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AN APPRAISAL OF THE EFFECT OF INTERNAL CONTROL SYSTEM IN FRAUD PREVENTION

1.0 Introduction

Fraud itself is a polemic syndrome which is capable of crumbling economic growth. This is because, as the saying goes that ―prevention is better than cure‖, management of every organization must do everything humanly possible to prevent fraud from occurring. Lin and Koo (2011) opined that companies have to adjust their technologies and methods of internal control in accordance with computerization in order to exercise effective controls. Yang et al (2011) argued that internal control techniques used in an Information Technology (IT) environment are quite different from those used in a manual environment. Yang et al (2011) submitted that transactions are automatically triggered or executed in an IT environment, and the internal controls are supported with information technology, pointing out that the adaptation of internal control techniques are a critical management issue in order to ensure the efficacy of internal controls and the achievement of operational objectives. Prevention of fraud is more economical than the spill – over effect of allowing fraud to occur. The performance of organizations may depend on the ability of such organizations to deal with fraud. The performance of an organization indicates how effective a firm is able to use its asset to generate returns vis-a-vis the ability to control and avert the occurrence of fraud and safeguard the organization assets through necessary internal control mechanisms.

Shanmugan, Haat and Ali (2011) argue that fraud prevention, embezzlement, detection and accurate financials are all reasons to justify for good internal control practices. Over the years, management of different organizations has continually put in place several control mechanism to safeguard the organizations’ resources. Despite these efforts, fraud is still prevalent in most organizations. It is on record that where there is collusion and management override of controls, no internal controls procedures will work.

Statement of the problem

The focus of this paper is to empirically determine the effect of internal controls on fraud detection and prevention. This issue has scarcely been examined in Nigeria, particularly on the relationship between the elements of internal controls (segregation of duty, and system authorization) and fraud detection and prevention. However, it is important for organizations to understand the implications and impact of the different internal controls on fraud detection and prevention, as this will possibly assist the organizations in cost minimization in terms of internal controls and know which of the internal control tools should be given priority in the course of the design of internal controls into the accounting systems. Several and related research carried out in the area of internal controls and fraud detection and prevention have not put into consideration the individuals relationship of the elements of internal control (segregation of duty and system of authorization) with fraud detection and prevention. This culminating in a research questions as follows:

1. How does segregation of duty affect fraud detection and prevention?

2. What is the effect of system authorization on fraud detection and prevention?

Objectives of the study

The broad objectives of this study are to empirically examine the effects of internal controls on fraud detection and prevention in Nigeria: evidence from Ondo State. The specific objectives are to:

1. examine how segregation of duty affects fraud detection and prevention

2. determine the effects of system authorization on fraud detection and prevention

2.0 Conceptual frame work

Concept of Internal Control (IC) Internal control elements includes: segregation of duty and system authorization.

Internal controls attempt to deter or prevent undesirable events from occurring. They are proactive controls that help to prevent a loss. According to Victorian Auditor General (2012), good fraud preventive controls are the basis of a workable framework of fraud control, even though they cannot mitigate fraud risk, coordinated and proactive implemented strategies can reduce the probability of its occurrence. Yang Lin and Koo (2011) stressed that companies have to implement various control means to achieve targets. They noted that on the basis of the timing of control events, internal controls can be divided into preventive controls, detective controls and corrective controls. They defined preventive controls as extant in nature, such as the control accounts and passwords for the prevention of illegal users from logging into the system. They are also of the view that detective controls are the controls over the happening of events, for example, the inspection of product codes to confirm the existence of products, while corrective controls are ex -post in nature. Association of Certified Fraud Examiners (ACFE) (2012) submitted that internal controls are the most effective fraud — fighting measure. The ACES opined that the design and implementation of internals activities should be a coordinated effort orchestrated by management of organizations with different categories of employees.

Segregation of Duties (SoD) Segregation of duty is an operational technique which provides for separate people to be responsible for performing the steps in processing accounting transactions. Deloitte (2007)

assented that segregation of duties is the separation of incompatible duties that could allow one person to commit and conceal fraud that may result in financial loss or misstatement to the company. According to Gramling Hermanson, and Ye (2010), segregation of duties is one of the fundamental elements of effective internal control, which presupposes that a process is divided among several people. As such, no single individual can take advantage of the situation for personal benefit or other impropriety. Ernst and young (2010) stressed that SoD is a basic internal control that attempts to ensure no single individual has the authority to execute two or more conflicting sensitive transaction with the potential to impact financial statements. Ernst and Young (2010) submitted that SoD dictates problem such as fraud, material misstatement and financial statements manipulation have the potential to occur when the same individual is allowed to execute two or more conflicting sensitive transactions.

System Authorization (SyA). Australian Institute of Criminology (AIC) (1998) noted that one key preventive strategy for debit and credit card fraud has been system authorization, in other word, the value limit at which authorization is required from financial institutions before the card can be accepted. AIC argued that in Britain, the percentage of plastic card transactions which required authorization increased from approximately 10 percent in 1992 to close to 50 percent in 1998. The order/mandate which must be given for a transaction to be effected within a given framework is known as system authorization. Management authorizes employees to perform certain activities and to execute certain transactions within limited parameters. In addition, management specifies those activities or transactions that need supervisory approval before they are performed or executed by employees. A supervisor’s approval (manual or electronic) implies that he or she has verified and validated that the activities or transaction conforms to established policies and procedures. Authorization and approval are the most important elements of this control activity.

Fraud Detection and Prevention (FD&P)

According to the Australian Prudential Regulation Authority (APRA) (1998), the opportunity for fraud is substantially reduced if internal controls are put in place. Australian Prudential Regulation Authority (APRA) highlighted the different types of controls to include accountability, safeguards, recording and system authorizations. However, based on recommendation of the Committee of Sponsoring Organizations of the Tread way Commission (COSO) to study the causes of fraudulent reporting and make recommendations to reduce fraud, COSO developed an internal control framework in line with the issued 11992 and entitled internal control integrated framework. Gupta and Gill (2012) posited that a continuous evaluation of an organization anti-fraud programs and red flags is a perquisite for successful prevention, suggesting that fraud red flags are the clues that may prompt management critical observation of specific transaction. Implementation of internal controls mechanism will amount to honest work environment and anti-fraud program. The position of Gupta and Gill (2012) implies that for there to be a fraud deterrence measure, organizations must take frill responsibility in terms of design and total implementation of internal controls/anti- fraud programs in its accounting system.

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