Abstract

This project titled the effects of the internal control system in detecting and preventing fraud in SMEs Buea, specifically the main objective of this study was to investigate the effects of internal control system in detecting and preventing fraud in SMEs. The investigation was further broken down into assessing the effect of control environment and activities on the level of fraud prevention and detection in SMEs, to determining the effect of information on the level of fraud prevention and detection in SMEs Buea.

This was to understand the variables of internal control in detecting and preventing fraud that affects SMEs in Buea which are: control environment and information. Explanatory research design was implemented and Data were collected from 50 respondents through self-administered questionnaire using Likert scale by Cronbach alpha of five responses. Data were analysing using SPSS 20V for descriptive statistics and correlation analysis was further used to estimate the parameters of reliability and validity of internal control on business establishment. Our findings shows that control environment and information control were significant at 5% level of significance. It was therefore recommended that control environment should be implemented so that fraud will be eliminated.

Furthermore, information should be implemented as well so that managers should track where those frauds are coming from and to know the continuity of the business with regards to computerised software to tract all financial records to best eliminate fraud in small and medium size enterprise in Buea municipality.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

The role of small and medium enterprises (SMEs) in a national economy has been emphasized all over the world, as they play a crucial role in the creation of jobs, growing the economy and reducing poverty (Subhan et al., 2013).

SMEs are flexible and innovative, taking into account the size and the business structure. Small and medium enterprises (SMEs) are much more vulnerable proportionally to fraud by employees, and much less able to absorb these losses than large corporation. The entrepreneur’s principal objectives are profitability and growth, the business is characterized by innovative strategic practices and continued growth and may be seen as having a different perspective from small business owners in the actual development of their firm (Subhan et al., 2013).

Fraud is a global problem affecting the society as a whole. It cuts across all walks of life. No person or organization is immune to fraud. Fraud has been in existence from long time. It is a complex problem since the perpetrators will always try not to leave any trail. Fraud affect organizations through loss of funds which can lead to low amount of funds available for business, can lead to loss of customer confidence and time wasted through investigations.

According to Association of Certified Fraud Examiners (ACFE) (2012), annual fraud survey report, typical organization loses 5 % of its revenue to fraud each year. According to Kroll (2013), 70 % of companies reported suffering from at least one type of Fraud. This was up from the previous 61% in the year 2012. It is therefore, imperative that organizations should try to minimize the chances of fraud occurring. This can be done through developing anti-fraud policies, proper internal controls and good governance among others.

According to Riney (2018), a combination of prevention and detection acts as a good tool for making vulnerable organizations stronger and more resistant to fraud. This is supported by Sow et al. (2018) who add that the most economical way to manage financial loss through fraud is prevention. Hence fraud prevention refers to practical measures established by an organisation to avoid or stop fraud occurrence (ACFE, 2020).

Furthermore, fraud prevention requires a system of rules which when put together minimizes the likelihood of fraud occurring while maximizing the possibility of detecting any fraudulent activity that may emerge (Biegelman & Bartow, 2006). Fraud detection, on the other hand, involves identifying fraud as fast as possible once it has been committed and comes in after fraud has failed to be prevented (Othan et al., 2015). Hence, fraud detection increases the perceived risk of getting caught thereby deterring people from engaging in fraudulent behaviour (Jeppesen, 2019).

Fraud detection plays a vital role in fraud investigation and prevention because the speed and way with which fraud is detected can have a significant impact on the fraud magnitude which in turn may help curb future fraud occurrence (ACFE, 2020). A major step to detecting and eventually preventing fraud is to identify the factors that can lead to fraud (Ghazili et al., 2014, ACFE, 2018). Hence, Cressey’s fraud triangle model was a model that was put forward to explain why people commit fraud (Biegelman & Bartow, 2006; Riney 2018).

Also, it ensures the qualities of internal and external reporting which requires the maintenance of proper records and process to generate flow of timely, relevant and reliable information. Internal control systems can be described as the whole system of control, financial and otherwise established by management in order to carry on the business of the enterprises in an orderly and efficient manner (Jenfa, 1991). Every organization operate on these set of procedures and policies on how to go about doing their day-to-day activities, these set of tasks need to be done in a sequence and in a way as to ensure the accomplishment of enterprise goals, Internal control is a process that guides an organization towards achieving its objectives, these objectives include operational efficiency and effectiveness, reliability of financial reporting, and compliance with relevant laws and regulations (COSO, 1992).

According to the University of California (2008), strong internal controls will depend on its components, such as the control environment; which is the control consciousness of an organization; it is the atmosphere in which people conduct their activities and carry out their control responsibilities. An effective control environment is an environment where competent people understand their responsibilities, the limits to their authority, and are knowledgeable, mindful, and committed to doing what is right and doing it the right way

According to Suh et al. (2019), one of the contributing factors of the small and medium size enterprises crisis has been the issue of internal fraud. Suh et al. (2019) further gave examples like the case of the USA where 355 small and medium size enterprises and 57 thrift institutions went insolvent resulting in a cost of up to $90 billion. Butcher and Galbraith (2019) also presented the issue of control fraud in the case of Latin America which resulted from the rapid growth of MFIs. This resulted in the diversion of interests meant to benefit the poor to those in charge of control in the MFIs in the form of a microfinance Ponzi scheme (Butcher & Galbraith, 2019).

Furthermore, Joseph et al. (2015) study on the effect of internal control on fraud detection and prevention in district treasuries in Kakamega, revealed a significant relationship between the adequacy of internal controls and fraud prevention and detection. Also, the study of Othman et al. (2015) on identifying the methods to detect and prevent fraud and corruption in the public sector in Malaysia revealed that internal control is among the most effective ways to detect and prevent fraud. Furthermore, Le and Tran’s (2018) study on Vietnamese companies revealed that internal control had a great impact on fraud control but with some components having more impact than others. Similarly, the study of Vu and Nguyen (2020) on public officials in Vietnamese companies showed that the internal control system reduced law fraud in the form of law violation but not the case of bribery. While the study of Shonhadji and Maulidi (2020) on governmental organizations revealed that risk assessment and monitoring activities (internal control) are efficient measures of fraud detection fraud.

Closer home, in Kenya fraud has been on the rise in the past. According to Price Waterhouse Coopers (PWC), annual crime report of 2014 in Kenya, 52% of one in two responded having experienced fraud in the last two years. It has affected most industries. However, financial institutions have been the hardest hit. Financial institutions in Kenya include; Commercial Banks, Micro Finance Institutions and Savings & Credit Cooperative Societies (Deposit taking SACCOs). Cuevas & Fisher (2006) states that Sacco’s fall under Financial Intermediaries. These institutions are member owned whose core business is to mobilize saving and enable members to access cheap loans easily. They have not been left behind by the fraud which has hit the corporate world.

Near home, in Cameroon, Furthermore, this view is held by Anita (2010), who explains that, microfinance institutions are not immune to the dangers of weak internal controls. She further argues that weak internal controls can also allow operational errors to remain uncorrected and that human or systems errors can result to the posting of figures of interest and other financial transactions into wrong accounts which can accumulate into a serious loss in the future.

Responsibility Social Investments (2013), highlights that potential costs and benefits of fraudulent practices is highly influenced by regulatory framework and that most of the regulations provide for very low interest rates (lending rates by the institutions) which could potentially increase the probability of fraudulent activities due to loans rationing. In addition, the Board of Directors of most of the institutions seem to have an overbearing influence on both the lending and overall financial policy which most often misdirects and demotivates the employees which has a link with fraud.  For example, COFINEST a major microfinance player in Cameroon got liquidated because of fraud and mismanagement leading to the arrest of major shareholders (Fotabong, 2012).

Internal control encompasses the policy, task and behaviors and other aspect of the company such as to facilitate its effective and efficient operation by enabling it to respond appropriately SMEs (Gree &Thunik, 2003) these include the safeguarding of asset from inappropriate use or fraud and ensuring that liabilities are identified and managed.

Also, it ensures the qualities of internal and external control reporting which require the maintenance of proper record and process to generate flow of timely, relevant and reliable information. Internal control systems can be described as the whole system of control, financial and otherwise established by management in order to carry on the business of the enterprises in an orderly and efficient manner (Jenfa, 1991).

Every organization operate on these set of procedures and policies on how to go about doing their day to day activities, these set of task need to be done in a sequence and in a way as to ensure the accomplishment of enterprise goals, internal control is a process that guide an organization towards achieving its objectives include operational efficiency and effectiveness, reliability of financial reporting, and compliance with relevant laws and regulations (COSO, 1992).

According to the University of California (2008), strong internal controls will depend on its components, such as the control environment, which is the control consciousness of an organization, it is the atmosphere in which people conduct their activities and carry out their control responsibilities. An effective control environment where competent people understand their responsibilities, the limits to their authority, and are knowledgeable, mindful, and committed to doing what is right and doing it the right way.

1.2 Statement of the Problem

Fraud is a global problem and affects every business, industry and organization. It leads to losses that continue to pose significant challenges to industries despite significant advances in fraud detection technologies According to Kroll (2013), 70 % of companies reported suffering from at least one type of Fraud. This was up from the previous 61% in the year 2012. Various studies have been done including, Khanna & Arora (2009).

The findings of the study included overburdened staff, low compliance level and lack of training as the causes of bank frauds. Several companies have faced employee fraud despite the fact that management has attempted to motivate employees to their best of ability to ensure employee loyalty. This is a problem faced by large companies alone as it happens in small companies as well (Isa, 2009).

Employee fraud may be caused by a number of factors which include lack of motivation, poor remuneration, poor and working conditions. Armed with this knowledge (Wyk, 2015), managers have attempted to generate strategies to reduce losses that may be caused partly through employee fraud. Examples of these strategies are good employee remuneration as well as other incentives which are expected to boost employee loyalty and commitment for the firm’s growth and development (Kassem, 2012). Employee fraud can have differing impacts on the success of a business and in most serious of cases it can lead to business failure and destroyed careers (Kula, 2011).

Even though there are many studies on effects of fraud on small and medium size enterprise, it is clear that little or no studies have been done on causes that are contributing to employee fraud in Buea Municipality some selected small and medium size enterprise. Yet, past studies have also not touched the influence of internal controls as a cause that contributes to employee fraud in small and medium size enterprise in Buea municipality.

Besides, the studies on whistle-blowing do not touch the part of employees in raising the red flag when they have information about the possibilities of fraud in the small and medium enterprise. The knowledge and research gap in these areas is what this study aims at filling. Therefore, this study aims at investigating the effect of internal control on the detection and prevention of fraud in small and medium size enterprise in Buea.

1.3 Research Questions

The research questions provide a framework and guideline through which substantial knowledge of the research study can be understood.

1.3.1 Main Research Question

The main research question of this study is what is the effect of internal control on the detection and prevention of fraud in small and medium size enterprises in Buea?

1.3.2 Specific research questions

We equally have the following specific research questions which include:

1. What are the effect monitoring activities on the detection and prevention of fraud in small and medium size enterprise in Buea?
2. What is the effect information and communication on the detection and prevention of fraud in small and medium size enterprise in Buea?
3. What is the effect risk assessment on the detection and prevention of fraud in small and medium size enterprise in Buea?

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