Project – Effective Internal Control System as a Means Of Detecting And Minimizing Fraud In A Manufacturing Company. (A Case Study Of Nigeria Bottling Company Ilorin Plant, Kwara State.

CHAPTER ONE

INTRODUCTION

• Background to the Study

An effective internal control system is a crucial component in detecting and minimizing fraud in a manufacturing company. According to the Committee of Sponsoring Organizations of the Treadway Commission (COSO), an internal control system is a process, effected by an entity’s board of directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives in the effectiveness and efficiency of operations, reliability of financial reporting, and compliance with applicable laws and regulations (COSO, 2013).

The system includes five interrelated components: control environment, risk assessment, control activities, information and communication, and monitoring activities. These components work together to prevent, detect, and correct potential misstatements, whether due to fraud or error.

The control environment sets the tone of an organization, influencing the control consciousness of its people (COSO, 2013). It is the foundation for all other components of internal control, providing discipline and structure. A strong control environment is characterized by ethical values, integrity, and competence of the company’s people, management’s philosophy and operating style, the way management assigns authority and responsibility, and the attention and direction provided by the board of directors. According to a study by Beasley, Carcello, Hermanson, and Neal (2009), companies with a weak control environment are more likely to experience fraud.

Risk assessment is the identification and analysis of relevant risks to the achievement of objectives, forming a basis for determining how the risks should be managed (COSO, 2013). In a manufacturing company, risks may arise from changes in operating environment, new personnel, new or revamped information systems, rapid growth, new technology, new business models, corporate restructuring, expanded foreign operations, and new accounting pronouncements. A study by Albrecht, Albrecht, Albrecht, and Zimbelman (2011) found that companies with effective risk assessment are less likely to experience fraud.

Control activities are the policies and procedures that help ensure management directives are carried out (COSO, 2013). They include a range of activities as diverse as approvals, authorizations, verifications, reconciliations, reviews of operating performance, security of assets, and segregation of duties. A study by Trompeter, Carpenter, Desai, Jones, and Riley (2013) found that companies with effective control activities are less likely to experience fraud.

Information and communication involve the identification, capture, and exchange of information in a form and time frame that enable people to carry out their responsibilities (COSO, 2013). Effective communication also must occur in a broader sense, flowing down, across, and up the organization. A study by Cohen, Krishnamoorthy, and Wright (2010) found that companies with effective information and communication are less likely to experience fraud.

Monitoring activities involve ongoing evaluations, separate evaluations, or some combination of the two to ascertain whether each component of the internal control system is present and functioning (COSO, 2013). Ongoing evaluations, built into business processes at different levels of the entity, provide timely information. Separate evaluations, conducted periodically, will vary in scope and frequency depending on assessment of risks, effectiveness of ongoing evaluations, and other considerations. A study by DeZoort, Hermanson, Archambeault, and Reed (2002) found that companies with effective monitoring activities are less likely to experience fraud.

An effective internal control system is a means of detecting and minimizing fraud in a manufacturing company. The system includes five interrelated components: control environment, risk assessment, control activities, information and communication, and monitoring activities. These components work together to prevent, detect, and correct potential misstatements, whether due to fraud or error. Companies with effective internal control systems are less likely to experience fraud.

• Statement of the Problem

The problem of fraud in manufacturing companies is a significant issue that can lead to substantial financial losses and damage to the company’s reputation. An effective internal control system is often touted as a means of detecting and minimizing such fraudulent activities. However, the effectiveness of these systems in practice is a subject of ongoing debate.

The first issue is the lack of a universally accepted definition of what constitutes an ‘effective’ internal control system. Different companies, industries, and regulatory bodies have varying standards and benchmarks, making it challenging to establish a clear and consistent understanding of effectiveness. This lack of clarity can lead to inconsistencies in the implementation and evaluation of internal control systems.

Secondly, there is the problem of human error and manipulation. Even the most robust internal control systems are susceptible to manipulation by individuals with a deep understanding of the system. This vulnerability raises questions about the system’s ability to detect and prevent fraud effectively.

Thirdly, there is the issue of cost versus benefit. Implementing a comprehensive internal control system can be expensive, and there is ongoing debate about whether the benefits of such systems, in terms of fraud detection and prevention, outweigh the costs. This cost-benefit analysis is particularly relevant for smaller manufacturing companies with limited resources.

Fourthly, there is a lack of empirical evidence to support the claim that an effective internal control system can detect and minimize fraud. While there are anecdotal reports and case studies, there is a need for more rigorous, systematic research to establish a clear link between internal control systems and fraud reduction.

Finally, there is the issue of compliance. Many manufacturing companies implement internal control systems primarily to comply with regulatory requirements, rather than to detect and prevent fraud. This compliance-oriented approach can lead to a box-ticking mentality, where the focus is on meeting minimum standards rather than striving for genuine effectiveness.

In conclusion, while an effective internal control system is often seen as a means of detecting and minimizing fraud in a manufacturing company, there are several challenges and issues that need to be addressed. Further research is needed to establish a clear understanding of what constitutes an ‘effective’ system, to explore ways of mitigating human error and manipulation, to conduct a thorough cost-benefit analysis, and to shift the focus from compliance to effectiveness.

• Aim and Objectives of the Study

The aim of the study is to examine effective Internal Control System as a Means of Detecting And Minimizing Fraud In A Manufacturing Company. The specific objectives of the study are:

1. To examine the role of an effective internal control system in detecting and minimizing fraud in a manufacturing company.
2. To identify the types of fraud commonly encountered in the manufacturing sector.
3. To evaluate the effectiveness of existing internal control systems in various manufacturing companies.
4. To propose improvements or enhancements to the internal control systems based on the findings of the study.

1.4. Research Questions

The research questions are buttressed below

1. What role does an effective internal control system play in detecting and minimizing fraud in a manufacturing company?
2. What types of fraud are commonly encountered in the manufacturing sector?
3. How effective are the existing internal control systems in various manufacturing companies?
4. What improvements or enhancements can be proposed to the internal control systems based on the findings of the study?

1.5 Research Hypothesis

The hypothetical statement of the study is stated below:

Ho: Internal control system cannot detect and minimize fraud in a manufacturing company

H₁: Internal control system can detect and minimize fraud in a manufacturing company

1.6. Significance of the Study

The significance of this study lies in its potential to shed light on the role of an effective internal control system in detecting and minimizing fraud in a manufacturing company. Fraud is a pervasive issue that can lead to substantial financial losses, damage to a company’s reputation, and even its eventual downfall. Therefore, understanding how an effective internal control system can help mitigate these risks is of paramount importance.

The second paragraph delves into the practical implications of the study. By examining the effectiveness of internal control systems in various manufacturing companies, the study can provide valuable insights for businesses in this sector. These insights can guide them in strengthening their own internal control systems, thereby enhancing their ability to detect and prevent fraud.

In the third paragraph, we discuss the potential for this study to contribute to the existing body of knowledge on internal control systems and fraud detection. Despite the prevalence of fraud in the manufacturing sector, there is a dearth of comprehensive studies examining the role of internal control systems in mitigating this issue. This study can help fill this gap in the literature.

The fourth paragraph highlights the potential for this study to inform policy-making. The findings of this study could be used by regulatory bodies to develop guidelines or standards for internal control systems in the manufacturing sector. This could lead to more robust controls and a reduction in the incidence of fraud.

In the fifth paragraph, we discuss the potential for this study to spur further research. The findings of this study could raise new questions or suggest new avenues of research, contributing to the ongoing scholarly conversation on this topic.

Finally, the sixth paragraph underscores the broader societal implications of the study. By helping to reduce the incidence of fraud, effective internal control systems can contribute to the financial stability of the manufacturing sector. This, in turn, can have positive ripple effects on the economy as a whole, including job creation and economic growth.

1.7. Scope of the Study

The study examines the effective Internal Control System as a Means of Detecting and Minimizing Fraud In A Manufacturing Company. (A Case Study of Nigeria Bottling Company Ilorin Plant, Kwara State.

1.8.  Operational Definition of Terms

“Effective” refers to something that is successful in producing a desired or intended result. It implies that something is functioning as expected and achieving its purpose.

An “Internal Control System” is a procedure or policy put in place by a company to ensure the integrity of financial and accounting information, meet operational and profitability targets, and transmit management policies throughout the organization. It’s a mechanism within an organization that helps it to achieve its objectives, such as promoting efficiency, reducing risk of asset loss, and helping ensure the reliability of financial statements and compliance with laws and regulations.

“Detecting” refers to the act of discovering or identifying the presence or existence of something. In this context, it means identifying instances of fraud within a company.

“Minimizing” refers to reducing something, especially something undesirable, to the smallest possible amount or degree. In this context, it means reducing the occurrence or impact of fraud.

“Fraud” is wrongful or criminal deception intended to result in financial or personal gain. It involves practices such as forgery, misrepresentation, or concealment of material facts.

A “Manufacturing Company” is a business entity that is engaged in the transformation of goods, materials, or substances into new products. The raw materials are transformed into finished goods through a set of production processes. These companies are involved in various industries such as food, textiles, machinery, chemicals, metal fabrication, etc.

Effective Internal Control System as a Means Of Detecting And Minimizing Fraud In A Manufacturing Company. (A Case Study Of Nigeria Bottling Company Ilorin Plant, Kwara State.