INTERNAL CONTROL SYSTEM'S EFFECT ON FRAUD DETECTION AND FRUSTRATION IN AN ORGANISATION

INTERNAL CONTROL AND FRAUD PREVENTION
June 18, 2020
impact of information and communication technology on adult education delivery in Lagos State
June 18, 2020

Price: 2000 Naira (BSC, MSC)

ABSTRACT

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CHAPTER ONE

INTRODUCTION

Although, the changes in the Nigerian banking industry have been spectacular, there is yet still, the need to do more. In the year 2010, 14 of the top 100 and indeed top 20 companies in Nigeria were from the banking industry. Forbes’ magazine (2012), listed 20 Nigerian companies that made up the top 25 West African companies and 9 out of the top 20 were also from the banking sector. This shows that we can no longer afford to leave banking totally to the bankers because the only active players left on the economic playing field are the banks; the other players being already wounded – either limping (oil and gas), or in the case of manufacturing, confined to the wheel chair (Akano, 2008).Ajayi (2005), maintained that banking sector reforms in Nigeria are driven by the need to deepen the financial sector and reposition the Nigerian economy for growth; to become integrated into the global financial structural design and evolve a banking sector that is consistent with regional integration requirements and international best practices. This therefore calls for effective internal control systems to surmount the mounting pressures of constant fraud.Internal control which is the strength of every organization as it were has become of paramount importance today, especially in Nigerian banks. The need for internal control systems in banks cannot be undermined due to the fact that the banking sector, which has a crucial role to play in the economic development of a nation, is now being characterized by macro economic instability, slow growth in real economic activities, corruption and the risk of fraud.Internal control would always have an effect on fraud detection and frustration, depending on the strength of its effectiveness. It should be emphatically stated that if fraud is not taken care of, it would cause serious problems which may invariably lead to the liquidation of the organisation. The prevention of fraud through internal controls would contribute immensely to
the development of the organisation and ensure continuity as well. It would also portray the good corporate image of the firm in the outside world leading to economic growth in its own proportion.Fraud, on one hand, comes in all sizes ranging from dollar cases of corporate fraud to cases of employee embezzlement and also to employees overcharging their expense report; all in manual forms in time past.Today, all transactions are gradually going digital since we now live at the dawn of the information age, and as a result, a more than usual attention is being required to be directed towards systems security, internal control and audit. This is because of the rapid growth of wireless technology and its increasing use in providing financial services, either in coordination with the internet or on a freestanding basis. There is even more demand for a careful look at issues that relate to internal control systems and audit.The incident that brought both Enron Energy Incorporation and Arthur Andersen Worldwide, during the second and third quarters of 2001, and then WorldCom in the year 2002, to the news leaves a lot to be pondered, considering the numerous and ripple implications it had on the companies involved and what their present positions and perceptions are in the light of the aftermath of the major financial scandals that surrounded them.Fraud, which is the progenitor of forgeries, indiscriminate granting of loans, illegal interbank transfer, false entries and other unwholesome practices is the most debilitating of ailments attacking the banking sector even till date. Although fraud in banks is a global phenomenon, its growth in Nigeria banking industry has been astonishing and this has resulted in huge financial losses to banks and their customers, the depletion of shareholders’ funds and banks’ capital base
which at a future time may inevitably lead to bank failure. Evident to this is the trauma that metwith the banking industry in the year 2009 where banks that had supposedly been performing well over the past years announced heavy losses due to credit exposures most of which were granted after disregard to the regulation guidelines on the granting of credits and other fraudulent practices. The problem of fraud in banking industry is not limited to any economy, nation, continent or even environment; it is simply a general phenomenon. The origin of bank failure in Nigeria can be traced to the 1930s during the bank failure and crises. Nwankwo (1994, as cited in Owolabi, 2010) stated that the crisis of confidence in Nigerian banking industry is not a new one; it has been with us for quite a long time. It occurred in the 1930s when all indigenous banks, except one (National Bank), collapsed. It occurred again during the banking ‘boom and crash’ of the late 1940s when all but four indigenous banks escaped the “liquidator’s hammer”. Also between 1952 and 1954, 16 out of 21 indigenous banks failed.Suffice to say that Nigeria equally witnessed many failed banks and finance houses in the late 1980s and 1990s. In the late 1990s, 26 failed banks were liquidated at once while others went through various surgical operations ranging from, restructuring, renaming, acquiring and complete sales to new investors, leaving the country with only one surviving indigenous bank and one thing that was constant in all the reforms was the prominence of fraud factor in major failures.The Chief Executives of many banks absconded abroad while some were tried due to their involvements in employee-related frauds and money laundering scams. Nigeria has also witnessed and is still witnessing corruption in all facets of her polity and economy which
includes the banking sector. There is value erosion in Nigeria. Social values are fast eroding and quest for material wealth is dominant, reasons why even staff members inculcate schemes to outsmart existing internal controls in Nigerian banks.The level of fraud in Nigeria has assumed an epidemic dimension. It has eaten deep into every aspect of life to the extent that even a three year old child talks about ‘419’, the most known sobriquet for Advance fee fraud, which is haunting us as a nation. Frauds are on a frightening scale and hence, a sophisticated consequence berths upon the general economy like the depression of the last decade. Over the years, the growth rate in occurrences of fraud attempts (successful and unsuccessful) has been shocking (Bolton and Hand, 2002). Though the industry is becoming more militant and vigilant, millions of naira is still being lost on a daily basis (Akindele, 2011). Attributed to this significant percentage of frauds is the collusion between staff of banks and the fraudsters, which constitutes a very serious economic crime. In Akindele (2011), the Nigeria banking industry was likened to not just a battle front with a clear cut firing line between banks and bandits but a veritable mine field in which some banks and their top management staff are in secret leagues with the enemy. It was stated that only the measured alertness and collaboration of genuine banks together with improved supervisory measures from CBN and NDIC will terminate such pirate organizations.As it were, fraud seems to have increased as new technology is born and more advanced techniques of enhancing business transactions are being developed. Fraudsters are constantly devising new plans, updating old methods and trying out new techniques of bypassing these electronic systems meant to ensure high security of banking operations. The introduction of automated systems that loose handwriting and fingerprint trails have not helped matters either
because Nigeria has failed to keep up with technological advancements due to her lackadaisical attitude towards maintenance and improvement.There are several keys to effective fraud prevention, but some of the most important tools in the corporate toolbox are strong internal controls. Therefore, an effective fraud prevention/ frustration and detection strategy must be adapted to the ever-changing schemes; as internal controls and technology change the operative environment of most companies. Nigeria cannot hence, still afford to trail far behind this global trend, especially now that other “developed and developing” countries are striving to keep abreast with the advancements in information and communications technology (ICT).The Effectiveness of internal control would provide examiners the reasonable assurance that;i. Bank operations are efficient and effective.ii. Recorded transactions are accurate.iii. Financial reporting is reliable.iv. Risk management systems are effective.v. The bank complies with banking laws and regulations, internal policies, and internal proceduresMoreover, control systems can help bank managers measure performance, make decisions, evaluate processes, and limit risks. Good internal control can help a bank achieve its objectives and avoid surprises. Effective control systems may detect mistakes caused by personal distraction, carelessness, fatigue, errors in judgment, or unclear instructions in addition to fraud or deliberate non-compliance with policies, although effective and well-designed control systems
are still subject to execution risk, that is, humans still execute most control systems. As a result, even well trained personnel with the best of intentions can become distracted, careless, tired, or confused, Internal control must still be consistently applied and well understood by bank staff if board and management policies are to be effectively implemented.This study seeks to establish the effect of Internal Control System on fraud detection and frustration in an organization.1.2STATEMENT OF THE PROBLEMDescribing, as a frightening proportion, the degree at which staggering sums of money arelost to fraudsters by the Nigerian financial sector in these recent times and the rate at which fraudsters tend to shift their attention and direct their energies to banks, devising all unimaginable tactics to exploit loopholes in the control measures and capitalize on carelessnessof the staff and customers, would only seem to be an understatement. This is due to the simple and bitter truth that fraud in the industry has prevented many organizations (banks inclusive) from achieving their laudable objectives and indeed, goal. Some banks are just seen in the physical as body, books and building but they have already been liquidated while some othersare already into distress. Taking a walk down memory lane, one can name a number of banks that were wound up or distressed due to fraud. The increased ability of criminal organizations to operate internationally is a potential danger for social and economic order in every country. The huge potential profits to be gained from such organized crimes encourage criminals, who were already involved in the less serious crimes, to extend their activities to organized crimes such as fraud, corruption, bribery, forgery, misrepresentation and money laundering on a national and international scale. In terms of how much hard cash is involved, armed robbers or those who
break and enter doors and windows, do collectively less harm to a country’s economy than those who are able to manipulate others by their persuasive powers, manipulate financial statements of companies, offer unfounded securities, commit forgery, organize credit card schemes, accept bribes or persuade the helpless and unfortunate to forego proper medical aid for quackery, as well as attempt other cute tricks to separate the unsuspecting and trusting citizens from their property. There have been many attempts to measure the true extent of fraud, but compiling reliable statistics around fraud is not easy, as one of the key aspects of fraud is deception, it can be difficult to identify, and different results from various surveys often only reflect the instances of fraud that have actually been discovered both within and outside the banking industry. It is estimated that the majority of frauds go undetected and, even when a fraud has been found, it may not be reported. One major reason for this may simply be that a company that has been avictim would not want to risk negative publicity. Also, it is often hard to distinguish fraud from carelessness and poor record keeping. Hence, the total losses experienced each year due to fraud operations are virtually impossible to calculate accurately. This type of crime, from a policing perspective, is detectable rather than preventable; even a large increase in the number of patrols, or a separate detective division would have negligible effect (Dechant, 2009). Contrary to popular belief, fraud occurs in companies which are effectively managed. For one to guarantee that fraud will not take place in an operation under his or her control is tantamount to frying plantain with fuel. In fact, it would be untenable to maintain a control system that eliminates all risks, and even if it were possible, the resulting lack of trust and bureaucracy would make life intolerable. Trust and effective management are symbiotic, and fraud is the result when the former is abused. The best and most hardworking employees are often the easiest to deceive.
These employees are often so focused on their primary work responsibilities that they do not have time to pay attention to details that appear unimportant, until it is too late. It is easy to be wise after the event, and fraud is always concealed in the detail (Comer, 2003).Therefore, fraud as a common phenomenon in our banking industry has perpetrated an agonizing influence leading to bad faith, loss of confidence and a significant reduction of trust in the industry by its depositors. The fundamental problem that, hence, triggered this study is “why has internal control system repeatedly had a poor effect on detecting and frustrating fraud”?1.3OBJECTIVES OF THE STUDYThe main objective of this study is to give a critical appraisal of the effect of Internal Control System on fraud detection and frustration in an organisation. Summarily, the specific objectives are to:i.appraise the effect of Internal Control System on fraud detection and frustration in an organisation.ii.examine the relevance and appropriateness of control measures adopted in preventing fraud.iii.ascertain how an effective Internal Control System can enhance the performance of the banking industry.iv.determine how a poorly effective internal control system will ensure fraud execution.v.ascertain the impact of Information and Communications Technology in reducingincidences of fraud.
1.4RESEARCH QUESTIONSIn order to achieve the objectives of this research work, the following research questions have been put forward:i.How does Internal Control System affect the detection and frustration of fraud in an organisation?ii.How do internal control measures, adopted nowadays, with respect to relevance and appropriateness, frustrate and/or detect fraud?iii.How does effective Internal Control System enhance the performance of the banking industry?iv.How does a poorly effective Internal Control System ensure the execution of fraud?v.How does Information and Communication Technology help to reduce incidences of fraud?1.5FORMULATION OF HYPOTHESESFor the purpose of this research, five hypotheses have been formulated – the NULL (H0) and the ALTERNATE (H1) – and they are as follows;i.H0: There is no significant relationship between the effect of internal control system and the detection and frustration of fraud.H1: There is a significant relationship between the effect of internal control system and the detection and frustration of fraud.ii.H0: Adoption of control measures has no significant effect on fraud prevention.H1: Adoption of control measures has a significant effect on fraud prevention.
iii.H0: Effective Internal Control System has no significant effect on good performance of the banking industry.H1: Effective Internal Control System has a significant effect on good performance of the banking industry.iv.H0: existence of a poorly effective Internal Control System is not a major cause of fraud in the banking industry.H1: existence of a poorly effective Internal Control System is a major cause of fraud in the banking industry.v.H0: Information and Communication Technology has no significant effect in curbing the incidences of fraud.H1: Information and Communication Technology has a significant effect in curbing the incidences of fraud.1.6SIGNIFICANCE OF THE STUDYThis research work is of utmost relevance to business organisations, researchers, students, accountants, auditors, fraud examiners and the general public at large. It buttresses on the effectiveness of Internal Control System and how it helps to detect fraud while also frustrating it.In addition, it is of great importance to business organisations (banks especially) as it showcases the lapses of Internal Control System and ways of improving them in preventing and/or detecting fraud. Control systems can help bank managers measure performance, make decisions, evaluate processes, and limit risks.
Furthermore, to researchers, it will be of great input to their research work while to students, it will broaden their intellect and make them see reasons why Internal Control System is highly expected to be effective.Moreover, Accountants, auditors and fraud examiners are not exempted from the importance of this study as it would endear them towards creating a new or improving on an existing InternalControl System for any organisation.And lastly, to the public at large (depositors inclusive), it will enable them to become conscious and cautious of Internal Controls in organisations (banks) when performing financial and physical transactions with them.1.7SCOPE OF THE STUDYThe content of this research work on Internal Control System should not be seen as being totally exhaustive of all possible situations available in the Nigerian banking industry on the theme of this study due to the vast size of the banking sector and boundless nature of the study. Based on this fact therefore, the researcher is limiting his activities to Internal Control System’s effect on fraud frustration and detection in an organisation with a case study of GUARANTYTRUST BANK PLC (GTB) in Lagos State, Nigeria. The period covered is from year 2008 –2012, i.e. 5 years.1.8LIMITATIONS OF THE STUDYIn the course of this research work, some hindrances were encountered which have, in one way or the other, caused some limitations to the research work. They include;i.Inability to get full access to relevant materials for a more expansive research
ii.Constraint of finance: inadequate cash availability as a limitation to this research work.iii.Constraint of time: insufficient time period to do a more expansive researchiv.Academic workload: other academic responsibilities also limit the research work not being as in-depth as desired.v.Lack of adequate facilities to work with.Despite the hindrances posing a threat in the course of this research work, the researcher however wishes to categorically emphasize that these hindrances would, in no way, hamper the validity of the research work.1.9OPERATIONAL DEFINITIONSThe following unfamiliar terms are used in the course of this research work including their meanings:i.419:The number “419” refers to the article of the Nigerian Criminal Code dealing with fraud. The scam has been used with fax and traditional mail, and is now used with the internet.ii.ACCOUNTING, INFORMATION, AND COMMUNICATION SYSTEMS: these capture and impart pertinent and timely information in a form that enables the board, management, and employees to carry out their responsibilities. Accounting systems are the methods and records that identify, assemble, analyze, classify, record, and report a bank’s transactions. Information systems produce reports on operations, finance, and compliance that enable management and the board to run the bank. Communication
systems impart information throughout the bank and to external parties such as regulators, examiners, shareholders, and customers. iii.ADVANCE FEE FRAUD:this is when fraudsters target victims to make advance or upfront payments for goods, services and/or financial gains that do not materialize.iv.CBN:The Central Bank of Nigeria was established by the CBN Act of 1958 and commenced operations on July 1, 1958. The major regulatory objectives of the bank are to maintain the external reserves of the country, promote monetary stability and a sound financial environment, and to act as a banker of last resort and financial adviser to the federal government.v.CHEQUE KITTING: This happens when a depositor utilizes the time required for a cheque to clear to obtain an authorized loan without interest charge. vi.COUNTERFEIT SECURITIES: This is one of the oldest forms of crime. Documents, securities, bonds and certificate could be forged, duplicated, adjusted or altered and presented for loan collection. vii.DECEPTION: this is an act to propagate beliefs that are not true, or not the whole truth (as in half-truths or omission). Deception can involve dissimulation, propaganda, and sleight of hand, as well as distraction, camouflage, or concealment.viii.FORGERY: The creation of a false written document or alteration of a genuine one, with the intent to defraud.ix.FRAUD: In criminal law, fraud is intentional deception made for personal gain or to damage another individual; the related adjective is fraudulent.
x.INTERNAL CONTROL EVALUATION QUESTIONNAIRE: is used to check whether a certain existing control is operating effectively or not to detect or prevent and correct a material misstatement (or simply misstatement) at an assertion level.xi.INTERNAL CONTROL QUESTIONNAIRE: is used to check whether a particular control exists or not to detect or prevent and correcting a material misstatement (or simply misstatement) at an assertion level.xii.INTERNAL CONTROL: In accounting and auditing, internal control is defined as a process affected by an organization’s structure, work and authority flows, people and management information systems, designed to help the organization accomplish specific goals or objectives. It is a means by which an organization’s resources are directed, monitored, and measured.xiii.MONEY LAUNDERING: The process of creating the appearance that large amounts of money obtained from serious crimes, such as drug trafficking or terrorist activity, originated from a legitimate source.xiv.NDIC: The Nigeria Deposit Insurance Corporation (NDIC) was established on 15 June 1988 to strengthen the safety net for the newly liberalized banking sector.xv.RED FLAG:This is a set of circumstances that are unusual in nature or vary from the normal activity. It is a signal that something is out of the ordinary and may need to be investigated further.

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