THE EFFECT OF INTERNAL CONTROL ON FINANCIAL PERFORMANCE

CHAPTER ONE

1.0 INTRODUCTION.

This chapter presents the background of the study, statement of problem, purpose, objectives, specific objective of the study, research questions, scope, and significance of the study about the internal controls and performance of public sector organization in Hargeisa Somaliland.

Background

Internal control as individual enterprise system is not as broad as other management spheres in science directions. The definition of internal control was presented for the first time in 1949 by the American Institute of Certificated public Accountants (AICPA). It defined internal control as a plan and other coordinated means and ways by the enterprise to keep safe its assets, check the covertness and reliability of data, to increase its effectiveness and to ensure the settled management politics. However, the presented definition of control concept has been constantly improved, and nowadays there is quite an extensive set of conceptions that indicates the system of internal control as one of the means of leadership to ensure safety of enterprise assets and its regular development. In 1992, its analysis distinguished the concepts of risk and internal control. Now, the concept of internal control involved not only accounting mistakes and implementing means of their prevention, but also a modern attitude that might identify the spheres of control management and processes, and also a motivated development of their detailed analysis (COSO 1992).

At the organizational level, internal control objectives relate to the reliability of financial reporting, timely feedback on the achievement of operational or strategic goals, and compliance with laws and regulations. At the specific transaction level, internal control refers to the actions taken to achieve a specific objective (e.g., how to ensure the organization's payments to third parties are for valid services rendered.) Internal control procedures (Anderson, 2008).

As defined in accounting and auditing, is a process for assuring achievement of an organization's objectives in operational effectiveness and efficiency, reliable financial reporting, and compliance with laws, regulations and policies. A broad concept, internal control involves everything that controls risks to an organization. (sawyer’s 2012).

Internal controls refer to the measures instituted by an organization so as to ensure attainment of the entity’s objectives, goals and missions. They are a set of policies and procedures adopted by an entity in ensuring that an organization’s transactions are processed in the appropriate manner to avoid waste, theft and misuse of organization resources. Internal Controls are processes

Designed and effected by those charged with governance,(Ssuuna 2009).

Internal control can provide reasonable, not absolute, assurance that the objectives of an organization will be met. The concept of reasonable assurance implies a high degree of assurance, constrained by the costs and benefits of establishing incremental control procedures.

Effective internal control implies the organization generates reliable financial reporting and substantially complies with the laws and regulations that apply to it. However, whether an organization achieves operational and strategic objectives may depend on factors outside the enterprise, such as competition or technological innovation. These factors are outside the scope of internal control; therefore, effective internal control provides only timely information or feedback on progress towards the achievement of operational and strategic objectives, but cannot guarantee their achievement (COSO 2009)

According to ISSAI (1992).Internal control is an integral process that is affected by an entity’s management and personnel and is designed to address risks and to provide reasonable assurance that in pursuit of the entity’s mission, the following general objectives are being achieved:

executing orderly, ethical, economical, efficient and effective operations;

fulfilling accountability obligations;

complying with applicable laws and regulations;

Safeguarding resources against loss, misuse and damage.

Internal control is a dynamic integral process that is continuously adapting to the changes an organization is facing. 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.

Internal control is not one event or circumstance, but a series of actions that permeate an entity's activities. These actions occur throughout an entity’s operations on an ongoing basis. They are pervasive and inherent in the way management runs the organization. Internal control is therefore different from the perspective of some observers who view it as something added on to an entity's activities, or as a necessary burden.

The internal control system is intertwined with an entity's activities and is most effective when it is built into the entity's infrastructure and is an integral part of the essence of the organization.

Internal control should be built in rather than built on. By building in internal control, it becomes part of an integrated with the basic management processes of planning; executing and monitoring Built in internal control also has important implications for cost containment.

Adding new control procedures that are separate from existing procedures adds costs. By focusing on existing operations and their contribution to effective internal control, and by integrating controls into basic operating activities, an organization often can avoid unnecessary procedures and costs. (COSO 2009).

All staff members should be responsible for reporting problems of operations, monitoring and improving their performance, and monitoring non-compliance with the corporate policies and various professional codes, or violations of policies, standards, practices and procedures. Their particular responsibilities should be documented in their individual personnel files. In performance management activities they take part in all compliance and performance data collection and processing activities as they are part of various organizational units and may also be responsible for various compliance and operational-related activities of the organization.

Staff and junior managers may be involved in evaluating the controls within their own organizational unit using a control self-assessment. (COSO 2009).

The local government financial management practices were a very old fashioned manual system – and often an erroneous one. The financial situation of a district often depends on its status and grade. In Somaliland, districts are administratively divided into Grade 4A, B, C and D which constitutes substantial fiscal disparities Grade A districts are always in a better fiscal state. The main sources of income for local governments include vendors’ tax, business licenses, property tax, rental incomes, and fees charged on the usage of local governments’ properties such as slaughterhouses. According to the proposed Roadmap on Municipal Finance Policy, prepared by UN‐HABITAT, revenue available to municipalities for financing their expenditure functions primarily comprises 19 sources. But most of the revenue comes actually from about 5six sources only (Proposed Municipal Finance Policy)PMFP (Adan 2012).

In Somaliland, The process of strengthening of the Public Internal Financial Control system has been started in 2010 and it is conducting throw development and applying of the principles of decentralized responsibility of the management and establishing functionally independent internal audit. The aim of this process is establishing system which will guarantee reasonable spending of the public funds. Internal Financial Control (PIFC) represents fully consolidated management, monitoring, control and audit system for the national public funds. The Public Internal Financial Control system is composed of the following: 

 (1) Financial Management and Control system; 

 (2) Internal Audit; and (3) Harmonization of internal control and internal audit. 

Problem statement.

Every organization needs strong internal control mechanisms such as authorization of access to assets and accounting records, regular independent verifications, a system of internal checks (segregation of duties), suitable documents to capture transactions, proper procedures for processing transactions, employment of honest and capable employees.

 Despite the fact that such control measures have been put in place by management, finances have continued being mismanaged in local government Hargeisa.

This is probably being caused by weaken impact internal controls. E.g. staff colluding internally or with outsiders to circumvent the controls, the impact internal controls covering only routine transactions, abuse of controls by those with authority.

The absence of adequate internal control measures exposes the financial management of an organization to certain threats such as:

- Stealing and miss-management of organizational vital documents which may be done by an employee to take undue advantage. And loss of the organizations assets. To make incorrect financial statement.

Internal controls represent the specific policies the public sector, manager and employees must follow in the activity. Internal control systems have a few weaknesses in Somaliland that the managers of public sectors must be solution. So that the problem is the study how can improve the system to get good performance employees.

1.3 Purpose of the study.

To examined the effect of internal control on the financial performance of public sector in Hargeisa local government Somaliland.

 1.4 The specific Objectives of the study.

a) To examine the level of internal controls in Hargeisa local government, Somaliland

b) To identify the level of public financial performance in Hargeisa local government, Somaliland

c) To find out possible studies to the challenge facing public financial performance in Hargeisa local government 

1.5 Research Questions

What is the Level of internal financial control in Hargeisa Local Government, Somaliland?

What is the level of public financial performance in Hargeisa Local Government, Somaliland?

How to find out possible studios to the challenge facing public financial performance in Hargeisa local government.

1.6Scope of the study

Content scope: The role of Local government has been considered crucial in terms of its contribution to the internal financial control and public sector performance. The purpose of this research is to evaluate the effect of internal control on public financial performance in Hargeisa local government.  

1.6.1 Geographical scope

The geographical scope of the study was conducted   hargeisa local government, Somaliland which is located in hargeisa city.This study is confined to internal financial control at Local government in hargeisa city, where the sample data was collected. Specifically, the study focuses on the internal financial control and the public sector performance.This study considered the management and staff at hargeisa local government, Somaliland plus people that was selected from the public who were assumed to be the customers.

1.6.3 Time scope

The study was covered a period of four months from (June to September) and would mainly consider information related to (2014) because this is the time when a local government experienced the problem poor internal financial control and poor public sector performance.

1.6.4 Theoretical scope

This study will be based control theory developed by W.M. Wonham in 1974.

1.7. Significance of the Study

The researcher may hope that this study will yield data and information that may be useful for understanding the contribution of ministry of finance to internal financial control in hargeisa. The findings and the recommendations of this study may be useful for the community and decision makers at ministry of finance, or Hargeisa local government in Somaliland. 

The research may be of great importance to various groups of people like to the current researcher, policy makers, and future researchers.

The Study may be important because it will contribute to the researcher’s fulfillment of requirements for the award of Degree in public administration and management.

1.8 Description of the study area.

This research was conducted at People’s local government work the target the head office and four branches in the local government located within in Hargeisa municipality, this is for the purpose of assessing whether the internal controls system (control environment, internal control activities, and risk management) operated within the local government.