INTERNAL CONTROL SYSTEM AS A TOOL FOR EFFICIENCY IN THE MANAGEMENT OF SMALL AND MEDIUM SCALE ENTERPRISES IN ILORIN.

CHAPTER ONE

INTRODUCTION

1.1 Background to the Study

The concept of internal control is said to trace its history back to the beginning of the 20th century when audit on financial statements came into being, it has consistently evolved to what it is presently due to continuous change in the business environment (Heier, Dogan and Sayers, 2005). The expansion of the world economy and the scale of enterprises growth after the turn of the century brought about major challenges in management leading to adoption of control systems that encompassed the entire enterprise. Xiaofang and HuiliIn (n.d) cited that in 1992, the US Committee of Sponsoring Organizations (COSO) promoted the concept and elements of internal control in its report ‘Internal Control- Integrated Framework’. COSO published ‘ERM-IF’ in 2004, and made the internal control and enterprise management closely integrated by breaking the previous limitations of internal control.

Teketel and Berhanu (2009) made it known that small and medium enterprise (SMEs) constitute currently the major part of economic activities in the world. Nowadays, they represent about 99% of all types of enterprises on the globe and provide high job opportunities to its labour force. Similarly, Ashamu (2014) indicated that micro and small businesses are believed to be the engine room for the development of any economy because they form the bulk of business activities in a growing economy like that of Nigeria.

Jiang (2010) made it known that SMEs are very important force for economic and social development. They play an important part in increasing national income, providing tax revenue and jobs. However, with the development of SMEs, their internal problems are gradually exposed, especially in the financial crisis of 2008, a large number of small and medium enterprises closed down, the reason is: the construction of internal control deficiency of SMEs. 

A system of effective internal controls is a critical component of SME management and a foundation for the safe and sound operation of organizations. A system of strong internal controls can help to ensure that the goals and objectives of an SME will be met, that the business will achieve long-term profitability targets and maintain reliable financial and managerial reporting. Such a system can also help to ensure that the SME will comply with laws and regulations as well as policies, plans, internal rules and procedures, and decrease the risk of unexpected losses or damage to the business.

Ishola, Abikoye and Olajide (2015) posited that retail business in which customer have direct access to small product can also benefit enormously from internal control procedure while internal control are crucial from helping you detect dishonesty, it can also help you to reduce risk that simple mistake will keep you from seeing in your organization, concentrate on poverty as detected inadvertent errors, so setting up a system of internal control can keep such problem from getting out of hand. When you have internal control in place, you are protecting your assets as well as the accuracy of the accounting record in proper place of accountability. The type of control to put in place depend largely on the size and nature of the organization i.e. either a private or public sector as in the content of these studies lies on a public sector organization.

According to Chukwu (2012), for an organisation to carry out its business there must be some resources put in place for the smooth running of the organisation like, materials. machines, money etc. These need to be well co-ordinated in order for the success of the organisation to be achieved. These factors are used by a group of persons known as management. Management can neither exist without an organisation as both are inseparable. The system of internal control therefore provides assurances to management on the dependability of the accounting data used in the decision making of the organisation.

1.2 Statement of Problem

Due to the business scale, human resource, financial and its own conditions etc. many SMEs are unwilling to establish the standard internal control system. They believe that establishing internal control system is a high cost method, which will bring heavy burden to the enterprise and maybe without significant results cannot compare with the managers manage all aspects of business directly. Even the SMEs with an established internal control system tend to shy away from monitoring the system as they are of the illusion that the system is working efficiently and optimum benefits is derived from this system. It is against this backdrop this research tend to examine internal control systems established in SMEs as a tool for efficiency in the management of SMEs.

1.3 Research Questions

Based on the problems identified above, the following research questions were raised for this study;

i) What is the relationship between efficient internal control system in SMEs and their overall performance?

ii) Is high cost of operating an internal control system a major reason many SMEs don’t adopt it?

iii) Is internal control system an efficient tool in the management of SMEs?

1.4 Objectives of the Study

The main objective of this study is to ascertain the efficiency of internal control system as a tool for the management of SMEs. However, the specific objectives are to;

i) Establish the relationship that exists between efficient internal control system and the overall performance of SMEs.

ii) Determine whether high cost of operating internal control system is a major reason most SMEs don’t adopt internal control system.

iii) Ascertain if internal control system is an efficient tool in the management of SMEs.

1.5 Hypotheses of the Study

Based on the research questions, the following null hypotheses were formulated.

i) There is no significant relationship between internal control system and the overall performance of SMEs.

ii) High cost is not a major reason SMEs don’t adopt internal control system.

iii) Internal control system is not an efficient tool in the management of SMEs.

1.6 Justification of the Study

Quite a number of research have been carried out in relation to this topic such as Cheruiyot (2014) who carried out a second degree research on effectiveness of internal control systems in safeguarding inventory. In the same vein, Shanmugam, Haat and Ali (2012) examined the impact of internal control on the performance of small and medium enterprises. However, little researchers have sought to examine internal control as a tool of efficient management which will distinguish this research from other studies. This study tends to be very beneficial to a very wide range of stakeholders such as small businesses, medium businesses as well as even large businesses. One need not be told the indirect stakeholders of the outcome of this topic, the Nigerian economy as a whole as it has been observed that SMEs account for over 90% of the businesses in Nigeria.

1.7 Scope of the Study

This research, due to some factors such as funds, time, proximity as well as academic workload, will not be able to encompass all SMEs operating in Nigeria. This study is limited to SMEs operating in Kwara state in which the Ministry of Industry and Solid Minerals Development (2012) put the registered number of SMEs operating in the state at 207 in various sectors ranging from manufacturing, food processing, pharmaceutical, poultry, animal rearing and fabricators. This study will therefore cut across all sectors so as to be able to make appropriate generalizations about the population later in this study.

1.8 Definition of Terms

Small and Medium Scale Enterprises (SMEs): The Central Bank of Nigeria defined Small and Medium Scale Enterprises in according to asset base and in number of staff employed. The criteria are an asset base of ₦5Million and ₦500Million and a staff strength base of 20 to 300 employees.

Audit: This is an independent examination and expression of opinion of the financial statement of an enterprise by an appointed auditor in pursuance of that appointment and in compliance with statutory requirements and professional obligation.

Internal Auditor: By contrast to the external auditor, the internal auditor is an employee of the SME with the major task of advising management on whether its major operations have sound systems of risk management and internal controls (Putra, 2008).

Internal Control System: The Internal Control System refers to an organized amalgamation of functions and procedures, within a complete system of controls established by the management and whose purpose is the successful function of the business (Cheung 1997).

Small Business Performance: Enterprise performance implies attributes that show changes in volumes of activities or physical size. It indicates the enterprises ability to prevail. When these changes are increasing the performance is generally positive. These attributes include profitability, productivity, employment levels and expansion in physical facilities.

Micro and Small Business: According to Babajide (2011), the MSE nomenclature is used to mean Micro and Small Enterprises. It is sometimes referred to as micro, small and medium enterprises (MSMEs). A small business is any business that is independently owned and managed, started with little capital and is being operated using a few number of employees to produce goods and services to satisfy the needs of the local community for profit.

Management: It is defined as the process of planning, organizing, coordinating and con trolling the activities of an organization. It is seen as a group of people who monitor and control the organization’s activities towards the achievement of the organization’s objectives.

1.9 Plan of the Study

This research comprise five chapters in which chapter one is the introduction. In this chapter, the background to the study and the statement of problem is featured as well as the research questions, objectives and hypotheses. The chapter one also contain the significance of this study and lastly, some of the terms used are defined. The chapter, literature review is the conceptual framework, the theoretical background as well as the empirical evidence. The methodology for the study is conveyed in the third chapter. In this chapter, the research design, the population and sample size, the method of data collection, and data analysis were stated. The penultimate chapter, chapter four, is the data analysis as well as its interpretation while the last chapter is the summary, conclusion and recommendations. In this chapter, suggestions for further research was indicated.