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EFFECTIVENESS OF INTERNAL CONTROL IN A TRADING COMPANY

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND TO THE STUDY

A trading company is an Enterprise that deals in selling and distribution of goods and services. They buy mostly from the producer/ manufacturer for resale to wholesaler, retailer, and final consumer, depending on stage of chain of distribution it falls. The company and Allied Matter Acts of 1990 requires that trading company should keep records of all financial activities both historical, budgetary and financial records should be internally substantiated through internal audit and further subjected to independent examination by an external auditor. There would not be enough watch-dog for any organization’s financial activities except effective internal control is put in place.

Effective internal control is the checks and balance mechanisms that force the management to be well focused and ensure that the organizational goals are achieved in an effective and efficient manner. If this is not in place the management may decide to do things that benefit their personal interest at the expense of the organization.

Organizations face internal and external forces that call for a strategy to help them continue to be

relevant and competitive in the business environment (Strickland, 2012). The organisations’ ability to meet their objectives with respect to remaining competitive and relevant rests largely on the policies and strategies as well as the effectiveness of procedures established to safeguard their operations (Kaplan, 2012). Originating from the agency theory and buttressed by the contingency theory are internal control systems (ICS) which ensure effective management of resources in addition to effective and efficient operations (Jokipii, 2014). Owing to the changing competitive surroundings, the extent to which ICS of organisations must be extensively structured to safeguard continuous increase in returns has become obvious (Ndungu, 2013).

ICS are systems made up of procedures and policies that help to safeguard a company’s assets, provide trustworthy financial reporting, enhance compliance with rules and regulations and achieve efficient and effective operations (Omani-Antwi, 2014). These systems of procedures and policies, according to Gray and Manson (2016) are usually associated with internal and external communication processes of an organisation, as well as procedures for managing corporate finance, the preparation of accurate and reliable financial reports on a timely manner, and the maintenance of inventory records and properties.

The framework for internal control systems developed by the Committee of Sponsoring Organization of Treadway Commission (COSO) argue that every sound system of internal control must have five components namely: control environment, risk assessment, control activities, information and communication and monitoring of internal control (COSO, 2009).

According to Pickett (2015), these components interact among each other, forming an integrated system that reacts dynamically to changing conditions. In essence, the ICS is intertwined with

the entity’s operating activities and is fundamental to the successful operation of the enterprise (Steinberg, 2016).

Theoretically, the positive association between the variables of internal control systems and performance is firmly grounded in the agency theory. As advocated by Sharma (2002), the agency theory is based on the assumption of separation of ownership and control wherein managers are autonomous and are likely to increase their personal gains at the expense of owners. For this reason, the agency theory stresses that in order to align managers‟ interests with those of the organization, firms implement management control systems, which consist of various control mechanisms, including, monitoring systems, and internal controls to resolve goal conflicts (Zimmerman, 2016).

The proponents of the contingency theory, on the other hand, posit that the best way to organize a firm is contingent on the environment in which it functions (Richard, 2007). Thus according to the contingency theory, a company would achieve its goals when it is organized based on the environment in which it relates (Richard, 2008). Consistent with COSO (2009), the contingency theory claims that different kinds of controls should be put in place to accomplish different objectives while considering the business environment so as to achieve performance targets (Chenhall, 2008; Jokipii, 2014; Luft & Shields, 2008).

From the empirical perspective, the positive relationship between the COSO internal control systems variables and performance is not quite clear. Muraleetharan (2016) posits that internal control-performance relationship is influenced by some but not all of the internal control systems variables. According to Muraleetharan, risk assessment, control activities as well as monitoring

of the COSO framework for internal control variables influence the positive link, while the relationship using control environment and information and communication fails to lend itself to prediction. On the contrary, results from Njeri (2014) have revealed that all elements except information and communication of the COSO framework of internal control systems predict the positive relationship.

To augment the findings of Muraleetharan (2016) and Njeri (2014), results from Europe on the study of enterprise risk management and performance have shown a negative relationship between high levels of enterprise risk management and performance (Eikenhout, 2015). Per these findings, the relationship between the elements of internal control and performance is not quite clear. To add to the foregoing discussion, the literature on ICS lacks studies on the conditions of ICS and performance as well as differences in the components of internal control systems.

Performance measures have been viewed from several perspectives by academic and professional researchers. Bourne et al, (2008) define performance measurement as metrics used

to quantify and compute an action’s efficiency and effectiveness. Performance assessment, according to Smith (2010), could be financial or non-financial. Financial performance measures are those which use financial performance indicators such as profit margin, return on assets and return on equity in measuring organisational performance. Non-financial performance measures, on the other hand, rely on performance indicators that are non-financial such as quality of service, resource utilisation, innovation and competitive performance (Epstein, & Manzoni, 2015).

Globally, ICS are important to the performance of the insurance industry since they play critical roles in any economy (Committee of European Insurance and Occupational Pensions Supervisors [CEIOPS], 2008). In view of its significance in insurance undertakings, the Conference of European Insurance Supervisors (CEIS) agreed, during its 118th Session, to create a working group with the task of bringing into being a framework on ICS for the insurance sector (CEIOPS, 2008). To argue further, the inspection manual of the Japanese Insurance Authority [JIA] (2017) also maintains that directors must develop a befitting system to secure the sound and appropriate

management of the insurance company’s business. This means that ICS are paramount to the performance of the insurance industry in the global world.

The success of the administration of the trading company will go a long way in determining the success of the whole organization. The success of the administration is a function the attitude of the management team or on the alternative, on the checks and balances mechanism put in place as watch dog to the management. Therefore, there is need to test and know if the internal control in the company is being allowed to be effective or not.

1.2 STATEMENT OF THE PROBLEM

Most of the trading companies in Nigeria look like well-nourished children but with indwelt like tape worms. One would expect that notable improvement and development will be the main features of the trading companies considering the available large markets in Nigeria, but this is not so, non-availability of needed infrastructures in the country, high degree of corrupt practices at all levels of the management, lack of information and lack of trust are obstacles that mitigate against success of trading organisation. Against this backdrop, holistic study of the trading company administration is deemed necessary; a good start will be on the “checks and balances” mechanism that is effective internal control put in place.

In the ambiance of the globalization of business operations and the increasing use of information technologies, complexities of business transactions, and business risk, the role of internal

controls as a corporate governance mechanism is becoming increasingly important (Jovanović &

Ljubisavljević, 2016). This is because in one of the earliest contributions, Bastia (2013) maintained that the management of the complexities following globalization increased the need for adequate internal control systems which in turn control risks as well as pursue business performance.

1.3 OBJECTIVE OF THE STUDY

The general objective of this study was to examine the effectiveness of internal control in a trading company. Specifically, the study sought to:

Assess the condition of internal control systems and performance of the Nigeria trading company.

Investigate whether there are significant differences in the internal control systems in the Nigerian trading company.

Examine the effect of internal control systems on performance of the Nigeria trading company.

1.4 RESEARCH QUESTIONS

The following research questions are set to achieve the objectives of the study.

What are the conditions of internal control systems and performance of the Nigerian trading company?

What are the significant differences in the internal control systems in the Nigerian trading company?

What are the effect of internal control systems on performance of the Nigeria trading company?

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