Internal Controls and Organizational Performance
INTERNAL CONTROLS AND ORGANIZATIONAL PERFORMANCE:
A CASE OF MEDIPONT INDUSTRIES LIMITED
BY
OCHOGE JOHN
05/U/9462/EXT
SUPERVISOR
MR. NZIBONERA ERIC
A RESEARCH REPORT SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF THE DEGREE OF
BACHELOR OF COMMERCE OF
MAKERERE UNIVERSITY
JUNE 2011
1
DECLARATION
I, Ochoge John, declare that this research report is my original work. It has not been submitted to any other university or higher institution for any award and where it is indebted to work of others, due acknowledgement has been made.
Signature…………………………Date:………………………..
OCHOGE JOHN
05/U/9462/EXT
APPROVAL
I hereby certify that this work entitled “Internal controls and organizational performance: a case of Medipont Industries Limited” has been submitted with my approval for examination as a university supervisor.
Signature……………………………………. Date ……………………..
MR. NZIBONERA ERIC
UNIVERSITY SUPERVISOR
DEDICATION
This piece of work is dedicated to my father, mother, wife and children.
ACKNOWLEDGEMENT
I truly thank God for the gift of good health and friends. My sincere heart appreciation goes to my supervisor Mr. Nzibonera Eric for the guidance and encouragement up to this stage of submission. My lecturers for academic encouragement and guidance. Fellow students for moral, academic support and encouragement. To my respondents of this study, please thank you for the cooperation during my interactions with you. Sincere appreciation to all relatives and friends especially Mr. Obbo Israel Ochieng of KPMG and family. May God bless you all.
TABLE OF CONTENTS
DECLARATION
APPROVAL
DEDICATION
ACKNOWLEDGEMENT
TABLE OF CONTENTS
LIST OF FIGURE
LIST OF TABLES
ABSTRACT
CHAPTER ONE
1.0 Introduction
1.1 Background to the study
1.2 Statement of the problem
1.3 Purpose of the study
1.4 Objective of the study
1.5 Research questions
1.6 Scope
1.7 Significance of the study
CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
2.1 Definition and understanding of internal controls
2.2 Internal Control Systems
2.3 Elements of internal controls
2.4 Organizational performance
2.5 Relationship between internal control and organizational performance
CHAPTER THREE
METHODOLOGY
3.1 Introduction
3.2 Research design
3.3 Study population
3.4 Sampling design
3.5Sampling size
3.6 Sources of data collection
3.7 Instruments of data collection
3.8 Data processing, analysis and presentation
3.8.1 Data processing
3.8.2 Data Presentation and Analysis
3.9 Limitations of the study
CHAPTER FOUR
DISCUSSION AND INTERPRETATION OF FINDINGS
4.1Introduction
4.2Findings on general information
4.3 Findings on the effectiveness of internal controls used in Medipoint Industries Limited
4.4 Findings on the level of performance in Medipoint Industries Limited
4.5Findings on the relationship between internal control and organizational performance at Medipoint Industries Limited.
CHAPTER FIVE
DISCUSSION, CONCLUSION AND RECOMMENDATIONS OF FINDINGS
5.1 Introduction
5.2 Discussion of major findings.
5.3 Conclusion
5.4 Recommendations
5.5 Areas for further research
REFERENCES
APPENDIX 1
R.V. KREJCIE AND D. W. MORGAN (1970) SAMPLE SIZE ESTIMATION TABLE
APPENDIX 1
QUESTIONNAIRE
LIST OF FIGURE
Figure 1: Gender of respondents
Figure 2: Marital status of respondents
Figure 3: Age of respondents
Figure 4: Education level of respondents
LIST OF TABLES
Table 1: Gender of respondents
Table 2: Marital status of respondents
Table 3: Age of respondents
Table 4: Education level
Table 5: Length of service
Table 6: Responses on whether there are adequate asset listings done by management
Table 7: Responses on whether procedures in place ensure asset additions, disposal, replacement and transfers for proper accountability
Table 8: Responses on whether capital assets purchased are approved by appropriate level of management
Table 9: Responses on whether asset numbering is done to show location and protection of the assets
Table 10: Responses on whether there is free access to cheque books and organization assets
Table 11: Responses on whether a person responsible for inventory management is different from the bookkeeper
Table 12: Responses on whether stock taking is done following the procedures and in the presence of the internal auditor
Table 13: Responses on whether the petty cashier is different from the main cashier
Table 14: Responses on whether there are adequate policies to ensure effective collection and follow ups of due accounts
Table 15: Responses on whether cost of production has been reducing dramatically for the past two years
Table 16: Responses on whether the company is now in a better position to serve clients more efficiently and effectively
Table 17: Responses on whether effectiveness is measured through quality services and products
Table 18: Responses on whether the company is able to build customer satisfaction through quality products and services
Table 19: Responses on whether performance of the company results from assets finance, employee skills and processes involved in production
Table 20: Responses on whether there is evaluation and discussion of the organizational performance annually by management
Table 21: Responses on whether stock outs increases the cost of production
Table 22: Correlations
ABSTRACT
The study sought to establish a relationship between internal control and organizational performance of Medipoint Industries Limited. The study objectives were; to examine the effectiveness of internal controls used in Medipoint Industries Limited, to establish the level of performance in Medipoint Industries Limited and to establish a relationship between internal control and performance in Medipoint Industries Limited.
A cross sectional survey was used in the course of the study. Both qualitative and quantitative data was gathered in order to establish the relationship between the independent and dependent variables, so as to examine how internal controls are used in Medipoint Industries Limited and therefore account for the performance levels. The study comprised of 30 employees and 20 customers of Medipoint Industries Limited. Simple random approach was used during the study. Purposive sampling was also used to select only respondents for the researcher to attain the purpose of the study. Data was collected using both primary and secondary sources. After collecting data, the researcher organized well-answered questionnaire, data was edited and sorted for the next stage. The data was presented in tabular form, pie charts and bar graphs with frequencies and percentages. The researcher used Statistical Package for Social Sciences (SPSS) to analyze the relationship between the variables under study.
It was concluded; the study findings indicated that the internal controls used in Medipoint Industries Limited were ineffective and unsatisfactory, the level of organizational performance was found to be inadequate and a significant positive relationship between internal controls and organizational performance was established to exist. It was recommended that; management of Medipoint Industries Limited should design effective internal control systems through ensuring that adequate asset listings is done by management, capital assets purchased are approved by appropriate level of management and asset numbering is done to show location and protection of the assets; management ensures that it strengthens strategies aimed at improving organizational performance in all categories of staff; management should appreciate the findings in the relationship between internal controls and organizational performance to ensure its continued production in a competitive industry in Uganda.
1
CHAPTER ONE
1.0 Introduction
This chapter presents the background of the study, problem statement, purpose, objectives, research questions, scope, and significance of the study and structure of the report.
1.1 Background to the study
Internal controls are put in place to keep organization on course towards profitability goals and achievement of its mission and to minimize surprise along the way. They enable management to deal with rapidly changing economic and competitive environment, shifting customer demands and priorities and restructuring for future growth. Internal controls promote efficiency, reduce risks of asset loss and help to ensure the reliability of financial statements and compliance with laws and regulations (Coso, 1992).
Because internal controls services many component purposes, there are increasing calls for better internal control systems; internal control is looked upon more and more as a solution to a variety of potential problems (Coso 1992). According to Chambers (1995), Cosserat (1999), Ridley and Chambers (1998) internal controls are systems comprising of the control environment and control procedures. They further state that the internal control systems includes all the policies and procedures adopted by the directors and management of an entity to assist in achieving their objective of efficient conduct of its business, including adherence to internal policies, the safeguarding of assets, the prevention and detection of fraud and error, the accuracy and completion of the accounting records and timely preparation of reliable financial information. Successful organizations ensure that they attain and consolidate continued survival in a competitive environment Drucker (1999). Thus successful organizations set performance measures that focus attention that identifies and communicates the success, support organization learning and provide a basis for assessment and reward (Brown, 1996).
Organizational performance is measured in terms of customer satisfaction, through reduced customer complaints (Kloot, 1999). In order to be able to perform organizations should critically look at customers and all stakeholders in business and know how best they are satisfying their needs. Kloot adds that organizations should continuously improve their services through assets accumulation, create value, improved quality services and flexibility internal control system is intervened with organizations operating activities and it is most effective when controls are built into the organizations infrastructure becoming part of the very essence of the organizations success in terms of continued improvement on performance standards as part of the competitive advantage of the organization.
However, the performance of Medipoint Industries Limited seems to be declining. The stakeholders are increasingly complaining on the stagnant asset accumulation, inadequate staff members especially in the accounts department low quality services provided by Equity bank, Wandegeya branch to mention but a few Medipoint Industries Limited annual report (2009/10).
1.2 Statement of the problem
Despite of the important role played by internal controls in organizations, Medipoint Industries Limited is experiencing low levels of performance, in terms of low levels of innovations, slow asset accumulation, inefficiency and fraud cases (Annual report, 2009/2010). The unsatisfactory performance could be attributed to weak internal control systems used by Medipoint Industries Limited.
1.3 Purpose of the study
The study sought to establish a relationship between internal control and organizational performance of Medipoint Industries Limited.
1.4 Objective of the study
- To examine the effectiveness of internal controls used in Medipoint Industries Limited.
- To establish the level of performance in Medipoint Industries Limited.
- To establish a relationship between internal control and performance in Medipoint Industries Limited.
1.5 Research questions
- How effective are internal controls in Medipoint Industries Limited?
- What is the level of performance in Medipoint Industries Limited?
- What is the relationship between internal control and performance in Medipoint Industries Limited?
1.6 Scope
1.6.1 Subject scope
The study was confined on internal control as an independent variable and the effectiveness was measured basing on control environment, control activities, information and communication flow; competence with the laws and regulations toward monitoring of operations, performance of Medipoint Industries Limited departments was the dependent variable and it was measured basing on asset accumulation efficiency, improved quality service increased innovations and flexibility.
1.6.2 Geographical scope
The study was conducted at Medipoint Industries Limited Kampala.
1.7 Significance of the study
(i) The study will enrich the researcher’s knowledge on the variables under study and help the researcher fulfill the requirements that lead to the award of the degree of Bachelor of commerce from Makerere University.
(ii) The study results will be useful to management, board of governors, and all stakeholders of Medipoint Industries Limited specifically they will use findings from the study to redesign policies aimed at improving on the levels of performance.
(iii) Findings will also be available for reference by academicians, researchers who seek to conduct further research in any of the variable under this study.
CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
This chapter provides a critical review of related literature on the study variables, definition and understanding of internal controls, Internal Control Systems, earlier studies on internal control elements, common weaknesses of internal control systems, determinants of internal control strength and components of an internal control system, it also discusses a link between the variables of this study.
2.1 Definition and understanding of internal controls
Internal control is a process effected by an entity’s board of directors management and other persons designed to provide reasonable assurance regarding the achievements of objectives in the following categories; efficiency and effectiveness of operations, reliability of financial reporting and compliance with applicable laws and regulations (Lower, 1998). The first category addresses an entity’s basic objectives, including performance and progressing goals and safeguarding of resources. The second category relates to preparations of reliable published financial statements. The third deals with complying with the laws and regulations to which the entity is subject to.
Internal Controls (IC) are to be an integral part of any organization's financial and business policies and procedures. They are adopted by management to ensure that the organization conducts business in an orderly and efficient manner (KPMG Forensic, 2004). Consequently Knechel et al (2007) argues that they provide the framework through which management uses the resources at its disposal to achieve the organization's goals. According to Romanian banking literature, internal controls consists of couple of measures at management's disposal intended to ensure the organizations proper functioning, correct management of its assets and liabilities and true recording in accounting evidences.
A broader definition provided by Furrugia (2002) views IC as the plan of organization and the coordinated procedures used within an entity to; safeguard its assets from loss by fraud or errors, check the accuracy and reliability of accounting data which management uses in decision making, and promotion of operational efficiency and encourage adherence to adopted policies in those areas in which the accounting and financial departments have direct or indirect responsibilities.
Chamsers (1995), Cosserat (1999), Ridley and Chambers (1998) defined internal control systems as comprising of the internal control environment and control of procedures. They further state that the internal control systems includes all the policies and procedures (internal controls) adopted by the directors and management of an entity to assist in achieving their objective of ensuring as far as practicable, the orderly and efficient conduct of the business, including allowance to internal policies, the safe guarding of assets, the prevention and detecting of fraud and error, the accuracy and completeness of the accounting records and timely preparation of reliable financial information.
The control environment sets the tone of an organization influencing the control cautiousness of its people (Gauthoier, 1996). It is a foundation for all other components of internal control providing discipline and structure. Effectively controlled entities strike to have competent people, instill an enterprise wide atitude of integrity and control consciousness, and set a positive tone at the top (Tener, 1993). They establish appropriate policies and procedures often including a written code of conduct which foster shared values and teamwork in pursuit of the entity’s objectives (Mautz and Wijan 1981).
In evaluating the effectiveness of the internal control environments, Coopers and Lybraud (1993) argued that there was need to consider whether the following control objectives are met; management conveys the message that integrity and ethical cannot be compromised, the organization structure provides a moral framework for planning, directing, and controlling operations, management ensures that appropriate responsibility and delegation of authority is assigned to deal with goals and objectives and the Board of Directors and audit committee are sufficiently independent from management to construct a challenge to management decision and take an active role in ensuring that an appropriate “tone at the top exists”.
Control activities are policies and procedures that help ensure that management directives are carried out. They help ensure that necessary activities are taken to address risks to achievements of the entity’s objectives. Control activities occur throughout the organization at all levels and all functions (Junner, 1993). They include arrange of activities; authorization, verifications, reconciliations, review of operating performance security of assets and segregation of duties (Ernst and Yong, 1995).
Information flow is essential to effecting control, information about an organization’s plan, control environment, risks, control activities and performance must be communicated up, and access an organization (Ruttrman Working Group, 1994). Reliable and relevant information flow both internal and external sources must be identified, captured, processed and communicated to the people who need it in a form and time frame that is useful (Chambers 1995). Information systems produce reports, containing operational financial and compliance – related information that makes it possible to run and control an organization (Coseo, 1992).
2.2 Internal Control Systems
The traditional accounting professional definition of internal control hinged on financial reporting and compliance aspect of control, however COSO, (1994) describes internal control system as a process involving board of directors, management, and other personnel created as a means of ensuring that the organization’s objectives can be achieved. The objectives are categorized as; effectiveness and efficiency of operations, reliability of financial reporting, compliance with the relevant laws and regulations. According to the Australian Auditing Standard AUS 402 (ISA 400), control environment is distinguished from control procedure in that the former represents the general management attitude, awareness and actions as far as it concerns internal control whereas the later refers to what management has put in place as guidelines to control information and transaction procedure so as to achieve the organization’s objectives.
Since organizations differ in management philosophy, structure and size the wider outlook of control elements will always reflect the above differences, (COSO, 1994). Organizational culture determines control through self-discipline and internal monitoring (Ezzamel et al., 1997). According to COCO (1995), ‘top down, command and controlled’ organizations emphasize formal controls while those that are down sized and empowered will adopt informal controls.