the impact of internal control in the manufacturing organization.

Due to the constant failure of many organization resulting from fraud and also due to lodholes in the accounting system of the organization. Internal control system has remain the bedrock for management efficiency.

More so, from the statement of the problems listed above, the researcher compent on the essentials need of control in the management function and simply defined it as a measure used by management to regulate the affairs of the firms.

The objectives of this research work state the key variables of those research work and the answer to the questionnaire, which is the factors that contribute to the presumed effect. Which the reviewed related literature find answers to the research questions.

The constructed variables that give relevant needs to these study, were group into two which is the independent and dependent variables.

EMPERICAL STUDIES

According to Okonkwo [2003] internal control can simply mean all measure used by management to regulate and control affairs of the business.

According to Mrs. Dupe Aquaisua F. [2004] internal control can be refffered to as the necessary and adequate procedures that can be put in place through which the asset of the organization an be safeguarded.

According to Aguolu O. [2002] defined internal control as the whole system of controls, financial or otherwise, establish by management in order to secure as far as possible the accuracy and reliability of the records run the business in an ordely manner and safeguard the company’s assets, it’s objective being the prevention or early detection of fraud and errors.

According to Okozie B.N [2004] internal control system is the set of accounting and administrative controls and practice that help to ensure that approved and appropriate decisions are made in an organization.

According to the statement of Auditing standards [SAS No1] defined internal control system as one comprising the plan of organization and all of coordinate methods and measures adopted within a business to safeguard it’s assets, check the accuracy and reliability of it’s accopunting data, promote operational efficiency and encourage adherence to prescribed managerial policies.

According to the American institute of certified publication accountants [AICPA] defined internal control as thr policies and procedures established to provide reasonable assurance that an entity’s established objectives will be met.

The statement number one [S no1] of the institute of chartered accountants of England and wales, defined internal control as one consisting of not only internal check and internal audit but the whole sytem of controls, financials or otherwise, established by management in order to carry on the business in an orderly manner.

IDENTIFYING THE GAPS

In the findings, the gaps difference between the reviews of authors is as follows.

I.E. Okonkwo was emphasing on the measures used by the management to regulate and control affairs of the business while the statement of Auditing standards [SAS No1] is emphasing internal control system as one comprising the plan of organization and all of the coordinate methods and measures adopted withing a business to safeguards it’s assets, check the accuracy and reliability of it’s accounting dated, promote operational efficiency and encourage adherence to prescribed managerial policies. Aguolu O. was emphasing on the system of controls. Financial or otherwise, established by management in order to run the business in an orederly manner and safeguard the companys assets. While Okozie B.N is emphasing on set of accounting and administrative controls and practice that help to ensure that approved and appropriate decisions are made in an organization.

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