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

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Price: 2000 Naira (BSC, MSC)

ABSTRACT

CHAPTER ONE

INTRODUCTION
1.1 BACKGROUND TO THE STUDY
Every organisation has a raison d’être, which includes making products or rendering certain
services at a price. They have employees ranging from a small to a large number depending on
their sizes. The products manufactured or services rendered are meant to yield profit in the case
of profit-making organisations.
From the foregoing therefore, there is the need for all organisations to adopt a good
principle, practice, policy, structure and an effective system of checks and balances as these
cannot be over-emphasized due to the simple truth that they keep the organisation moving along
the desired lines as per the wishes of the owners while also protecting the assets of the business
leading to today’s successful business continuity in just about any economy.
The organisations that exist in an economy can either be profit-making or non-profit making,
the non-profit-making being non-governmental organisations and other institutions that render
ecclesiastical, charitable or educational services of a public character. The profit-making
organisations include, among others, the banks and insurance companies. However, the banking
system comprises the major cornerstone of any economy. So, for any economy to develop and
grow, the financial sector must be strong, solid, effective and efficient. The existence of an
effective banking industry is a panacea to growing any economy. In other words, the financial
sector, through its role in intermediating funds from the surplus units to deficit units, serves as
the pivot of any economic development. This also stimulates investment, economic growth and
employment as well as international trade and payment.
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 met
with 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
procedures
Moreover, 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.
1.2 STATEMENT OF THE PROBLEM
Describing, as a frightening proportion, the degree at which staggering sums of money are
lost 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 carelessness
of 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 others
are 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 a victim 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”?
1.3 OBJECTIVES OF THE STUDY
The 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 reducing
incidences of fraud.
1.4 RESEARCH QUESTIONS
In 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?
1.5 FORMULATION OF HYPOTHESES
For 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.
1.6 SIGNIFICANCE OF THE STUDY
This 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 Internal
Control 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.
1.7 SCOPE OF THE STUDY
The 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 GUARANTY
TRUST BANK PLC (GTB) in Lagos State, Nigeria. The period covered is from year 2008 –
2012, i.e. 5 years.
1.8 LIMITATIONS OF THE STUDY
In 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 research
iv. 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.
1.9 OPERATIONAL DEFINITIONS
The 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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