The Impact Of Internal Audit On Fraud Detection And Prevention

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The Impact Of Internal Audit On Fraud Detection And Prevention


Abstract


The purpose of this study is to examine the impact of Internal Audit on fraud detection and prevention with Power Holding Company of Nigeria as a case study. The effectiveness of the internal audit were carefully examine and the aim of the study is to ascertain the contribution of internal audit in fraud prevention in PHCN. The survey research design was adopted and a sample size of eight (8) was gotten using Taro Yamene’s 1964 formula out of the population of eight (8). In determining the number of questionnaire administered to the respondents, stratified random sampling and the kumar proportionate were adopted. The data for the study was gathered with a four point likert scale questionnaire. The study revealed that internal audit has statistical significance association on fraud prevention in manufacturing organization.

The study recommends that since services of a qualified internal auditor has statistical association on fraud prevention, detection and remediation in manufacturing company, management should always adopt the services of the Internal auditors in the firm so as to ensure no financial leakages and accountability in the firm.


Chapter One


Introduction

1.1 Background to the Study

Saying that fraud is an important (however not loved) part of business, is nothing new. Fraud is a million dollar business, as several research studies reveal. Among them are important surveys of Price Waterhouse & Coopers (PwC, 2007) and of the Association of Certified Fraud Examiners (ACFE, 2006). The study conducted in the United States by the ACFE in 2004-2005 and the worldwide study, held by PwC in 2006-2007 yields the following insights. No industry seems to be safe and bigger companies seem to be more vulnerable to fraud than smaller ones. Small businesses however suffer disproportionate fraud losses. 43% of companies worldwide have fallen victim to economic crime in the years 2006 and 2007. The average financial damage to companies subjected to the PwC survey was US$ 2.42 million per company over two years. Participants of the ACFE study estimate a loss of 5% of a company’s annual revenues to fraud. Applied to the 2006 United States Gross Domestic Product of US$ 13,246.6 billion, this would translate to approximately US$ 662 billion in fraud losses for the United States only. These numbers all address corporate fraud, more precisely internal fraud. About the way fraud is detected, both studies of PwC and the ACFE stress the importance of tips and chance. However, as a number two detection means in studies, internal audit and internal control systems can have a measurable impact on detecting fraud. The more control measures a company puts in place, the more incidents of fraud will be uncovered. Organizations allocate lots of resources to internal audit and control sto prevent internal fraud. These costs, together with the costs of fraud, represent a large economic cost for the business environment. Academic literature is currently investigating the use of data mining for the purpose of fraud detection. Brockett et al. (2002), Cortes et al. (2002), Est´evez et al. (2006), Fanning and Cogger (1998), Kim and Kwon (2006) and Kirkos et al. (2007) are just a few examples of a more elaborated list of articles concerning the hot topic of fighting fraud. Although a lot of this research may be framed in different settings -going from different techniques to different fraud domains-, there are two characteristics that stand for all executed research up till now: the focus is on external fraud and a predictive data mining approach is applied for fraud detection. We however are interested in internal fraud, since this represents mainly these large costs in the PwC and ACFE surveys. Further, we are convinced that not fraud detection alone, but detection in combination with prevention, is of priceless value for organizations. We use the term fraud risk reduction for encompassing both fraud detection and prevention. Fraud is the International distortion of financial statements or other records by a person (internal or external) to the organizational which is carried out to conceal the misappropriation of assets or otherwise for gain “(Adeniji 2004 and institute of chartered accountant Nigeria – ICAN 2006).

However, auditors have a significant role to play in the detection and prevention of fraud because they are not only agents of shareholders but their access to internal and external information makes them efficient monitor (Dyck, Morse &Zingales, 2008).The existence and in fact, the high incidence of fraud in company brings to mind the question of competence, skills, due care, honesty, and integrity of auditors in company or business enterprise, qualities are expected to be displayed by an auditor in every time in every circumstances (Olofin, 2005 &Agbaje, 2007).

Lorsase (2004) notes that when fraud occurs in work place, the question asked is “where were accountants and auditors? That an auditor has the responsibility for the prevention, detection, and reporting of fraud, and illegal acts and errors is one of the most controversial issues in auditing, and has been one of the most frequently debated areas amongst auditors, politicians, media, regulators and the public (Gay & Roger,2002) However, there seems to be misconception that auditors duties are largely the preventing, detecting and reporting of fraud (Idris, 2009). The internal audit unit is vested with the power of independent checks, in order to access compliance with established rules and regulations of the company (Okoya, 2002).Despite the fact that audit exist in various company with internal control system in place, but the act of financial crime still continues e.g. fraud, irregularities and even breaches of other control and no any strong measures being taken to prevent such occurrence.

Auditors are primarily concerned about fraud as it relates to misstatement in the financial statement (Bells &Carcello, 2000). So, auditing has a greater impact in the control of fraud and financial irregularities in companies that make effective use of their auditing system .The study tends to identify financial report users’ perceptions of the extent of fraud in company and to determine their perceptions of the auditor’s responsibilities.

Moreover, according to the Institute of International Auditors (1991), the internal audit unit is expected to review the means of safeguarding assets and where appropriate, verify the existence of such assets. Financial control has concentrated on the cash out flow, purchasing procedures and accountability of budget holders for current expenditure on resources inputs (Mainoma, 2007) and (Buhari, 2001). Therefore, internal auditing furnishes authorities with analysis, appraisals, recommendations and information concerning all activities reviewed. The survival of every organization depends on it effective and efficient utilization of resources (both financial and non-financial).The internal audit unit is vested with the power of independent checks, in order to assess compliance with established rules and regulations of the organization (Okoya, 2002).

According to Thompson (2003), internal auditing should not be restricted to financial transaction only. Internal auditors can equally assist management by ensuring that adequate financial and management controls have been implemented and are operating effectively or by identifying the weakness in such system and making recommendations toward their improvement. These include among others; internal audit with which errors are more likely to be discovered in their early stages. Existence of assets is verified so as to protect the assets of the company, errors in account can be corrected early once detected by the internal auditors, its acts as moral influence on the staffs and promotes efficiency by compelling the officers to keep on their books of account entered up to date, a detailed examination of the financial account submitted by contractors is facilitated, cash disbursement, such as for wages and salaries, may be checked before they are cashed.

The responsible for ensuring that internal control is established in the organization lies with management. The internal audit is supposed and to be custodian of internal control by providing assurance to the management that the company has put in place adequate and effective internal control system, and must not hesitate to draw management’s attention to lapses observed in the control. A good and visible internal control system increases operational efficiency, thereby making it more difficult for the preparation of fraud (Mayo, 2003). Effective internal control requires; appropriate accounting procedure and system, division of duties I.e. separation of responsibilities, especially those of authorization, regular verification of supervision of each person’s work by their superior officers. Internal control in its broad sense includes all controls operated by an organization to facilitate its activities and improve its efficiency and productivity. It also includes all administrative controls designed to effect, supervise and check management policies and strategies within an organization such as work study, production control, marketing, selling and distribution, financial and accounting control. The main objective of internal auditing is to provide assurance to management that the internal control system in the company is sound in design and effective in operation. It also helps to achieve value for money(Momoh 2005).

Okwoli (2004) also shares the view that the present requirement of internal audit is not the detection of fraud and errors, but reviewing the system of internal control. This is because in private company, internal audit is meant to carry out an independent appraisal of the effectiveness of internal controls and other financial controls in such ministry. Norm Anton as cited in Daniel (1999), emphasizes the importance of internal audit by saying that ‘’without audit, no efficiency, no development. The growth of any economy depends to a large extent on the system of control adopted by the management and the success and sustenance of the internal control lies on internal auditing. The above observation underscores the importance of internal audit in every organization of the internal control to effect.

Organization all round the world be it financial or otherwise needs auditing for proper assessment of their financial statements. In order to achieve set out goals and objectives, resources must be properly managed to get the profound results needed. (Joe, 2013).

Auditing in the Nigerian organizational system is relevant hence financial management in any company leads to the success and growth of the company. Auditing as a tool for accountability for efficient and effective company administration is clear term study which will educate us on the importance of company audit and how it will affect the staff if mismanagement of fraud eventually occurs.


1.2 Statement of the Problem

Unfortunately, the problem is getting worse. During the past year, both the number of fraud incidents and the dollar value of fraud increased dramatically, with 55.4 percent of respondents reporting increased fraud in the past twelve months. The economy has driven much of the growth. “Increased pressure” is cited as by far the biggest factor contributing to fraud. At 49.1 percent, it is comfortably ahead of increased opportunity (27.9 percent) and more than twice the rate of “rationalized” acts by the perpetrators (23.7 percent). As in prior downturns, the problem is expected to worsen. More than 80 percent of respondents indicated that they expect the incidence of fraud to increase. Thirty-six percent expect it to increase significantly. The greatest emerging source of fraud is employee embezzlement which accounted for a disturbing 48.3 percent of last year’s increase. Internally generated fraud — e.g. corruption, financial statement fraud, and embezzlement — are also expected to continue to grow substantially. Unfortunately, the poor economy like Nigeria is increasing the pressure to commit fraud in two ways. In addition to placing more personal economic pressures on employees, layoffs are depleting internal control systems. Nearly 60 percent of CFEs who work as in-house fraud examiners reported their companies had layoffs in the past year.

Among those who had layoffs, almost 35 percent of companies had eliminated some internal controls. Fraud is the use of one’s occupation for personal enrichment through the deliberate misuse or misapplication of the employing organization’s resources or assets, and is unfortunately, much more common in private than some owners realize. It has really been the undoing of many unlucky businesses. Private companies are likely to be victims of internal fraud, even much more than their larger counterparts (conventional Companies) as owners tend to put blind faith in their employees. They also neglect to take proper precautionary measures against fraud, which can add to the cost of doing business. The problem is that the trust that many owners o private companies placed in their employees is not always justified.

Clearly, fraud is a pervasive corporate problem, affecting organizations across industries and sectors without regard to size. Because of fraud’s disastrous consequences, failure to put deterrent procedures in place could put a company out of business within days. Fraud prevention, then, is a defined program of proactive measures to avoid or mitigate fraud. Failing to address these issues places a company at a competitive disadvantage when fraud becomes a cost of doing business. The study therefore, wants to ascertain how internal audit contribute to effective fraud control in organizations.


1.3 Objectives of the Study

As previously mentioned, audit quality is the output of audit practice, and one of the major elements of audit quality is fraud detection.

The objective of this study is to

  1. Determine the extent internal audit affects audit quality or audit fraud detection.
  2. Determine whether well organized internal audit could change orientation of workers towards frauds.
  3. Make possible recommendations.

1.4 Research Hypotheses

This study is required to test the following:

  1. H0: Internal audit does not contribute significantly to fraud prevention in PHCN.
    H1: Internal audit contributes significantly to fraud prevention in PHCN.
  2. H0: Internal audit does not contribute significantly to fraud detection in PHCN.
    H1: Internal audit contributes significantly to fraud detection in PHCN.
  3. H0: Internal audit does not contribute significantly to fraud reorientation in PHCN.
    H1: Internal audit contributes significantly to fraud reorientation in PHCN.

1.6 Significance of the Study

Of course, there are a number of specific ways in which fraud can be thwarted. Many of them provide additional ways to break up closed-off silos or encourage specific reporting. This study can give an insight on how to protect cash and cash receipts, have checks mailed by someone other than the preparer aer signing, have bank statements delivered to the owner unopened and have the bank accounts reconciled by someone independent of the cash receipts and disbursement functions. It will also examine how to protect inventory and minimize your cost of sales, periodically count cost and compare inventory to control accounts and/or perpetual records. Pre-number documents and account for the sequence when you develop forms for purchase orders, receiving, inventory transfers and shipping. You will also want to take some very concrete actions: Store expensive components, products or tools in a locked closet. Designate a single exit door for your employees. And, of course, check the trash. Segregated functions and specific purchases are your best strategies on the expense side. Separate requisitioning, purchasing and receiving functions from invoice processing, accounts payable, cash receipts and disbursements, and general ledger functions. Develop an approved vendor list to discourage under-the-table arrangements and shell vendors.
The work is very relevant in one way or the other to PHCN as a whole, primarily this study is designed for all those who may be interested in carrying out further study on internal audit system as it related to fraud prevention, detection and remediation in organizations in Nigeria.


1.7 Scope and Limitations of the Study

This research work covers internal audit system and how it could be structured and operated as a measure against fraud perpetration in the public sector i.e. how it can effectively prevent and detect fraud. Public sector as practiced in the Power Holding Company of Nigeria (PHCN) Enugu branch.

However, the following are the constraints encountered in the process of the research work.

Time:

Being a student with so much to do such as reading for the forthcoming examinations. Etc., time therefore, constitutes a constraint in the writing of this project.

Fund:

As a student with no steady sources of income, rather than the little form home. The present economic situation in the country today, has an adverse effect on the financial aspect of this research work.

Epileptic Power Supply:

The inadequate supply of electricity has been a major problem encountered during this study.

Respondent:

Non-challant attitude of some staff in the public sector, is also another limitation


1.8 Definition of Terms

It is very eminent to define some professional terms and language used in this work to make it easily understandable to interested readers of other disciplines.

Audit:

Ajembi (1999) describe audit as an examination by an individual or a firm of a set of financial statement and to the underlying books and records which result, the auditing provides an opinion on the financial statement. Audit here refers to internal audit.

Accountability:

This simply defined as the process of keeping and documenting all the relevant data of an event.

Stewardship Account:

This is an account required of the stewards or agents to render to the person they are subjected to the management of a firm render stewardship account to the members of the boards of directors.

Financial Statement:

This is a formal record of the financial activities and position of a business, person or other entity.

Shareholders:

This is a person who owns a share in an organization or firm.

Financial Irregularity:

This is the international distortion of the financial statement for whether purpose of misappropriation of fund.

Compliance Audit:

This is a kind of audit method carried to ensure that all books and records are in agreement with the laid down procedures and regulations.

Audit Risk:

These are the areas in which international auditors should be on the lookout, in the course of their audit exercise.

Audit Scope:

This is the coverage of the firm’s operation in the audit exercise that shall be specifically covered.

Audit Procedure:

This is the step by step technique which an auditor follows in his/her work duties or exercise.

Internal Audit Committee:

This normally comprises of the managing director, the finance controller of the head of finance and account and head of internal audit. This committee is mostly required to review the audit control of the organization.

Audit Manual:

An audit manual describes in writing, the objectives and procedure of internal audit programme.

Working Paper:

Audit working papers are those documents prepared or obtained by the auditor and retained by him/her in connection with his/her performance of the audit.

Audit Time Frame:

This is the interval which the internal/ auditor exercise is expected to be carried on firms operation before the end of the of the business year.


Background of PHCN

Electricity in Nigeria started towards the end of the 19th century, when the first generating plant was installed in the city of Lagos in 1898. Later other electricity undertakings were set up by the native and municipal authority in different parts of the country. The Electricity Corporation of Nigeria usually referred to as ECN, thus became the statutory body responsible for generating, transmitting and distributing of electricity to all electricity customers in Nigeria. This was achieved through decree No. 24 of 27th of June, 1972 which merged the Electricity Corporation of Nigeria (ECN) and the Niger Dams Authority to become National Electric Power Authority, currently known as the Power Holding Company of Nigeria.


Chapter Five


Summary of Findings, Conclusions and Recommendations

5.1 Introduction

This chapter deals on the summary of the findings, conclusions of the study, recommendation, suggestions for further studies.


5.2 Summary of Findings

This study was undertaken to examine the impact of internal audit on fraud detection and prevention. The study opened with chapter one where the statement of the problem was clearly defined. The study objectives and research hypotheses were defined and formulated respectively. The study reviewed related and relevant literatures. The chapter two gave the conceptual framework, empirical and theoretical studies. The third chapter described the methodology employed by the researcher in collecting both the primary and the secondary data. The research method employed here is the descriptive survey method. The study analyzed and presented the data collected in tables and the hypotheses were tested using the chi square to test hypothesis. While the fifth chapter gives the study summary and conclusion.


5.4 Conclusion and Recommendations

The research conducted has vividly opined to a reasonably extent the role of audit as an effective tool for fraud control in an organization. The failure of the management to adopt the services of the internal auditor in an organization can lead to fraud, loss of finance and lack of accountability. The growth of any economy depends to a large extent on the system of control adopted by the management and the success and sustenance of the internal control lies on internal auditing. Organization all round the world be it financial or otherwise needs auditing for proper assessment of their financial statements.

Having conducted this research and analyzed the field data, the researcher recommends the following points, which if adhered to will positively bridge the gender gap.

  1. Since services of a qualified internal auditor has statistical association on fraud prevention in manufacturing company, management should always adopt the services of the Internal auditors in the firm so as to ensure no financial leakages and accountability in the firm.
  2. Also, having discovered that service of qualified internal auditor has statistical association on fraud detection in a company, then the management should put in their best resources to ensure that experts in the field of auditing are employed to avoid biased result.

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