Category: Internal Control

In this essay, I will review the main strengths and weaknesses of internal control.

Internal Control Strengths

There are five key strengths of internal control, which are described below.

Only Accepting Orders Through Website

Only accepting orders through a secure and trustworthy website, electronically, at the time of order placement addresses risks like details of customers getting hacked, sending items to customers who cannot pay. This is a preventative control which works through only accepting orders through safe means, Derby Advanced Pty Ltd (Derby) minimises cash handling and through having on-time payment they prevent inviting bad debts.

Credit Approval

Preventive control being observed as approved customers are being recorded on credit card file, which also highlights those with poor credit—this is good customer accounting.

Crosscheck of Names on Credit Check Report and Sales Order

This an effective detective control, as it addresses the risk of goods being sent to customers who have not paid, or whose payments have been rejected. It does this through cross checking customers who have paid—highlighted in the credit card report file against goods which are being shipped.

Marking Completed Shipping Orders

This is a preventive control which addresses the risk of the order being accidentally shipped again through an accidental recirculation as well as the possibility of fraud through employees using the order again.

Scannable Picking Ticket

Having scannable codes on picking tickets to get the exact sales order of the customer eliminates risks of incorrect items being packed and shipped.

Internal Control Weaknesses

There are five key weaknesses of internal control, which are described below.

Unsafe Placement of Source Documents

Not safe or efficient to put picking tickets that are awaiting goods on a desk where they can easily be misplaced, tampered or taken. This should be addressed by using safes or lockboxes for important source documents.

Periodic Data Backup

Database is not being backed up on master data file. This should be controlled to prevent loss of data. Derby should back-up files periodically and keep at least two copies, of which one needs to be in different and secure location paired with the lacking logical physical access controls.

Regular Bank Reconciliations Not Being Conducted

The detective control of regular bank reconciliation it not in-place to identify incorrectly posted numbers in ledgers and in accounting transactions.

Manual Check of Each Item Against Original Sales Order

Manual check of items against order by the shipping officer is subject to human error. To reduce this risk Derby should adopt RFID or barcoding inventory management.

Carrier Picks Goods from Loading Dock and Delivers Them to Customer

Without proper controls in place this can expose Derby to risks such as leaving source documents and goods in an unsafe location unattended. Also, to not have confirmation on record which indicates whether the carrier has picked up the package and if the carrier has successfully delivered the package. Controls introduced can be securing the loading dock with biometric or card keypad and recording the courier’s access to the facility. The courier should also log the items they have picked up and get signatures of customers when items are delivered.

Internal controls are often overlooked in company planning, and are usually underemployed in businesses. Despite this, internal controls are very important in order for a company to be afloat, and it helps the company to be more efficient and run smoothly. The AICPA defines internal control as the process affected by plan management and other personnel, and those charged with governance and designed to provide reasonable assurance regarding the achievement of objectives in the reliability of financial reporting (AICPA, 2014, pg. 4).

Before taking this class, I had a broad understanding of what internal control was, and how it is important to the survival of the company. Today, however, I can understand the value of internal control and its place in keeping firms profitable and in good standing. A proper internal control reduces the risk of asset loss, and helps ensure that plan information is complete and accurate, financial statements are reliable, and the plan’s operations are conducted in accordance with the provisions of applicable laws and regulations.

When internal controls are effective, the company has reasonable assurance that its plan is achieving its financial reporting objectives. However, when the internal controls are not effective, there is little or no assurance. Therefore, after taking this class, I feel that I can better understand what internal controls are and how to help future companies I will work to use it effectively. Looking back on my previous accounting jobs I realize that some of the companies I worked had internal controls that were not efficient. However, I will choose my first job as an accountant to analyse its internal controls.

In 2009, I started my first accounting job as a junior accountant for a construction company back in my country, Angola. When I started in the company, I was working under a senior accountant who only came once a week to check on how I was doing. However, the owner only asked us to do the financial statements and bookkeeping for a fiscal year, and it was a temporary job. Basically, he only wanted us to update their financial statements because he was trying to get a loan. Now, I realize the company lacked a lot of internal controls, most importantly, it needed an in house accountant because it did not have one since it opened in 2002.

The company was a construction company dedicated to building residential houses, which specialized in helping future homeowners build their dream home to their exact specifications. In addition, it had a community were future homeowners could choose a house to live in or rent. The company had many issues from not having bookkeeping in order, proper inventory and accounts payables procedures to proper cash and customer procedures. For seven years, the company did not have an accountant, in fact, the person that was in charge of the payroll was the same that signed the timesheet, paid vendor and deposited checks. The following is what I would apply based on what I have learned in this class in this company.

In-House Accountant

Accounting is a very important part of the company’s operations, but many organizations have to decide if they will use in-house accounting or outsourced accounting. An in-house accountant is an accountant who works for the company and does the accounting activities of the company. I believe that the in-house accountant would help the company with bank reconciliation, income statement, balance sheet, maintaining a clean general ledger,and keeping track of company’s daily activities. In addition, the accountant would help with completing and filing the required legal and compliance documents for the company, prepare annual statements of accounts, and handle the company’s payroll properly.

In case the owner decides to apply for another loan, it is a good idea to have an in-house accountant because it might improve the company’s chances of getting a loan. This is because it shows that the company is serious about its business, and the accountant would present facts that backs up the application for funding, in addition to answering questions the bank might have regarding revenues and expenses projections.

Segregation of Duties

It is the main concept in a system of internal control. The duties within a department should be segregated so that one person does not perform processing from the beginning to the end. One person should not be in a position to authorize a transaction, execute the transaction, record the transaction and provide the sole review of the transaction. Reconciliations should be performed by a person independent of the basic process. On the accounts receivable side, segregation of duties ensure that the same person who is receiving cash is also not depositing it and recording it in the accounting records. For accounts payable, segregation of duties ensure that the same person approving payments is also not writing the checks and reconciling the bank account. In addition, the owner should be the one paying employees with adequate approval from the supervisor if needed. Furthermore, the employees working on the clients’ house should have a signing sheet which should be signed by the supervisor.

While working there, I noticed that there was no signing sheet, and coworkers would often cover for each other saying that the person was working at the clients’ site when asked, even though most of the time this was not true. In addition, there was only one person doing everything in terms of receivables and payables. This particular employee was in charge of payroll, paying vendors, and receiving money from clients and depositing it afterward. However, according to the owner, there were missing payments.

Therefore, segregation of duties would help reduce the risks of inaccurate financial reporting and improper use of funds. In addition, I would recommend arranging duties so that the employee who authorizes payment of a bill does not sign checks. Otherwise, the checks could be written to friends in payment of fictitious invoices, and those employees who sign checks neither have access to canceled checks nor prepare the bank reconciliation. This policy makes it more difficult for an employee to conceal a theft.

Inventory Management

A strong inventory tracking and management system should be in place and only key personnel should be able to use it. Access to inventory master files and the ability to modify, delete or change data should be restricted to only be used by the owner, and verify that inventory management systems are relevant aids for assessing time to reorder or replenish various products.

Because every time the company would buy inventory a different person would receive it and ask for it to be sent in different places, and there was no log of why they needed the material or who requested it; it would be beneficial to establish a system of access controls that prevents unauthorized access into inventory storage and administrative areas. In addition to conducting a risk assessment for environmental risks due to floods and high winds, and establishing a system for responsible employees to verify delivery, receipt, and storage of inventory.

Creating a paper trail of internal documentation and cross-check to ensure items received and those on the invoice are identical, and confirming that a system of signing items out of inventory and into the client’s site exists, that it requires signature authorization and compliance is enforced as a policy.

One possible solution to this issue would be to establish a basic audit schedule and conduct unannounced audits or check inventory frequently. Additionally, assemble a plan for conducting physical inventory counts when necessary. I recall one event in particular that could have been avoided if these procedures were in place. During this particular project, the company had ordered a lot of bags of cement. When the bags were delivered, the courier left them outside at the client’s site on a Friday afternoon. Since there were no workers at the site, and it rained a lot the whole weekend, by Monday the bags hardened and they had to order a new shipment. However, no one knew who received the shipment, and why it was left outside.

According to Eric Bank, “Before you start the count, improve your odds of success by preparing warehouses and other locations. You can organize work areas, ensuring all items are properly labeled and stored in their correct locations. You can ease the counting process by pre-counting items that are seldom picked and removing excess and obsolete inventory. You also can prepare the inventory takers by reviewing procedures and the instructions for the equipment that they’ll use to make the counts, such as radio frequency tag readers or bar code readers”. Therefore, the physical protection of assets should be one of the primary goals. Cash should be stored in a fire-proof safe, office supplies should be kept at reasonable quantities, and equipment should be stored in a secure locked areas. Keeping accurate lists of equipment helps to reduce the risk of misplacing the equipment or someone converting the equipment to personal use.

Cash and Customers Procedures

In order to accomplish accurate posting of transactions, employees should be properly trained and authorized to perform accounting and cash handling functions. Only authorized personnel should have access to automated accounting systems, cash storage, original accounting documentation, and sensitive information. Proper training should include an understanding of the essential need for timeliness in processing transactions. Errors and omissions should be identified and corrected on a timely basis.

The company would charge fifty percent to start building the client’s house and the rest the clients would pay when the house was completed or in installments. However, there was no actual log of the progress of the houses, and the owners were getting upset because the timeframe given to them had already passed, and the houses were not finished yet.

In order to control cash receipts the company should implement the following procedures: the firm should prepare a record of all cash receipts as soon as cash is received, deposit all cash receipts intact as soon as feasible, preferably on the day they are received or on the next business day. Additionally, duties should be arranged such that the employee who handles cash receipts does not record the receipts in the accounting records, and arrange duties so that the employee who receives the cash does not disburse the cash.

In contrast, in order to control and manage its cash the company should implement the following: account for all cash transactions accurately so that the correct information is available regarding cash flows and balances, make certain that enough cash is available to pay bills as they come due, and prevent loss of cash due to theft or fraud. I believe that by implementing these procedures, it would be easier to track cash easily and efficiently.

Implement Internal Control Over Capital Assets

The company had a lot of equipment that were not being depreciated. Since these equipment are significant to the company’s internal operations, I believe there key internal controls should be implemented over acquisition, storage, and record keeping such as periodic inventory evaluations, purchase authorization, and separated ledgers.

According to Duff and Phelps “The fixed asset accounting records of an organization have farreaching effects. Depending on the type of institution, fixed assets can represent the largest item on the balance sheet. Therefore, deficient fixed asset records can lead to inaccurate financial reporting…and inaccurate financial reporting can lead to a qualified audit opinion, which can damage management’s credibility with shareholders, lenders and suppliers” (Duff and Phelps, 2017, p. 2). The company had a lot of construction equipment such as dump trucks, diggers, lifts and others, but none of them were being depreciated. I believe it is crucial to start implementing internal control over capital assets because the company financial reports are inaccurate.

Utilize Technology to Help

New technology exists to help companies prevent theft, and separation of duties can be easily accomplished via system-based approval processes for purchases and payments. Controls on customer payments received can be gained by streamlining client payment collection via lockbox services, and the risk of stolen check stock can be reduced by utilizing a bill payment service. I believe that this would help the company a lot because everything was on paper, and there was no way to tell for sure if the company was profitable or not.

“If a weak control environment results in weak general IT controls or if there are weaknesses in the application and data-owner controls, management will need to evaluate and understand whether there are alternative or compensating controls at the business-process level relating to segregation of duties and the accuracy and completeness of processing. If application-level controls are weak, management must look for compensating detective and monitoring controls. These detective and monitoring controls would need to be highly detail-oriented and extensive in nature and scope. They must not depend on computer processing to operate effectively and must be documented, evaluated and tested” (Sections 302 and 404 of the Sarbanes-Oxley (SOA) legislation). Information Technology is now included in almost every aspect of a company’s function and has created a need for proper management to provide detailed oversight on this convoluted function. The overall health of a company depend on the operation of its IT department. That is why investing in IT controls is essential for financial operations and to ensure greater operational efficiency. However, it is important to probe the needs of the company and tailor the IT operations to fit those specific needs.

By improving those areas will help the company awareness of the importance of internal control over financial reporting, and will enable the company to assess the costs and benefits of implementing adequate controls, weigh the risks of each significant deficiency or material weakness, and determine if and how to address them. I am aware that it is going to cost the company a lot to implement these measures, however, procedures such as these safeguard companies from going bankrupt. In my country an employee usually gets paid a hundred dollars or less per month, and I realized the company had a lot employed that stayed hours without doing anything.

Internal control procedures such as these can help curtail wasteful spending and would have helped the company tremendously from going bankrupt and closing down. Also, since I started doing this paper, I tried to contact the company without success, so I called one of the employees there and he told me that the company went bankrupt in 2011, and the reasons were financial issues. Now, I know that if a company does not have a proper internal control in place, it will be bankrupt in no time.

References

1. AICPA. (2014). The importance of internal control in financial reporting and safeguarding plan assets. AICPA. Retrieved July 14, 2019, from https://www.aicpa.org/content/dam/aicpa/interestareas/employeebenefitplanauditquality/resource
2. Bablani, S. (2016, June 27). Internal Controls Over Information Technology at Your Firm. Retrieved July 14, 2019, from https://www.accountingweb.com/technology/trends/internal-controls-over-information-technology-at-your-firm
3. Bradford, C. (2016, September 29). Checklist for Internal Inventory Controls. Retrieved July 14, 2019, from https://yourbusiness.azcentral.com/checklist-internal-inventory-controls-10692.html
4. Cash Management: Internal Controls Checklist. (2017, February 17). Retrieved July 14, 2019, from https://www.cpapracticeadvisor.com/accounting-audit/article/12294853/cash-management-internal-controls-checklist
5. Duff and Phelps. (2017, Spring). Fixed Asset Controls and Reporting: Who’s Paying Attention To Your Largest Assets? Retrieved June 19, 2019, from https://www.duffandphelps.com/-/media/assets/pdfs/publications/fixed-asset-management-and-insurance-solutions/fixed-asset-controls-and-reporting-whos-paying-attention-to-your-largest-assets.ashx
6. Walsh, K. (n.d.). Internal Controls: What Are They & Why You Should Care. Reciprocity. Retrieved July 14, 2019, from https://reciprocitylabs.com/what-are-internal-controls-and-why-are-they-so-important/

Executive Summary

The concerned study focuses on the functions and importance of internal control on the regular activities of any business. In this regards, the key difference between internal control on financial records and internal control has been identified. The key beneficiaries of public reporting on internal control have been highlighted in the study along with its key benefits. Moreover, discussion has been made if the process is required for the companies of Australia. In addition to this, the effects of public reporting on internal control on the stock price market has also been highlighted so that knowledge can be gathered on the influences of various types of deficiencies identified from the process of internal control.

Section I

Introduction

The risks in any business organisation can be identified and modified with the help of internal control over the financial records of that organisation. For this, it is difficult to understand the right term that can be used for this risk assessment. This is more because of the purpose of risk management can be served by using similar words and terms for solving various issues. In this regard, there is also an issue between the two terms that are internal control over financial reporting and internal control. As internal control is important for any company, there are some beneficiaries of this process in public reporting of the financial records, which can get some primary benefits of this reporting. Moreover, it is crucial to analyse if this process is also required for various Australian companies and its effects on the share price value of the market.

a. Difference between internal control over financial reporting and internal control

The two terms of internal control over financial reporting and financial control can be differentiated with some key functions that are specific to each of the mentioned terms. The term internal control over financial reporting, which is also known by the abbreviation of ICFR is focused on covering the control that are the key elements of financial documents and reporting (Vovchenko et al., 2017). These include balance sheet of any company, it profit and loss statement and so on. Moreover, this term also include reviewing and checking of various other functions such as procurement of finance for payments, management of human resources, cash orders, inventory management and so on. Through these, ICFR covers various risks that can be detrimental to financial recording and affect financial reporting either directly or indirectly (Abbott et al., 2016). Therefore, it can be said that ICFR is having the function of managing and controlling the financial statements so that reasonable assurance can be made based on the outcomes along with ensuring that the financial records are totally free from any types of material misstatements.

In the words of Bentley-Goode, Newton and Thompson (2017), the term internal control deals with other functions that are associated with only the functions of a business. This process is associated with managing and controlling the business operations so that their effectiveness and efficiency can be ensured in comparison to the industry. As opined by Ge, Koester and McVay (2017), these may include safeguarding the business assets along with ensuring that the business operations are conducted by making compliance with various legal policies. Moreover, internal control is one of the major responsibilities of the functions of operations management (Davidson, Dey and Smith, 2015). This is because it is a crucial part of the regular activities of any business organisation. Therefore, it can be said that internal control is intended towards various business functions and management of business operations to maintain its profitability and market effectiveness.

b. Primary beneficiaries of public reporting and primary benefits

The primary beneficiaries of public reporting that is made with the help of appropriate internal control are the stakeholders that are associated with the activities of any business organisation. Due to the dependence of many stakeholders including investors, employees, creditors, management, shareholders, and so on upon the regular activities, functioning and profitability structure of any company, internal control is important to be included in the auditing functions. As mentioned by Habib and Bhuiyan (2016), proper internal control can help in making the financial records free from any errors and misstatements that can make the reports much reliable and accurate. Based on these results, various financial decisions can be taken over by these stakeholders, for which they can be mentioned as the primary stakeholders of public reporting by internal control.

The primary benefits of this type of reporting are huge as this maintains accuracy in the reports that are made public requirements. In the words of Donelson, Ege and McInnis (2016) as frauds and errors are quite common inside the business activities; performance of proper internal control within regular intervals can detect them so that rectifications can be made in the statements accordingly. Moreover, this is also important for maintaining the value and brand reputation of any company. Some key aspects that require internal control can be mentioned below.

Financial fraud

Various financial frauds can be detected with the help of internal control. It is quite easy for a person, who is dealing with the financial reports in making intentional frauds by making fraudulent adjustments on the financial statements (Alzeban and Sawan, 2015). Therefore, internal control is the key tool in identifying these frauds and making necessary rectifications for the same.

Business loopholes

Loopholes in business may arise due to some backlogs in the business policies in any organisation. Some employees can take advantage of such conditions for their own benefits that can be said to be equivalent to frauds. In this case, regular process of internal control can act as a barrier for sealing these loopholes and making necessary improvements (aicpa.org, 2014).

Procedures and protocols

As opined by Cheng, Goh and Kim (2018), the business procedures and protocols can be maintained with the help of internal control. Through this function, management can establish all the required procedures and protocols for managing the business activities and human resources that will be effective in establishing regular activities of any business.

Management and financial information

Apart from all the functions mentioned above, managing and organising the financial data in most efficient way can be done with the application of internal control procedures. The financial as well as business management information can be kept safe and in order by internal control so that business productivity can be increased.

In regards of the functions and importance of internal control over the financial records, it can be said that the entire business community and companies of Australia should introduce this requirement in their business auditing processes. In the words of Kravet, McVay and Weber (2018), this is because the function of internal control is required for identifying the errors, misrepresentations, and misstatements incurred in the financial statements of any Australian companies. Moreover, appropriate internal control can reduce various risks of loss of business assets along with ensuring that the prepared financial plans and information are accurate, reliable and complete. Furthermore, it also ensures if the financial statements are prepared in compliance of the business laws and regulations and legal provisions of the country. In case internal control procedure is quite effective, the key users of the financial reports can be assured that the business plans are successful in achieving the objectives and aims of financial reporting (aicpa.org, 2014). Therefore, the requirement is quite necessary for the companies of Australia as this can help in minimizing the chances of intentional fraud and unintentional errors along with identifying the smallest of errors in the financial records before they tend to create big problems for the companies.

c. Requirement of public reporting on internal control and effects on share prices

In case the companies of Australia apply public reporting on internal control along with having provision for making assurance on that report, then a negative assurance on this report can affect the share price movement of the Australian market. Due to negative assurance of the internal control report, a suspicion would develop on the performance of any Australia company that would make its value and reputation to decrease in the eyes of its stakeholders (Hao, Qi and Wang, 2018). Moreover, this would decrease the trust of the stakeholders of any such company after a negative assurance is made regarding the financial reports of that company. In the words of Kim, Yeung and Zhou (2019), with the decrease of company value, the share market will also start falling for a decrease in the share price of such companies. Moreover, with a decrease in trust, such company may also face decrease in investment aspects from its investors’ sides. Therefore, negative assurance will start decreasing the share prices of the country along with having negative impact on its economic conditions.

Figure 1: Current Share Price Movement in Australia (Source: marketindex.com.au, 2019)

As per the above graph, it can be seen that the current status of the share price of Australia is quite high that had gradually started increasing from 2012 (marketindex.com.au, 2019). In case a negative assurance is received from public reporting regarding internal control, this can tend the currents status of share price to fall steadily. Moreover, this can also affect the regular activities and performance of these companies by reducing the total earnings received from their individual share prices (Kim, Yeung and Zhou, 2019).

The nature of deficiency in the internal control process can make huge differences on the effects of share market prices. This is because deficiency in this process can make huge differences in the rise and fall of the share price of the Australian share market. These deficiencies can also have an adverse impact on the abilities of any company to authorise, initial, record and process various financial information (Chen et al., 2017). As there can be various natures of these deficiencies, these can have diverse effects on the share market prices of any country. In this regards, it can also be mentioned that due to formation of negative impacts of these deficiencies on the business activities of any company, the assets and liabilities of these companies can also get negatively influenced by initiating a decrease in their values (Kim and Zhang, 2016). Moreover, with such decrease, the financial efficiency of the company gets reduced, thus affecting its shareholders and investors. In turn, this tends to decrease the overall value of the stock market price of a country such as Australia.

Among the other forms of deficiencies in the internal control process, four key forms of deficiencies can be identified that can have negative influences on share market price. These deficiencies can be identified below.

Lack of punctuality

Due to lack of punctuality and timeliness in preparing account reconciliation and cash deposits, discrepancies may arise through the process of internal control (Chen et al., 2017). In these cases, the records could not be kept properly due to time lag and therefore, can create hindrances for the process of internal control.

Lack of physical stock and inventory

Lack of physical stock and inventory can create huge problems in continuing internal control process. This is because it can create various discrepancies due to non-recording of physical inventories and stock.

Lack of overdrafts

Due to lack of proper monitoring of the overdraft funds, deficiency can arise in the preparation of internal control. Moreover, this can also create problems while recording about the overdrafts that may create discrepancies with the source of these overdrafts.

Lack of reconciliation and review

Lack of proper reconciliation and review of various departmental expenditures can create serious problems and deficiencies in the internal control process (Kim, Yeung and Zhou, 2019). As in most of the cases, departmental expenses could not be recorded effectively; internal control becomes difficult to be conducted by the higher authorities.

Conclusion and Recommendation

As per the entire study regarding internal control, it can be said that this act is extremely important for any companies across the world so that various risks can be identified before they can create any serious problem. In this context, it is mention worthy that as the companies in Australia are not having internal controls included in their business activities; they may face problems in their future years regarding the preparation of financial documents. Without proper implementation of this function, the companies may face the challenges of frauds and errors in their business reports. Moreover, without proper internal control in their activities, the company may also tend to face a decreasing stock market price for their individual stocks and shares. As internal control may also have different types of deficiencies according to the activities, this can create huge pressure on the Australian companies by reducing their value in the market along with reducing their share prices. Therefore, it is recommended for all the companies and business organisation of Australia to adopt internal control procedure in their regular activities. Moreover, the government of the country should also be aware of such situations so that proper legal policies and laws are implemented regarding the application of internal control in the business operations.

Reference List

Journals

1. Abbott, L.J., Daugherty, B., Parker, S. and Peters, G.F., 2016. Internal audit quality and financial reporting quality: The joint importance of independence and competence. Journal of Accounting Research, 54(1), pp.3-40.
2. Alzeban, A. and Sawan, N., 2015. The impact of audit committee characteristics on the implementation of internal audit recommendations. Journal of International Accounting, Auditing and Taxation, 24, pp.61-71.
3. Bentley-Goode, K.A., Newton, N.J. and Thompson, A.M., 2017. Business strategy, internal control over financial reporting, and audit reporting quality. Auditing: A Journal of Practice & Theory, 36(4), pp.49-69.
4. Chen, J., Chan, K.C., Dong, W. and Zhang, F., 2017. Internal control and stock price crash risk: Evidence from China. European Accounting Review, 26(1), pp.125-152.
5. Cheng, Q., Goh, B.W. and Kim, J.B., 2018. Internal control and operational efficiency. Contemporary Accounting Research, 35(2), pp.1102-1139.
6. Davidson, R., Dey, A. and Smith, A., 2015. Executives’“off-the-job” behavior, corporate culture, and financial reporting risk. Journal of Financial Economics, 117(1), pp.5-28.
7. Donelson, D.C., Ege, M.S. and McInnis, J.M., 2016. Internal control weaknesses and financial reporting fraud. Auditing: A Journal of Practice & Theory, 36(3), pp.45-69.
8. Ge, W., Koester, A. and McVay, S., 2017. Benefits and costs of Sarbanes-Oxley Section 404 (b) exemption: Evidence from small firms’ internal control disclosures. Journal of Accounting and Economics, 63(2-3), pp.358-384.
9. Habib, A. and Bhuiyan, M.B.U., 2016. Problem directors on the audit committee and financial reporting quality. Accounting and Business Research, 46(2), pp.121-144.
10. Hao, D., Qi, G. and Wang, J., 2018. Corporate social responsibility, internal controls, and stock price crash risk: The Chinese stock market. Sustainability, 10(5), p.1675.
11. Kim, J.B. and Zhang, L., 2016. Accounting conservatism and stock price crash risk: Firm‐level evidence. Contemporary Accounting Research, 33(1), pp.412-441.
12. Kim, J.B., Yeung, I. and Zhou, J., 2019. Stock price crash risk and internal control weakness: presence vs. disclosure effect. Accounting & Finance, 59(2), pp.1197-1233.
13. Kravet, T.D., McVay, S.E. and Weber, D.P., 2018. Costs and benefits of internal control audits: Evidence from M&A transactions. Review of Accounting Studies, 23(4), pp.1389-1423.
14. Vovchenko, N.G., Holina, M.G., Orobinskiy, A.S. and Sichev, R.A., 2017. Ensuring financial stability of companies on the basis of international experience in construction of risks maps, internal control and audit. European Research Studies Journal, 20(1), pp.350-368.

Websites

1. aicpa.org, 2014. The importance of internal control in financial reporting and safeguarding plan assets. Available at: https://www.aicpa.org/content/dam/aicpa/interestareas/employeebenefitplanauditquality/resources/planadvisories/downloadabledocuments/plan-advisoryinternalcontrol-hires.pdf [Accessed on 12 September 2019]
2. marketindex.com.au, 2019. S&P/ASX 100. Available at: https://www.marketindex.com.au/asx100 [Accessed on 12 September 2019]

Introduction

In this chapter literature review on internal controls and revenue collection is discussed. The theoretical framework is presented first, followed by empirical literature on studies involving internal control and revenue collection. The conceptual framework is discussed last and then the chapter summary concludes the chapter.

Theoretical Review

The main theories that premise the relationship between internal controls and revenue collection are the Agency theory. Attribution theory, and Reliability theory.

Agency Theory

Jensen & Meckling (1976) postulate that a firm consists of a nexus of contracts between the owners of economic resources (the principals) and managers (the agents) who are charged with using and controlling those resources .According to the agency theory, agents have more information than principals and this information asymmetry adversely affects the principals ability to monitor whether or not their interests are being properly served by agents.

A contract should be written to address the interest of both the agent and the principal. The agent-principal relationship is strengthened more by the principal employing auditors and control systems to monitor the agent (Jussi & Petri, 2004).

Jensen & Meckling (1976) postulate that the agency theory assumes that principals and agents act rationally and use contracting power to maximize their wealth. This theory is applicable to internal control and revenue, because internal control are a mechanisms used in business to address the agency problem by reducing agency costs that affects the overall performance of the relationship. Internal control reduces information asymmetry by providing additional information to shareholder about the behavior of management that reduces information asymmetry.

Attribution Theory

The attribution theory examines the use of information in the social environment to explain events and behaviors (Schroth and Shah, 2000). Reffett (2007) asserts that when evaluators believe more people would have acted differently in a given circumstance, they attribute responsibility for an outcome to the person. So, failure to detect internal control on revenue generation by auditors when it is their duty, imply the auditors are negligent. Auditors are more likely to be sued when they fail to detect common misappropriations that would result to decreased revenues (Bonner et al. (1998). It is so because evaluators believe that the fraud could have been detected by other auditors.

In short attribution theory calls for auditors to report on the effectiveness of firm’s internal control. When fraud occurs, auditors should be held accountable (Reffett, 2007).

Reliability Theory

According to Gavrilov & Gavrilova (2001) reliability theory describes the probability of a system completing its expected function during an interval of time. According to the reliability theory, each component of an internal control system needs to be a defined measure of success. Internal control systems should be reliable in the assessment and control of risks. Weak internal control systems result in more substantive work and hence increased costs. Organisations are required to assure the functionality of systems, internal control included.

Conceptualising Internal control

Internal control are mechanisms to prevent errors from entering the process or detecting errors. Management rely on internal control to make sure things don’t get goofed up (Kenneman, 2004). Puttick (2001) adds that internal controls as a set of organizational policies and approved internal processes crafted by management of an organization to achieve management’s primary objective of ensuring that the business operates flawless. The Financial Management Journal (2005), postulate Internal control represents an organization’s plans, methods, and procedures used to meet its objectives of safeguarding assets and preventing and detecting errors, fraud, waste, abuse and mismanagement.

Ongeri (2010) stipulate organizations need five interrelated components of an Internal Control which control environment, risk assessment, control activities, Information and communication, and monitoring components.

Control Environment

The control environment influences the control consciousness of its people (Whittington & Peny, 2001). Control environment comprises of factors like integrity and ethical values of employees, competence of person performing assigned duties, audit committees, management operating style and organizational structure. The effectiveness of these factors depends on their interaction with internal and external auditors.

According to Aldridge and Colbert (1994) control environment reflects the attitude of management in regard to importance of internal controls in revenue generation. Effective internal control requires a strong control environment under which the components of systems are well implemented.

Risk Assessment

According to Karagiorgos et al (2009) risk assessment refers to the assessment of factors that affect the possibility of objectives of the organization not being achieved. It is the process of identifying management relevant risks to the preparation of financial statements that would be presented fairly in conformity with general accepted accounting principal (GAAP). The purpose of risk assessment is to identify, analyze and manage risks that affect entity’s objectives. The aim is to keep the firm’s risk at an acceptable level. A firm should use its risk management systems to help assess potential opportunities and threats to its objectives. Internal control is about understanding and controlling risk as well as acting as a monitoring function.

Information and Communication System

Internal control requires that all information be identified, captured, and communicated in a form that enable people to carry out their financial reporting responsibilities (Aldridge and Colbert, 1994). Effective communication should see information flowing down across and up within all sections of the organization (Theofanis et al 2011). They are pervasive characteristics that affect all aspects of the internal control framework and Effective information dissemination enable people to carry out their responsibilities to run and control the organization. Internally communication should be multi directional within the organization. External communication relates to communication with governing boards and regulatory agencies.

Control Activities

Aikins (2011) define control activities as policies and procedures to ensure directives of the management are properly carried out. Policies and procedural guidelines normally assist in the proper execution of control activities.

Monitoring and evaluation

Theotanis et al (2011) describe monitoring as the process of assessing the quality of internal control structure overtime. Amuda and Inenga (2009) avers that monitoring of operations ensures effective functioning of internal control system. Monitoring can be achieved by regularly supervising and managing activities like monitoring of customers complaint and audit conducted directly by internal auditors. Evaluations ascertain whether components of internal control continue to function as designed and intended. Internal control deficiencies are communicated to management for corrective action.

Internal Controls in Revenue Collection

According to Obat (2010) Internal controls include segregation of duties, custody of assets, strict authorization procedures, internal audit, passwords, proper record controls and management supervision.

Segregation of Duties

Matamande (2012) states that if work is done by one individual there is a chance that the person can fraudulently convert the assets of the organization to own use and also manipulate the accounting records. There must be a clear separation between those initiate records and those who are responsible for the collection of the money.

Custody of assets

Puttick et al (2008). Outline measures meant to ensure that only those authorized have access to the organization’s assets.

• Money should be transported in fully armored cash in transit (CIT) vehicles.
• Money not banked within stipulated time (24hrs) should be kept under lock and key in a safe in a strong room.
• Cash in hand should be kept to a minimum by regularly clearing tills during the day and banking the takings promptly.

Authorization

Transactions should be entered into systems once they have been authorized by the appropriate individual. The system should deny access to unauthorized personnel (Matamande, 2012).

Internal Audit

Internal audits should be regularly and randomly in all departments. Internal audit is an effective tool in revenue management because internal auditors are employees hence are better placed to understand the accounting systems, the control procedures and the control environment (Matamande, 2012).

Management supervision

These are controls over the control systems which involve the following:

• Monitoring to ensure that laid-down procedures are operating as they were designed to.
• Analyzing error detected by internal controls and taking remedial action.
• Considering changes where the weaknesses have been exposed.
• Conducting surprise cash audits (Matamande, 2012).

Empirical Review

Abbott, et.al (2010) investigated the importance of the control environment on audit performance. The study essentially looked on whether audit committee activity and independent is inversely related to fraudulent financial statements. The result of the study indicated that firms with independent directors and with the minimum activity level are less likely to be associated with fraudulent financial statements.

Sovens and De Beelde (2006) studied the importance of the control environment when studying internal audit practice. The study established that control environment characteristics are significantly related to the role of the internal audit function and fraud detection within an organization.

Berra (2010) focused on control activities and monitoring, and investigated the effects of internal controls on employees’ propensity to be fraudulent. The result showed that the presence of control activities separation of duties increases the cost of committing fraud. Thus, the benefit from committing fraud has to outweigh the cost in an environment with internal controls.

Amudo and Inenga (2009) evaluated internal control systems on the Regional Member Countries (RMCs) of the Africa Development Bank Group (AFDB). It was found that there is ineffective internal control. The study recommended on improvement of the existing internal control systems.

In a study to establish the impact of internal control design and bank’s ability to investigate staff fraud, Ewa and Udoayang (2012) found that internal control design influences staff attitude towards fraud. A strong internal control mechanism deter staff from committing fraud. On the other hand, a weak one exposes the system to fraud.

Conceptual Framework

The conceptual framework was developed after reviewing related literature on the study variables and it shows the relationship between the studies of variables under investigation. The independent variables were control environment, risk assessment, information and communication, control activities and monitoring and evaluation. Revenue collection was the dependent variable.

Figure 2.1 Conceptual Framework

Source: Researcher’s work

Summary

The chapter presented on the three theories anchoring this study namely the agency theory, the attribution theory and the reliability theory. This was followed by a discussion of empirical studies on internal control. Lastly the chapter presented the conceptual framework. Chapter three which follows presents on research methodology.

1.1 Introduction

This section will mainly focus on the background of the problem which will be about what has caused the problem. Also the research will focus on the main aims of this research and research objectives giving the reader a clear picture of what the researcher wants to achieve. The research will also come across the significance of the study giving the importance of why this study is being carried out. Moreover the research will focus on the limitations of the research meaning the effects that the researcher may come across when conducting a research.

There are other sections that the study will come across. One of those sections is the literature review. This section will focus on the perceptions or the views of other authors relating to the internal controls on the revenue collection.

1.2 Background of the study

Botswana Unified Revenue Services continues to face low levels of revenue collection. This study will find out the internal controls that may be put in place so as to curb out the problem. There are many Batswana whom shall pay tax and they are not doing so. Remember that it is the right of every Motswana earning P3600 per month to pay tax. Even though they know that, they are not paying tax hence resulting in low generation of tax revenue. This research will look into the relationship between internal controls and revenue collection in Botswana Unified Revenue Services (BURS).

Botswana unified revenue services was founded in 2004 as an Act of Parliament in 2004 and came into operation in August 2004. Originally it was put in place as the sector of taxes and will be controlled by the Ministry of Finance. It was formed at a time when resourceful tax collection was recognized as an essential part of the Government’s aptitude to complete both its governance and its civic duties. Certain internal controls were then put in place so as to ensure that there was continued viability. Even though there were set internal controls in the department so that it can make more revenue collection, there were leakages that were taking place due to some activities that were taking place in the organization.

This study will therefore look into the effectiveness of internal controls in revenue collection in BURS. This research will look more onto the accounting software’s and the internal controls that are into place at BURS and their impact in the revenue collection at BURS.

1.3 Statement of the Problem

‘BURS’ continues to face the low levels of tax collection because people do it intentionally knowing that they will be avoided. Despite of rules and regulations that put in place there is fluctuation on the levels of tax revenue generation and collection which is happening across all the sectors of the government as well as private sectors. No matter how fine it is, the internal control system can only offer a reasonable, not absolute assurance that the objectives of the company are met in relation to the tax revenue collection. In analyzing the problems related to this, is to check whether there are operative internal control systems in preventing and detecting of the problem that led to the losses. Internal controls are designed to give the company the confidence in its aptitude to achieve a particular task and avoid errors and losses through monitoring and improving organizations and financial reporting processes as well as ensuring compliance with laws and regulations. The internal controls on the tax revenue generation have caused effectiveness in the performance of the finances. A research has been carried out in respect of the effect in the internal control system on tax revenue collection. Regardless of the internal controls that are put in place in BURS, the revenue collection remains below the target market and the resources are being poorly managed. This is due to the fact that the internal controls that are put in place are weak. This is because people are being too slow to pay their taxes on time and some are being corrupt. The authority has identified that one of the major causes of low revenue collection is corruption which has led to the integrity plan action being formed which will lead to transparency thus reducing corruption in revenue collection. Thus, the idea of this research is to inspect and assess the internal control system in procedure at BURS with the outlook of knowing whether escalation of internal controls can have any impact of revenue collection and to answer the question “To what degree has internal controls enhanced revenue collection in BURS in Francistown.

1.4 Aim of the study

This study aims to establish best internal controls that will help to generate revenue at BURS.

1.5 Research Objectives

The study aims to achieve the following:

1. To identify the controls those are put in place by Burs in the revenue collection.
2. To establish the importance of the internal controls in enhancing revenue collection at BURS in Francistown.
3. To suggest the best practices of internal controls that can be used in BURS to enhance revenue collection.

1.6 Research Questions

1. What are the internal controls that are put in place by BURS to enhance revenue collection?
2. What is the importance of internal controls in enhancing the revenue collection at BURS in Francistown?
3. What do you think are the best practices that can be put in place in order to enhance revenue collection in BURS here in Francistown?

1.7 Significance of the study

This research would be critical to BURS in figuring arrangements and systems for gathering and keeping an eye on corrupt tax collection field. The investigation would make mindfulness with regards to the dimension of internal controls which have been set up and to utilize the proposals proposed to include to the effectively actualized. To the training consequently, the investigation would assist researchers with understanding how inner controls work and how to actualize them and to know the territories of income leakage. The discoveries of this exploration would likewise add to hypotheses by giving extra proof to help the current speculations. Individuals will utilize data in this investigation as a major aspect of writing survey while completing other research on the effect of inner control on income gathering. This study will likewise be useful to the Botswana government in thinking of the spending limit and setting out gathering focus for the income accumulation body.

1.8 Limitations of the study

One of the limitations of this study is that there is less time that we are supposed to complete this project. Also it is costly to do this research project as I have to pay for transport costs and other expenses that are needed in order to complete the project. The management of BURS may not want to disclose some of the information as they feel that it is confidential.

1.8.1 Mitigation measures

I intend to do all the work required from me well on time so that I can catch up with time. Also I will be saving so that I can be able to pay well the expenses without constraints. Some of the information will be taken from the government portal for incase the management do not disclose some information.

Literature Review

This research is proposed to survey the impact of internal controls on income gathering with accentuation in BURS. The survey of accessible writing thusly endeavored to build up whether there is a connection between’s Internal Control as an autonomous variable and income accumulation as a reliable variable. The survey especially centered around; Control condition, Internal Audit, Control exercises, Information and Communication and monitoring the primary parts of Internal Control.

Internal controls

According to Hilario (2015), he explains that internal controls are one of the important aspects that every business should adhere to. He explains them as set standard and principles that are used in the business so that they can help to detect fraud and error. He said that these internal controls should be realistic and should bas on the truth so that the business can be able to achieve what it has set.

Internal controls in Revenue Collection

According to Obat (2010), BURS was framed to create enhance income accumulation measures just as ensuring that all income spillages are shut. He continue to explain that these internal controls were meant to avoid some of the individuals to cheat the government by not paying tax. It was likewise to guarantee that it speeds up exchange by setting up those measures that permit controlled development of commodities and ventures. BURS in this manner have set up those measures to decrease the spillages. They perpetually incorporate isolation of obligations, care of benefits, exacting approval strategies, inner review, and the utilization of passwords, legitimate record controls and the executive’s supervision.

Segregation of duties

This convention expresses that if certain activities are performed by one individual quite possibly that individual can deceitfully change over the advantages of the association to possess self and furthermore control the bookkeeping records. In representing income in BURS the three angles fundamental any income exchange which is approval, execution and recording are performed by various people. One can realize that there is segregation of duties since all the activities are being carried out by different individuals.

Custody of Assets

According to Kaplan (2007), BURS have set up essential measures for the insurance of organization resources. The measures are intended to guarantee that just those approved approach the association’s advantages. For the situation of some fringe posts where there are no financial offices cash is transported from these ports of section in completely protected money in travel (CIT) vehicles. The money is contained in real money boxes which are fixed and bolted.

Authorization

Matamande (2012) continues to explain that there is utilization of passwords guarantees that nobody has the option to enter unapproved data which may twist income age. The utilization of Passwords disheartens people to embrace degenerate exercises as exchanges are ceaselessly observed on the web.

1.10 Methodology

This Chapter centers around the strategies that was be utilized to gather information and examine it. It significantly concerns the exploration structure, the populace to be contemplated, the example choice strategies and examining procedures, information gathering systems utilized, and information examination utilized.

1.10.1 Research Design

This research will use non-numeric data and he numeric data wherever applicable. This is because whenever the two are being used together they can provide a solid and valuable research which will have a true picture of what is happening around the research topic. This also are quick to use and they saves time.

1.10.2 Study Population

The exploration targets BURS staff since most workers are straightforwardly or in a roundabout way associated with basic leadership and controls.

1.10.3 Study Sample

The research essentially focused on top and center dimension the executives individuals since they are the Custodians of Internal control. The specialist hence utilized purposive testing strategies in choosing interviewees with an alternative of supplanting the individuals who don’t wish to react to the scientist’s request. Purposive testing is the place the researcher intentionally chooses who to incorporate into the example.

1.10.6 Information Collection methods

There will be different methods that the researcher will use to collect data. The researcher will use both qualitative methods and quantitative methods of data collection. When dealing with the quantitative methods this is whereby one uses the numeric methods to collect data and the qualitative involves the use of descriptions.

• Questionnaire- it is an instrument of data collection that involves asking questions in a written form. A questionnaire is the most inexpensive method of data collection. It is easy to use. Moreover, one can get the fast results as soon as possible. When using a questionnaire one can choose what kind of questions they can ask to a certain group either open minded or multiple choice. Even though it is a good method of collecting data, one may find out that it has some disadvantages. One of its disadvantages is that some people may skip some of the questions. Also one may get dishonest answers from the respondents. Some people may not understand the question clearly and wrongly interpret it.
• Interview –this is one of the qualitative methods that the researcher will use. In this case the researcher will ask some of the questions face to face so that they can understand and clear up some of the confusions that the researcher may have. It is a good method since the researcher may be able to narrate some of the questions that the respondant may not understand.

1.10.7 Information Analysis

The researcher will use different methods to analyze the data collected.

This will involve:

• Graphs
• Tables
• Pie charts

References

1. Hilario Ribeiro, Daniel (2015), internal control system
2. Kaplan E and Schultz Y (2007), authorization as part of internal control system.
3. Matamande, et al (2012), The effectiveness of internal controls in revenue management. A case study of Zimbabwe Revenue Authority. University of Zimbabwe.
4. Obat, J. (2010). The effectiveness of Internal Control Systems in achieving value for money in revenue services

Introduction

Over recent years, corporate governance has become a mandatory center in practice and academic literature (Kim, Nofsinger and Mohr, 2009). The essential pillars of good corporate governance are: discipline, transparency, independence of board members and committees, fairness, accountability and social responsibility (King Report, 2002). Moreover, the most simplified definition of corporate governance is a system through which companies are directed and controlled (Cadbury Report, 2002). Corporate governance is made up of several mechanisms which include: Non-executive directors, executive incentives, institutional investors and internal control. However, Wearing (2005) stated that, a good corporate governance in a firm cannot exist without an internal control mechanism and companies can undergo financial substantial losses without an Internal control. Internal control is defined as “an executive process of board of directors, authorities and other employees to achieve purposes in these of the categories: efficiency and effectiveness of operations, reliability of financial accountability, obeying laws and legal act” (Shim, 2011). This essay will therefore emphasize on the importance of internal control using different related theories, the background to the creation of the mechanism and finally the role and effectiveness of internal control with the various reports that have come up.

Theoretical framework

There are various fundamental theories which have been brought up on the literature of corporate governance and these are as follows: agency theory, stewardship theory, resource dependence theory, stakeholder theory (Norton and Joseph, 2000). The most relevant theory regarding the internal control in corporate governance is the agency theory. Agency theory is basically the relationship between principals and the agents. The principals which are the shareholders and the agents which are the executive managers in a company (Safieddine, 2009).

In this theory, the shareholders who are the owners of the firm, appoint the agents or managers to deliver the work respectively and expect the managers to make decisions in the shareholders’ interests (Collins, 2007). However, on the contrary, this might not be the case, as the agents may be succumbed to self-interest and this was a highlighted aspect due to the problems arising from separation of ownership and control according to the Blake and Mouton Paradigm which was enforced in 1985 (Coyle, 2003). The first argument made by Bhimani (2008) was that the agents might be embedded with opportunistic behaviour and thus falling short of the correspondence between the aspirations of the principals’ pursuits. In addition, Harvey and Brown (1998) concluded that the uttermost focus of corporate governance should be to maximise shareholders’ wealth while ensuring that wealth maximization conflict does not arise with the interests of other stakeholders. Kulik (2005) argued that if there is conflict of interest, the management should take interests into account on legal terms instead of acting in their best interest. In other words, there should be an alignment of the goals and strategies between the management and the owners (Collier and Zaman, 2005). Nonetheless, McVay (2007) argued that agents will concentrate on works with a higher return and a fixed wage instead of providing fluctuating incentive payment. Thus, not eradicating any corporate misconduct regarding internal control.

Moreover, Jensen and Meckling (1976) are of the view that the agency problem can be reduced by control mechanism which has arisen from the separation between ownership and management. Control mechanism is the basic of internal control and they are employed to ensure that the managers act in the interest of the owners (Healy and Palepu, 2001). Two drawbacks factors that can be deduced from the agency perspective are different risk appetite and agency costs (Borad, 2019). One way to improve the agency problems is to establish explicit contracts which incorporate the disclosure of relevant information by the management and the shareholders who are the provider of finance (Healy and Palepu, 2001). By this means, the mechanism of transparency is of better use by evaluating to which extent the management is using the resources of the firm in the interests of the shareholders thus, attracting more institutional investors.

The second theory that has made an impact on the mechanism of corporate governance is the stakeholder theory. The stakeholder theory can be defined as any group of individuals in a firm who can affect or is affected when the objectives or goals of an organization have been encountered (Solomon, 2013). Unlike the agency theory, where the managers are working in order to meet the criteria of the shareholders, the stakeholder theory emphasises on the fact that the managers have to maintain the relationship between its stakeholders such as suppliers, employees and business partners (Arnold, 2012). Broadbent and Guthrie (2008) view the firm as a system of stakeholders operating within a larger system of a host of society that provide necessary legal and market infrastructure for the firm’s activities. Khan (2014) supported this view by stating that the goal of directors and management should be maximizing total wealth creation by the firm.

In addition, one mandatory issue concerning the stakeholder theory is the existence of problem asymmetry between the managers and the potential investors (Freeman, 2002). Besides, it would be difficult for stakeholders to obtain reliable information on their investee company if there is not a structured system of disclosure (Hill and Jones 1992). However, these problems in information asymmetry can lead to moral hazard and adverse selection problem (Solomon, 2013). Furthermore, this issue can be eradicated by ensuring a relevant and corporate disclosure in firms and also the second essential aspect is the accounting function which links the auditors and the investors in better decision-making purposes (Bushman and Smith, 2001).

Hence, coming into contrast with both the agency and the stakeholder theory, the most essential one regarding internal control will be the agency theory because it is the vital theoretical framework that can help with the transparency, disclosure, risk remuneration and control in companies. Also, the BP (2005) report implies that the priority will be accountable to shareholders’ needs as they will enhance in the better profitability and goals of the company.

Background of Internal Control Mechanism

Internal Corporate governance control became an important phenomenon in the rise of the major accounting scandals that took place in both Europe and the USA (Donaldson, 2005). Some of the examples are as follows: The collapse of Barings Bank in 1995 which happened because of Nick Leeson, a trader in the bank who was taking huge amount of risks and even created a secretive account that covered for the losses he encountered in the bank which was unknown because of lack of control (PennState, 2018). Furthermore, the second major financial humiliation that awaken the public’s attention was the Enron scandal which happened in 2001 (CNN, 2018). So, because of these scandals, various reports emerged on the basis of handling better internal control. The USA government carried out the first steps to regulate the internal control systems in public listed companies by introducing the Sarbanes-Oxley’s Act (SOX) in 2002 under section of 404 to enhance the transparency and accuracy of financial reporting (Nofsinger, 2009). Secondly, the guidance that came up for the UK companies listed on the London stock exchange was the Turnbull Report which was introduced in (1999) by Nigel Turnbull and got updated in October 2005 to the Financial Reporting Council (FRC). The Turnbull guidance views internal control as a system that encompasses the policies, processes, tasks, behaviours and other aspects of a firm while keeping its focus on risks management (Hills, 2011). Finally, there was the Turner Review (2009) which came into practice because of the aftermath of the disastrous banks scandals.

The roles and the effectiveness of the Internal Control mechanism

As a benchmark with the Turnbull report the roles that the Internal control mechanism is supposed to play are as follows:

• To encourage the board of directors by initiating that the internal control framework can help in better communication with the shareholders and how the risks are going to be managed.
• To aid companies in complying with the internal requirements of the combined code.
• Disclosure of Financial risks
• Increasing Transparency
• Monitoring and control

The Cadbury report in 1992 informed that the importance of an effective system of internal control should be comprised of the audit committee, internal audit function and the external audit linked together effectively.

The Audit committee has been identified as the foundation of effective corporate governance and it states that they should be interconnected to the board of directors regarding risk management (Solomon, 2013). Deloitte and Touche (2005) presumed that the larger the boards are, the less effective they are in monitoring and controlling the financial reporting process. One evidence was derived that the economic crunch in Europe represented a radical redefinition of the nature of internal control as a feature of corporate governance, explicitly aligning internal control with risk management (Brandon, 2004). In addition, bankers, regulatory bodies and financial system acquired most of the criticism (Gupta and Nayar, 2007). Moreover, internal checks are compulsory processes which define day to day administrative controls routine while ensuring that the work of one person is independently proved by that of another person in the normal course of work (Coram, 2008). One study piloted by Tunji (2013) stated that many banks did not have an adequate board to have access to the risk-relevant information to ensure that the risk management system were in motion. This happened because there were irregular meetings between the risk management committees and board of the banks. One example to backup this argument will be the scandal that happened in 2008 by the Lehman Brothers. Sraders (2018) stated that they Hid over $50 billion in loans disguised as sales and this was done by selling toxic assets to Cayman Island banks with the understanding that they would be bought back eventually. Lehman brothers created the impression that they had $50 billion in cash and $50 billion less in toxic assets. New York Times (2018) discussed that the public would never doubt that they were doing illegal transactions since they were ranked the first ‘Most Admired Securities Firm’ by Fortune Magazine.

Ebaid (2011) proposed that the second tool of internal control is the internal audit function. This was traditionally designed so as the firms’ assets are safely safeguarded and mainly assisted in the production of reliable accounting information for decision-making. The internal audit’s perspective is to have an independent, objective assurance and consulting activity designed to add value and improve an organization’s operations (IIA, 2009). Dichev (2011) stated that to evaluate and improve the effectiveness of risk management, control and governance process an internal audit fits more accurately. For example, it has been assessed that six percent of US companies’ that did not have an internal audit, lost revenues in 2002 through fraud committed by employees (Holtfreter, 2004) and of the 491 Australian and New Zealand companies who responded to the KPMG survey in 2004, almost half had experienced a fraud costing them $457 million (KPMG, 2015) resulting in the malfunctioning of internal control.

Moreover, the external audit represents one of the most vital paradigm in a firm’s system of internal control because it helps in monitoring the corporate governance checks and balances, henceforth increasing transparency (Solomon, 2013). The audit function from the view of an agency theory is helping shareholders in the monitoring and control of a firm’s management area. The external audit mainly emphasizes on the area of fraud in a company and make financial statements more credible to disclosure (Obosi, 2006). Indeed, the auditing is an important department in the company and one example to prove that is the fall of Enron which occurred due to the failure of the external audit function (Hermanson, 2000) and because of that the Smith report came into occurrence to tackle this incident. The smith report (2003) denotes that there should be a certain amount of information disclosure between the appointing auditors and the shareholders. Furthermore, to maintain the effectiveness of external auditors, the Cadbury report imposed the idea of rotation of auditors as this could be a means of avoiding cosy auditor-client relationship resulting in better auditor independency (Cadbury, 1992). In awareness with the agency theory, there is evidence that shareholders considered that the external auditors’ actions in accounting information are credible because the share prices react to earnings announcements (Abott and Peter, 2003).

Academic researchers such as Intosai (2008), Sullivan & Cromwell (2007) argued that credit ratings may be affected by internal governance mechanisms instituted by firms and that the quality of internal controls is interconnected with cost of equity capital. In July 2005, firms that had a lower internal control quality were more likely to have lower credit ratings which results in speculative-grade rating, lower profitability and lower cash flows from operating activities (PCAOB, 2007). Studies showed that there were net losses in the current and prior fiscal year compared to firms with high-quality controls (Strawser, 2017).

A survey was conducted by Alkhafaji (2007) and 92% agreed that effective internal controls are an essential ingredient of good corporate governance. However, the remaining 8% was of a different opinion, saying corporate governance does not have any relationship with effective internal controls since some banks can outsource the services of control department. Coffee (2006) argued that the firm should adopt sound and effective internal controls and avoid the risks of poor board oversight and issues of directors who sit on the board just to selfishly enrich themselves. For example: In the United Kingdom in 1991, the Bank of Credit and Commerce International (BCCI) collapsed due to fraud by top executives costing depositors and investors large sums of money amounting to 6 billion pounds nearly half the bank’s assets (GlobalTimes, 2018). Additionally, Larcker, Richardson and Tuna (2007) deduced that to have a good and efficient internal control, there should be more non-executive directors to acquire independency on the firm thus, reducing the risk of frauds.

In addition, some of more real life examples are as followed: Mensah et al, (2003) found empirical evidence in Ghana that effective internal control improves good governance practices and decreases the corruptions in various firms among the shareholders and the agents. Another real life example on the effectiveness of internal control is the 2012 report from Mark Spencer stating that they disclosed information about their board of directors. Studies have shown that the company has improved in the communication between the agents and the shareholders, their risk profile has developed in a positive manner and they have made huge progress on acknowledging risks and taken up the necessary actions to handle the strategy (Mark & Spencer, 2012).

Recommendations and conclusion

To conclude, the results obtained clearly supported the assertion that the effectiveness of internal control systems contributed to a good corporate governance in financial institutions. Also, the success of the system is proportional to positive internal control culture as mentioned in the literature review. Also, auditors play a major role in the effectiveness of good internal control.

In addition, Banks should have an inclusive internal control management process to identify, measure, monitor and control internal control system effectively and with great compliance. Furthermore, financial institutions need to cultivate an ethical culture of doing business from the top management escalating down to the most junior employee in the organization so as to promote adherence to internal controls in a competitive environment. Additionally, firm credit rating is a function of internal control quality and financial reporting is mandatory for the proper preparation of the reliability of financial statements, the quality of which impacts information risk and credit rating. Regulators should be interested in this implication to the relatively recent SOX legislation. However, no system of internal control can guarantee the prevention and detection of all control deficiencies that result in the inability to achieve organizational objectives. Changes in the external environment may result in conflict or in the manner in which internal control systems operate, create risks to the organization’s objectives that the internal control system may fail to manage. Besides, Economic crunch exposed the weaknesses of the financial sector and the fragility of the internal control. Thus, Internal Control Standards for the Public Sector must to be revised. Finally, the regression analysis emphasized the significance of corporate governance components in reducing the level of fraud in which the Internal audit plays the major role.

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1.1 Introduction

This section will mainly focus on the background of the problem which will be about what has caused the problem. Also the research will focus on the main aims of this research and research objectives giving the reader a clear picture of what the researcher wants to achieve. The research will also come across the significance of the study giving the importance of why this study is being carried out. Moreover the research will focus on the limitations of the research meaning the effects that the researcher may come across when conducting a research.

There are other sections that the study will come across. One of those sections is the literature review. This section will focus on the perceptions or the views of other authors relating to the internal controls on the revenue collection.

1.2 Background of the study

Botswana Unified Revenue Services continues to face low levels of revenue collection. This study will find out the internal controls that may be put in place so as to curb out the problem. There are many Batswana whom shall pay tax and they are not doing so. Remember that it is the right of every Motswana earning P3600 per month to pay tax. Even though they know that, they are not paying tax hence resulting in low generation of tax revenue. This research will look more into the relationship between internal controls and revenue collection in Botswana Unified Revenue Services (BURS).

Having strong internal controls in an organization will make high chances of giving a high assurance that all that is expected out of a company is being met. One may find out that sometimes internal controls are being put in place so as to solve agency problem.

One may find out that there are some internal controls that are being put in place at BURS but there are still some leakages. Even though there are some internal controls, the government is continuing to generate less revenue in tax collections.

This study will therefore look into the effectiveness of internal controls in revenue collection in BURS. This research will look more onto the internal controls that are into place at BURS and their impact in the revenue collection at BURS. After this research, the department should set up internal controls that they think are the best so that they can increase revenue collection at BURS and even come up with how they have to improve internal controls that are already in place.

1.3 Theoretical foundations

There are some theories that link very well to the internal controls and revenue generation. This research project will be based on the internal controls that are put in place and how they contribute towards revenue collection in BURS.

Hypothesis has been portrayed as ‘an inter-disciplinary part of designing and science that manages the conduct of dynamical frameworks with information sources. The outside contribution of a framework is known as the reference. When at least one yield factors of a framework need to pursue a specific reference after some time, a controller controls the contributions to a framework to get the ideal impact on the yield of the framework. The goal of a control hypothesis is to figure answers for the best possible restorative activity from the controller that outcome in framework steadiness, that is, the framework will hold the set point and not sway around it. Frameworks (Sarens and Beelde 2006) have data sources and yields to bring an item in the wake of preparing thus data sources and yields of a control framework are commonly related by differential conditions. Setting targets, spending plans, plans and different desires set up criteria for control. Control itself exists to keep execution or a situation inside what is normal, permitted or acknowledged. Control worked inside a procedure is inward in nature. It happens with a blend of interrelated segments, for example, social condition affecting conduct of representatives, data important in charge, and arrangements and methods. Inner control structure is an arrangement deciding how interior control comprises of these components (Sanusi and Mustapha, 2015).

Internal controls concept

According to Hilario (2015), he explains that internal controls are one of the important aspects that every business should adhere to. He explains them as set standard and principles that are used in the business so that they can help to detect fraud and error. He said that these internal controls should be realistic and should bas on the truth so that the business can be able to achieve what it has set.

According to Obat (2010), BURS was framed to create enhance income accumulation measures just as ensuring that all income spillages are shut. He continues to explain that these internal controls were meant to avoid some of the individuals to cheat the government by not paying tax. It was likewise to guarantee that it speeds up exchange by setting up those measures that permit controlled development of commodities and ventures. BURS in this manner have set up those measures to decrease the spillages. They perpetually incorporate isolation of obligations, care of benefits, exacting approval strategies, inner review, and the utilization of passwords, legitimate record controls and the executive’s supervision.

Revenue concept

According to Rittenberg and Schwieger (2005) he explains that revenue is an asset that is in monetary form which enhances the organization activities. They continue to say that this asset is mostly in cash form and they are paid by all eligible customers. When analyzing the organization performance one has to look at how much was collected and the wealth that has been created. In order for the business to have better revenue collection, it has to take into consideration all the different stakeholders that have an impact in revenue generation. All the companies should have in place the internal controls that will be effective for revenue collection.

Relationship between internal controls and revenue

According to Jersen (2003), he explains that internal controls are being put in place so as to give a high assurance that things are being done in the correct way. Doyle (2005) explains that internal controls are being put in place so as to deal with problems that are associated with the low levels of revenue generation. It continues to tell us that these internal controls they help in the fighting of fraud and corruption that can take place in revenue generation.

When internal controls are being put in place they can help to make high values of revenue generation. This is due to the fact that every stakeholder will perform his or her responsibility. It explains that there are five internal controls that are there that can help in revenue generation. These internal controls will be explained further in literature review.

1.4 Statement of the Problem

‘BURS’ continues to face the low levels of tax collection because people do it intentionally knowing that they will be avoided. Regardless of the rules and regulations that put in place there is fluctuation on the levels of tax revenue generation and collection which is happening across all the sectors of the government as well as private sectors. Internal controls are only designated to make sure that the company’s aims are being met in terms of revenue collection. In analyzing the problems related to this, is to check whether there are internal control systems in preventing and detecting of the problem that led to the losses. Internal controls are designed to give the company the confidence in its aptitude to achieve a particular task and avoid errors and losses through monitoring and improving organizations and financial reporting processes as well as ensuring compliance with laws and regulations. The internal controls on the tax revenue generation have caused effectiveness in the performance of the finances. A research has been carried out in respect of the effect in the internal control system on tax revenue collection. Regardless of the internal controls that are put in place in BURS, the revenue collection remains below the target market and the resources are being poorly managed. This is due to the fact that the internal controls that are put in place are weak. This is because people are being too slow to pay their taxes on time and some are being corrupt. The authority has identified that one of the major causes of low revenue collection is corruption which has led to the integrity plan action being formed which will lead to transparency thus reducing corruption in revenue collection. Thus, the idea of this research is to inspect and assess the internal control system in procedure at BURS with the outlook of knowing whether escalation of internal controls can have any impact of revenue collection and to answer the question “To what degree has internal controls enhanced revenue collection in BURS in Francistown.

1.5 Aim of the study

This study aims to establish best internal controls that will help to generate revenue at BURS.

1.6 Research Objectives

The study aims to achieve the following:

1. To identify the controls those are put in place by BURS in the revenue collection.
2. To establish the importance of the internal controls in enhancing revenue collection at BURS in Francistown.
3. To suggest the best practices of internal controls that can be used in BURS to enhance revenue collection.

1.6.1 Hypothesis

The hypothesis is that there is no important effect of internal controls on revenue generation at BURS in Francistown.

1.6 Research Questions

1. What are the internal controls that are put in place by BURS to enhance revenue collection?
2. What is the importance of internal controls in enhancing the revenue collection at BURS in Francistown?
3. What do you think are the best practices that can be put in place in order to enhance revenue collection in BURS here in Francistown?

1.7 Significance of the study

This research would be critical to BURS as it will help the company to recognize the effectiveness of internal controls that they put in place in order to enhance revenue generation. The research will help the company to find out if there are any weaknesses with the internal controls and help them to find a way better of improving them so that they become effective. This research will furthermore help the employees of BURS to work tirelessly accordingly to the internal controls so that they can be able to meet the set objectives. The study will help the researcher to know more about the background of the internal controls and how they function at BURS.

1.8 Scope

The scope of the research will be based on the relationship between internal controls that are put in place at BURS and the revenue generation. There are different methods that will be used in order to collect data. These include the use of questionnaires and interviews. The data collected will then reveal all the efforts that the company has put in place in order to increase the levels of revenue generation at BURS.

1.9 Limitations of the study

One of the limitations of this study is that there is less time that we are supposed to complete this project. Also it is costly to do this research project as I have to pay for transport costs and other expenses that are needed in order to complete the project. The management of BURS may not want to disclose some of the information as they feel that it is confidential.

1.8.1 Mitigation measures

I intend to do all the work required from me well on time so that I can catch up with time. Also I will be saving so that I can be able to pay well the expenses without constraints. Some of the information will be taken from the government portal for incase the management do not disclose some information.

Summary

From this chapter we have learnt out that there can be internal controls that are put in place in order to generate revenue at BURS in Francistown but they are not giving that high confidence that they are doing well. This is due to the fact that the researcher has found out that even though the internal controls are being put in place, BURS in Francistown continues to generate low levels of revenue. The researcher then came with the research objectives and questions that were discussed above which shall then give a true picture of what might be the problem. This project shall play a very important role as it will help BURS to recognize the effectiveness of internal controls that they put in place. It shall also help the effectiveness of each employee as they will have to perform their responsibilities knowing that they have to meet all the aims of the company. The researcher is likely to face some challenges in the process as there is less to do the project. Even though this problem, the researcher will make sure that she plans her time well so that she can be able to catch up.

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