lOMoARcPSD|15087672

EFFECT OF INTERNAL AUDIT CONTROL ON QUALITY OF FINANCIAL REPORTING

ON REGISTERD SACCOS IN BUNGOMA COUNTY

RESEARCH PROJECT SUBMITTED TO THE DEPARTMENT OF BUSINESS

IN PARTIAL FULFILLMENT
OF REQUIREMENT FOR THE AWARD OF DIPLOMA IN

ACCOUNTING AT KISIWA TECHNICAL

TRAINING INSTITUTE

JULY 2024

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DECLARATION

Declaration by Student

This Research project is our original work and has not been presented by anyone else for any
ward in any institution or any other examination body

Approval By Supervisor
I do hereby certify that this is a true report for the project undertaken by the above-named
student under my supervision and that it has been submitted to KISIWA TECHNICAL
TRAINING INSTITUTE with my approval
Signature…………………………………………… Date…………………………...

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ACKNOWLEDGEMENT

I acknowledge the support of my family and my friends who has stood by me throughout my
studies and particularly for their unending support. I pay my gratitude to my supervisor for
guidance, support, patience and understanding throughout the research period. My sincere
gratitude also goes to the entire KISIWA TECHNICAL TRAINING INSTITUTE fraternity
for giving me an opportunity to pursue my career here.

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DEDICATION

I dedicate this project to my family for giving me the chance to be in college by paying my
school fees and believing in me. To my friends for giving me the support I needed during the
project writing and also for helping me and anyone who is willing to adopt the new changes
and embrace technology. May God bless you.

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TABLE OF CONTENT
DECLARATION.......................................................................................................................ii

ACKNOWLEDGEMENT........................................................................................................iii

DEDICATION..........................................................................................................................iv

LIST OF TABLES..................................................................................................................viii

LIST OF FIGURES..................................................................................................................ix

CHAPTER ONE........................................................................................................................1

INTRODUCTION.....................................................................................................................1

1.1 Background of the Study.....................................................................................................1

1.2 Statement of the problem.....................................................................................................4

1.3 Objectives of the Study........................................................................................................6

1.3.1 General objective..............................................................................................................6

1.3.2 Specific Objectives...........................................................................................................6

1.4 Research Questions..............................................................................................................6

1.5 significance of the study......................................................................................................6

1.6 scope of the study.................................................................................................................7

1.7 limitations of the study.........................................................................................................7

CHAPTER TWO.......................................................................................................................9

LITERATURE REVIEW..........................................................................................................9

2.1 Introduction..........................................................................................................................9

2.2 Theoretical Review..............................................................................................................9

2.2.1 Control Theory..................................................................................................................9

2.2.2 Theory of Audit of Internal Control..................................................................................9

2.2.3 Reliability Theory.............................................................................................................9

2.2.4 Contingency Theory........................................................................................................10

2.3 Theoretical Literature.........................................................................................................10

2.3.1 Definition and understanding of internal controls..........................................................10

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2.3.2 Internal Control Systems.................................................................................................12

2.3.3 Components of an internal control system......................................................................13

2.3.4 Internal control systems strengths and weaknesses........................................................14

2.3.5 Results of lack or weaknesses in internal control system...............................................15

2.3.6 Control Environment......................................................................................................16

2.3.7 Risk Assessment.............................................................................................................17

2.3.8 Control Activities............................................................................................................17

2.3.9 Monitoring......................................................................................................................19

2.4 Empirical Literature...........................................................................................................19

2.5 Summary and Research Gap..............................................................................................21

2.6 Conceptual Framework......................................................................................................21

2.6.2 Dependent Variables.......................................................................................................24

2.6.3 Intervening Variables......................................................................................................25

CHAPTER THREE.................................................................................................................27

RESEARCH METHODOLOGY.............................................................................................27

3.0 Introduction........................................................................................................................27

3.1 Research Design.................................................................................................................27

3.2 Target Population...............................................................................................................27

3.3 Sample Size and Sampling Procedures..............................................................................27

3.4 Data Collection Instruments..............................................................................................28

3.5 Validity and Reliability of Research Instruments..............................................................28

3.6 Data Analysis and Presentation.........................................................................................29

CHAPTER FOUR....................................................................................................................31

RESULTS AND DISCUSSION..............................................................................................31

4.1 Introduction........................................................................................................................31

4.1.1 Response Rate.................................................................................................................31

4.2 Descriptive Statistics..........................................................................................................31

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4.2.1 Demographic Characteristics of the Respondents..........................................................32

4.2.2 Background Characteristics of the Saccos......................................................................33

4.2.3 Control environment and the financial performance of Saccos......................................34

4.2.4 Control activities and the financial performance of Saccos............................................35

4.2.5 Risk assessment and the financial performance of Saccos.............................................38

4.2.7 Monitoring activities and the financial performance of Saccos......................................39

4.2.8 Financial Performance of Saccos in Bungoma County.................................................41

CHAPTER FIVE.....................................................................................................................43

SUMMARY, CONCLUSIONS AND RECOMMENDATIONS............................................43

5.1 Introduction........................................................................................................................43

5.2 Summary of the Findings...................................................................................................43

5.3 Conclusions........................................................................................................................45

5.4 Recommendations..............................................................................................................45

5.5 Suggestions for Further Study...........................................................................................46

REFERENCES........................................................................................................................47

APPENDIX 1: LETTER OF RESPONDENTS......................................................................53

APPPENDIX 11: RESEARCH QUESTIONNAIRE..............................................................54

APPENDIX 111 BUDGET......................................................................................................59

APPENDIX IV: WORK PLAN...............................................................................................60

LIST OF TABLES

Table 4. 1: Response
Rate.....................................................................................................37 Table 4. 2:
Demographic Characteristics of the Respondents..............................................38
Table 4. 3: Background Characteristics of the
Saccos..........................................................39
Table 4. 4: Control environment and the financial performance of
Saccos..........................40 Table 4. 5: Control activities and the financial performance of
Saccos...............................42 Table 4. 6: Risk assessment and the financial performance of

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Saccos.................................43 Table 4. 7: Monitoring activities and the financial

performance of Saccos.........................45
Table 4. 8: Financial Performance of Saccos in Bungoma County..................................46

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LIST OF FIGURES

Figure 1: Conceptual Framework.......................................................................................28

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LIST OF ABBREVIATIONS

IT : Information Technology

ICA : International Co-operative Alliances

MDGs : Millennium Development Goal

SASRA : Sacco Societies Regulatory Authority

SACCOs : Savings and Credit Co-operatives

WOCCU : World Council of Credit Union

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DEFINITION OF OPERATIONAL TERMS

Control activities
These are the policies and procedures implemented by an organization to ensure that
managements’ directives are carried out. These activities are often grouped into the
three categories of objectives to which they relate namely operations, financial
reporting and compliance (Shelton & Whittington, 2008). These activities are as
diverse as approvals, authorizations, verifications, reconciliations, security of assets
and segregation of duties (Glenn & Rao, 2009).
Control Environment
Is an element of internal control? It is the philosophy and management style,
organizational structure, methods of imposing control and tone of an organization (the
way it operates). It concerns the establishment of an atmosphere in which people can
conduct their activities (Jones, 2008).
Internal control
A process effected 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 (APB, 1995a).
Monitoring
This is another internal control element. Monitoring refers to the process of assessing
the quality of a system’s performance over time. It assess the effectiveness of the
internal control system in achieving the entity’s objectives. It seeks to ensure that
systems are performing as intended.
Risk assessment
This too is another internal control component. Risk assessment is a process used by an
organization to decide how to deal with the risks that pose a threat to the achievement
of the organization’s objectives (Farrugia, 2002). Savings and Credit Co-operative
A co-operative society whose main aim is to mobilize savings and then loan them to
individual members as loans for specific developmental projects at affordable rates of
interest (International Co-operative Alliance, 1995).

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ABSTRACT

The Savings and Credit Cooperative Societies sector is considered both economically and
socially important. The sector has continued to mobilize savings and developed demand
driven financial products which has encouraged members to save additional resources to
finance education from primary to college through affordable loans to the members.
However, sectorial report indicates that nearly 5% of Savings and Credit Cooperative
Societies collapse every year and registered members withdraw their membership annually.
In terms of internal control literature, components of internal control have been studied in
context of institutions like banks and manufacturing firms and little has been done on
components of internal control system with respect to financial performance of Savings
and Credit Cooperative Societies. Therefore, the study aimed at establishing the effect of
internal control system on financial performance of Savings and Credit Cooperative
Societies in Kenya. The specific objectives of the study were to establish the effect of
control environment and risk assessment on financial performance of Savings and Credit
Cooperative Societies in Bungoma county. The study adopted descriptive research design
on the target population of 208 members of staff from ten Savings and Credit Cooperative
Societies within Bungoma county. The study employed a nonprobabilistic purposive
sampling technique to come up with a sample of 69 members of staff. The study used both
primary and secondary data. The questionnaires were pre-tested to ensure validity and
reliability. The study used secondary data for four years (2013-2016). Multiple regression
analysis was used to determine the relationship between dependent and independent
variables. Findings of the study indicated that control environment and risk assessment had
a positive and significant effect on financial performance of Savings and Credit
Cooperative Societies. This implies that internal control system is a major determinant of
financial performance of Savings and Credit Cooperative Societies as proposed in the
theory. The study recommends the Savings and Credit Cooperative Societies should put in
place effective policies to ensure proper implementation and management of internal
control system.

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CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Financial reporting are the financial records that show a company's business activity and
financial performance. Saccos are required to report their financial statements on a
quarterly and annual basis. In the current business world, all businesses are struggling to
come up with strategies that enable them to outperform their competitors. Saccos are also
not an exception and therefore the reason why most Saccos are adopting internal control
systems.

Firm' internal control systems are key for saccos since the existence of a poor control
system is the underlining source of poor performance in saccos particularly because fraud
goes undetected (Etuk, 2011). From an administration perspective, need arises to
guarantee that internal control frameworks are set up considering the end goal to decrease
the event of misrepresentation. Inside control is an ever-changing indispensable process
that adjusted ceaselessly to progressions in the banking industry (Etuk, 2011).

Monitoring was the assessment process to determine the value of the structure of control
over a certain period. The processes of internal controls would be sufficiently examined
to build up the level of adequacy of the framework's exhibition. Observing in an
establishment ensured the discoveries of reviews and different surveys (Theophanous,
Modjtahedi, Batech, Marlin, Luong & Fong, 2011). Amudo and Inanga (2009) stated that
the smooth functioning of the controls system was guaranteed through proper monitoring.

Having an internal audit function is important, the quality of the reports from the
internal audit is of utmost importance. The completeness of the report, the objectivity
of the advice, the timeliness of the report and the clarity of where the report is directed
to important characteristics that quality reporting should have. It is important to ensure
that internal audit reports are quality and the reporting is made to the right people in the
organization. As Sacco’s continue to be affected by poor governance and poor
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performance, a question arises as to what effect the internal audit reporting quality may
have on their financial performance
1.2 Statement of the problem

Most of the registered SACCOs in Kenya have functional internal audit departments with
well qualified staff charged with responsibilities of re-assuring that internal control systems
are adequate and quality processes and systems are in place (Olando, Jagongo and Mbewa,
2013). However, there is continued poor financial performance, incidences of fraud,
incidences of budgets not being followed and cases of non-conformance to rules and
regulations on usage of finance. This has put member savings at risk despite investing in the
internal audit department (Olando et al, 2013).

There have been several studies carried out which demonstrate the importance of internal
audit reporting on the effectiveness of the organization. Hutchinson and Zain (2009) studied
the role of internal audit quality and the independence of the audit committee on firm
performance and growth opportunities in UK companies. The study established that report
should be in a format that is prescribed by the organization and meet completeness standards
as per the organization’s guidelines. Sparks (2011) assessed the value of timely internal audit
reporting to SACCOs in Canada. According to Sparks the audit report should have insight
into the changes that are taking place and the effect these changes can have on the
organization. This then should be timely communicated to the management for action to be
taken. Clikeman (2003) studied the role of internal auditors in educating management on
finance and corporate governance in Brazil.
Though having an internal audit function is important, the quality of the reports from the
internal audit is of utmost importance. The completeness of the report, the objectivity of the
advice, the timeliness of the report and the clarity of where the report is directed to important
characteristics that quality reporting should have. It is important to ensure that internal audit
reports are quality and the reporting is made to the right people in the organization. As
Sacco’s continue to be affected by poor governance and poor performance, a question arises
as to what effect the internal audit reporting quality may have on their financial performance.
As observed from previous empirical studies, there are few studies that focus on internal audit

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reporting quality. It is against this background that this study sought to evaluate the role of
internal audit reporting on financial performance of Sacco’s in Kenya.
1.3 Objectives of the Study

1.3.1 General objective

The general objective of the study was to determine the effect of internal audit control on
quality of financial reporting on registered of saccos in Bungoma County

1.3.2 Specific Objectives

The specific objectives of this study were:
i. To determine how control environment affects the financial performance Sacco’s.

ii. To determine how control activities affects the financial performance of Sacco’s

iii.To determine how risk assessment affects the financial performance of Sacco’s.

iv. To determine how monitoring activities have affected the financial performance of
Sacco’s.

1.4 Research Questions

i. How has the control environment affected the financial performance of the Sacco’s?
ii. How have control activities affected the financial performance of the Sacco’s?
iii. How has risk assessment affected the financial performance of the Sacco’s?
iv. How have monitoring activities affected the financial performance of the Sacco’s

1.5 significance of the study

The study findings will also be of importance to government in that it will give regulatory
agencies of the government like SASRA deeper insight on the role of internal audit reporting
on financial performance. This will go a long way in informing policy and regulations on
internal audit reporting of Sacco operations. Sacco’s have been established as one of the most
important financial institutions towards financial deepening and their financial performance is

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important for the growth and advancement thus steering economic growth. The findings
therefore will affect policies on how internal audit reporting in these institutions is performed.

Members of a Sacco are the ones who are directly affected if the financial performance of a
Sacco is poor. The findings from this study will inform Sacco members on the role played by
internal audit reporting in influencing financial performance of these Sacco’s. Members
therefore can use their voting rights to ensure that top management of their Sacco’s who are
elected ensure that internal audit reporting plays its rightful role and it has the desired effect
on financial performance.

Finally, the current research study will be important to researchers for theoretical purposes in
that it will add to the empirical and theoretical literature available in the field of internal audit
reporting and financial performance of Sacco’s. This can be used by scholars and students
interested in the area of study. The limitations and gaps in the study and suggestions for
further research that will be provided by this study can be used by future researchers.
1.6 scope of the study

The scope of this study covered 10 saccos in Bungoma county. The financial statements of
the selected saccos were examined and values of internal audit and performance proxies were
extracted for investigation. The focus of the study was on the effect of internal audit reporting
on financial performance of saccos. Internal control that were included in the study were
control environment, risk assessment, monitoring activities, and control activities.

1.7 limitations of the study

Internal audit reporting is a very sensitive area. The researcher encountered some challenges
in conducting this study. First, employees who were the subjects of the study were reluctant
to respond to the questions as they involved answering sensitive questions about internal
audit reporting and financial performance of the saccos. This could have made some of the
respondents to be reluctant in providing the requisite information for the study purposes. To
counter this challenge, confidentiality and anonymity of responses was assured to the
responding subjects.

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Secondly, there could have been bias in the responses provided in the various questions.
Subjects could be tempted to provide positive responses or negative responses to portray the
situation as they would want it to be without a strong basis on the facts underlying internal
audit reporting and financial performance. To counter the risk of bias, respondents were
provided with an introductory letter that informed them of the need to provide accurate and
objective responses. They were also informed of the need for providing objective responses
as the study could be used to inform policy and practice on internal audit reporting in future.
Another limitation that was encountered is the lack of criteria for measuring quality and
effectiveness of internal audit reporting. Respondents could have been not conversant with
the internal audit reporting and hence would not be in a position to rate the reporting as per
the scales that were provided. However, respondents were briefed on the purpose of the study
before administration of questionnaires and those respondents who felt that they did not have
relevant information to provide were provided with the opportunity to opt out. Further, the
questionnaires were well structured to have the minimum effort and time and at the same time
collect all relevant information.

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CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter provides a critical review of related literature on the study variables, definition
and understanding of internal controls, Internal Control Systems, earlier studies on internal
control elements, common weaknesses of internal control systems, determinants of internal
control strength and components of an internal control system, it also discusses a link
between the variables of this study.

2.2 Theoretical Review

Internal Control theories have been stated by various authors as follows:

2.2.1 Control Theory

According to Wanda (2004) control theory is involving the separation of authorization,
custody, and accounting. The reason this approach result in control over the concession stand
is that no one of these individuals could cause a loss to the concession stand without being
either prevented from doing so or being detected after causing the loss.

2.2.2 Theory of Audit of Internal Control

Accounting to China Papers (2013) this theory attempts to identify the problems that exist in
audit of internal control in many companies and tries to put forward a series of suggestions to
improve companies’ audit of internal control with study from American experience. This is
because of the financial fraud that floods the capital market all over the world; which
seriously impacts the order of capital market and conflicts the confidence of investors. The
society has given a great deal of attention to the distortion of financial information as this
results to financial fraud states the same author.

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2.2.3 Reliability Theory

According to Stratton (1994), the most likely users of the reliability model are the external
auditor and management. During the external audit evidence is gathered to support a
professional opinion. The main aim of this theory is to control risk.

2.2.4 Contingency Theory

Annuka, (2010) states that in order to ensure the efficiency and effectiveness activities,
reliability of information and compliance with applicable laws, firm demand adequate
internal control. However several frameworks assume that the need for internal control varies
according to a firm’s characteristics. Contingency theory concurs with this as it claims that
each organization has to choose the most suitable control system by taking into account
contingency characteristics.

The theory used in this study is the control theory.

2.3 Theoretical Literature

2.3.1 Definition and understanding of internal controls

Internal control is a process effected by an entity’s board of directors’ management and other
persons and is designed to provide reasonable assurance regarding the achievements of
objectives in the following categories; efficiency and effectiveness of operations, reliability of
financial reporting and compliance with applicable laws and regulations (Robertson, 1996).
The first category addresses an entity’s basic objectives, including performance and
progressing goals and safeguarding of resources. The second category relates to preparations
of reliable published financial statements. The third deals with complying with the laws and
regulations to which the entity is subject to.

Internal Controls (IC) are an integral part of any organization's financial and business policies
and procedures. They are adopted by management to ensure that the organization conducts
business in an orderly and efficient manner (KMPG Forensic;, 2004). Knechel, Naiker, &
Pachego (2007) add that IC provides the framework through which management uses the
resources at its disposal to achieve the organization's goals. According to Wernefelt (1989),
internal controls consists of couple of measures at management's disposal intended to ensure

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the organizations proper functioning, correct management of its assets and liabilities and true
recording in accounting evidences.

A broader definition of IC provided by Farrugia (2002) views IC as the plan of organization

and the coordinated procedures used within an entity to; safeguard its assets from loss by
fraud or errors, check the accuracy and reliability of accounting data which management uses
in decision making, and promotion of operational efficiency and encourage adherence to
adopted policies in those areas in which the accounting and financial departments have direct
or indirect responsibilities.

2.3.2 Internal Control Systems

The traditional accounting professional definition of internal control hinged on financial

reporting and compliance aspect of control (Robertson, 1996). However Coso (2004)
describes internal control system as a process involving board of directors, management, and
other personnel created as a means of ensuring that the organization’s objectives can be
achieved. The objectives are categorized as; effectiveness and efficiency of operations,
reliability of financial reporting, compliance with the relevant laws and regulations.
According to Wanda (2004) control environment is distinguished from control procedure in
that the former represents the general management attitude, awareness and actions as far as it
concerns internal control whereas the later refers to what management has put in place as
guidelines to control information and transaction procedure so as to achieve the
organization’s objectives. Since organizations differ in management philosophy, structure and
size the wider outlook of control elements will always reflect the above differences (COSO,
2004). Organizational culture determines control through selfdiscipline and internal
monitoring (Whyte, 1991). According to the same author, ‘top down, command and
controlled’ organizations emphasize formal controls while those that are down sized and
empowered will adopt informal controls.

According to Sikka (2007), an internal control system is an organization’s confidence in its

ability to perform or undertake a particular behavior. He further asserts that a system of
internal controls potentially prevents errors and fraud through monitoring and enhancing
organizational and financial reporting processes as well as ensuring compliance with
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pertinent laws and regulations. Shelton & Whittington (2008), claim that internal controls
represent a continuous process which involves part of the board of directors, senior
management and all levels of personnel, and whose aim is to ensure that all the established
goals will be achieved.
Williams (2005) says that some things considered to be good are not always enough for
information. Internal controls have to give the possibility to check quality. Shelton and
Whittington (2008) concur that sometimes even the quality of information is not enough, if it
is uncompleted; that is why internal control needs to ensure that all elements are taken into
consideration during their processing and the information provided needs to be geared to the
pursued aim. He concludes that, that is why internal control has to avoid such situations and
ensure the procurement of information is availed in a suitable time. The International
Organization of Supreme Audit Institutions (INTOSAI) (2002), focuses more on a series of
actions that permeate an entity's activity rather than one event or circumstance where by these
actions occur throughout an entity's operations on an ongoing basis

2.3.3 Components of an internal control system

Antecedents of internal control procedure strength according to COSO (2004), include;
organizational ethical environment, risk management training and internal audit activities.
The ethical environment refers to how top management is committed to the morally
acceptable behaviors which are based on honesty, integrity and self-discipline. (Victor &
Cullen, 1987) Similarly, identifies control environment factors, risk assessment, control
activities, information and communication and monitoring as interrelated components of a
control system. Control categorized as control environment is being more emphasized over
control activities by writers like Schein (1985), and COSO (2012). This is a shift from
traditional control procedures that are put forward to monitor in real time or after the event,
control environment puts greater importance on setting control around people. It is believed
that people with strong set of belief are able to do their own, do the right thing for the
institutions they work for without necessarily being directed to do so.

2.3.4 Internal control systems strengths and weaknesses

While COSO (2004), emphasizes that internal control procedural quality depends upon the
control strength on cash management, physical assets, purchasing and accounts payable,

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sales, payroll, bank account management and employee recruitment, INTOSAI, suggests that
effectiveness of internal control system will be judged from the reliability of financial reports,
efforts to comply with applicable laws and regulations, unfailing management reporting,
protection of assets, guarding against fraud and errors and encouraging efficiency and
effectiveness of operations.
Albretcht, Howe, & Romney (1984) outline twelve most common internal control
weaknesses, in order of frequency as; Too much trust in employees, lack of proper procedure
for authorization, lack of personal financial information disclosure (for bank frauds), lack of
separation of transaction authority from custodian of assets, absence of independent checks
on performance, lack of adequate attention to detail, failure to separate asset custody from
accounting for assets, failure to separate accounting duties, absence of clear lines of authority,
relaxed or absence of audit activities or reviews, no conflict of interest statement required and
lack of adequate documents and records. A view held by Buckhoff (2002) and supported by
literature by Bailey (1981) is that lack of segregation of duties, lack of independent
reconciliation on cash received and deposited and performing incompatible roles greatly
facilitates internal fraud. The conditions for fraud to occur, the same authors highlight include
an incentive to commit fraud (pressure), good reason for justifying fraudulent behavior
(attitude) and an opportunity to commit fraud. It is pointed out that opportunity is easy to
control by establishing strong internal system unlike pressure and attitude which are human
factors that are usually beyond direct influence of management (Albretcht et al., 1984).

2.3.5 Results of lack or weaknesses in internal control system

The International Organization of Supreme Audit Institutions INTOSAI (2002) defines fraud
as “an intentional act by one or more individuals among management, those charged with
governance, employees or third parties, involving the use of deception to obtain unjust or
illegal advantage”. Fraud they reiterate is not the same as error. Error is unintentional and the
perpetrator of the error may not be aware of it, furthermore the perpetrator is not looking to
benefit in any way from the commission of the error, this is entirely unlike fraud. According
to Robertson (1996) there are two broad classes of fraud management, management fraud and
employee fraud. Fakunle (2006), states that management fraud mainly involves the
manipulation of records with a view to benefit in some way. Robertson states that this is a
deliberate act committed by management that injures investors and creditors through mostly
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misleading financial statements. On employee fraud, he states that this is mostly perpetrated
by employees and it is aimed at defrauding the employer.
The responsibility for preventing fraud and error lies with the Sacco board of directors. They
can develop adequate policies to protect Sacco assets; they should employ qualified personnel
and put systems in place to detect both if and when they occur. The board should also be
aware of areas which can be utilized to perpetrate the vice so they can better prevent and
detect these vices (INTOSAI, 2002). According to a report by consultative group to assist the
poor written by Deshpande (2006) there has been massive fraud of funds by Sacco leaders,
and delinquency in Saccos has increased. For instance “Alut kot Sacco in Lira loaned out
money in 2002 but had only recovered 26% of the amount by 2010”, (Ojwee, 2010). Bwana
& Mwakungoja (2013), state that some of the constraints to development of Saccos in Kenya
and Tanzania include widespread corruption, nepotism and fraud by some officers.

Another spectacular case of fraud reported was that of Umerenge Sacco in Rwanda.
Apparently board members of the Sacco granted themselves loans or recovered the same
from borrowers without making any records. The result being that money is stolen while the
client is pursued. It was discovered that some managers stole money from the Sacco’s safes
and yet still retain their positions. Misappropriation of funds by the Sacco employees was
also a vice in the Sacco. To mitigate this, the Rwanda government through the central bank
governor rolled out a plan to offer training to Sacco employees and managers and to also
computerize all the branches (Croix, 2012)

In Kenya a case was presented to the Kenya anti-corruption agency by an insider concerning
the Harambee Sacco (Croix, 2012). The members paid loans and cashiers made entries into
the computers but for some reason the money was not banked. Croix adds that one cashier
could not account for the whereabouts of Kenya shilling 324 million and another of 30
million. It was also discovered that some Sacco directors and members got huge cash
payments as loans and had the transactions deleted from the Sacco’s system hence leaving
them with no debt obligation. Additionally members and outsiders robbed the Sacco of more
than 100 million through the automated teller system. On the same, “a report by SASRA on
this malfeasance states that, that is why the Sacco had only 1.4 billion of its 9.8 billion loan

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book” (Croix, 2012). Employee frauds are more likely to be encountered where internal
controls are weak (Awe, 2005)

2.3.6 Control Environment

The control environment is the foundational context within which the other aspects of internal
control operate (COSO, 2012). The philosophy and management style, organizational
structure, methods of imposing control, assignment of authority and responsibility are all key
aspects of the control environment (Jones, 2008). Beneish et al,(2008) define the control
environment as the tone of an organization and the way it operates. They further says that it
concerns the establishment of an atmosphere in which people can conduct their activities and
carry out their control responsibilities effectively. Likewise, COSO (2004), looks at the
ethical environment of an organization to encompass aspects of upper management’s tone in
achieving organizational objectives, their value judgments and management styles. The
control environment represents the control atmosphere for the entity and is the foundation for
the other components (Nicolaisen, 2004).

Crawford, Klamm, & Watson, (2007) state that control environment comprises of seven
elements; communication and enforcement of integrity and ethical values, commitment to
competence, participation by those charged with competence, management’s philosophy and
operating style, organizational structure, assignment of authority and responsibility, and lastly
human resources policies and practices. A member of the audit Team,(2004) put these same
elements as components of the control environment. ISA (2002) clearly looks at the control
environment to represent management’s overall attitude, awareness and actions regarding
internal controls. Crawford et al concur that higher level administrators of an organization are
responsible for establishing the appropriate control environment.

2.3.7 Risk Assessment

Risk assessment is the process used by an organization (management) to decide how it will
deal with the risks that pose a threat to achieving its objectives (Farrugia, 2002). It entails the
identification and prioritization of objectives, the identification of risks and assessment of
their likelihood and impact. Consequently Jones (2008), looks at risk assessment as the

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identification, evaluation and management of risks. He further notes that risks can relate, to
financial statement fraud or to the misappropriation of assets.

2.3.8 Control Activities

Control activities are the policies and procedures implemented by an organization to ensure
that management’s directives are carried out. These activities are often grouped into the three
categories of objectives to which they relate, namely, operations, financial reporting, and
compliance (Shelton & Whittington, 2008). They further argue that these control activities
include a range of activities as diverse as approvals, authorizations, verifications,
reconciliations, reviews of operating performance, security of assets and segregation of
duties.

More specific activities include segregation of duties, rotation of jobs and internal check
(Glenn & Rao, 2009). The same authors also reiterate the fact that segregation of duties is one
of the key concepts of internal control. According to them it is also one of the most effective
internal control components in combating employee fraud. They define segregation of duties
as the “dividing of tasks among various individuals making it possible to reduce risk of error
and fraud”. Segregation contributes to an organization’s check and balances. It involves
separation of the following duties in each business process; custody of assets, record keeping,
authorization and reconciliation. Ideally “no one person should handle more than one activity
of the above mentioned responsibilities in a given process”. Segregation being implemented
deters and prevents employee fraud. When segregation cannot be implemented, compensatory
measures should be taken, Glenn et al, point out. Compensatory measures should be done by
an independent person/body. This means one who has supervisory role and takes no part at all
in custody, record keeping or reconciliation responsibilities for the process.

2.3.9 Monitoring
This refers to the process of assessing the quality of a system’s performance over time (Jones,
2008). It entails the activities and procedures designed to assess the effectiveness of the
internal control system in achieving the entity’s financial reporting objectively (Williams,
2005). Monitoring activities may be ongoing or may be separate evaluations and it is
important given the complex and dynamic environments faced by most organizations (Henle,

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2005) . It seeks to ensure that systems are performing as intended. However, this is
accomplished through ongoing monitoring activities, periodic evaluations or a combination of
the two (COSO, 2004). William further contends that these activities permeate the entire
organization, at all levels and in all functions.

According to Musa (2008), the internal management principles need to be enforced strongly
to improve efficiency of collections, and even perhaps consider insuring the loans in case of
demise of member loaned. Saccos mobilize savings and penetrates to areas not valued by
other financial institutions, while also serving special needs of members. The prospects for
the industry are so huge. By identifying the fact that the easiest source of funding is the
locally mobilized savings, the Saccos should come up with innovative ideas to encourage the
members of the common bond to save, as a first step. The same author notes that human
resource plays a large role in ensuring the success of internal controls. This is so as the
systems are only as good as the people using them. If the people connive to abuse the controls
then the controls will fail all together. Muoki (2010) states that the greatest preventative
antidote to fraud is to ensure a Sacco provide strong and effective staff motivation and
remunerations. Kigen (2010) reiterates that Saccos are vulnerable when they have high
employee turnover or when staff members are on leave. Also when an employee is fired,
there is the risk that that former employee may continue to collect money from clients behind
the Saccos back.

2.4 Empirical Literature

A research titled “internal control and organizational performance” was done by Ochoge
(2011). The research centered on Medipoint industries limited. The objectives of the study
were; to examine the effectiveness of internal control in this industry and to establish a
relationship between internal control and performance. The internal control parameters used
in this study were: control environment, risk assessment, monitoring, information and
communication and control activities. The study population was the employees and customers
of medipoint industry limited. Simple random technique was used to get the sample for the
study. Primary and secondary sources were used to collect the data. The findings of the
research were that internal control used in Medipoint industry was unsatisfactory and
ineffective. Secondly there was a “significant positive relationship between internal control

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and organizational performance. The researcher recommended that the management of this
industry should design an effective internal control system.

Another research on internal control and how it affects performance was done by
Muraleetharan, (2011). The research focused on “internal control and its impact on financial
performance of an organization”. Internal control in the study was measured by control
environment, monitoring of the internal control and risk assessment. Financial performance
on the other hand was measured by profit, efficiency and liquidity. The objective of the study
was to find out the relationship between internal control and financial performance. The
limitation of the study was that the study was limited to private and public sector
organizations in Jaffna district. Primary and secondary data was used for the survey. This was
collected through questionnaires, interviews, journals and books. The public and private
organizations in the study were randomly selected. The statistical tools used in the study were
the chi square and multiple regressions. Chi square was used to find out whether the variables
were dependent or independent while multiple regressions were used to determine the impact
of internal control and financial performance. The researcher through the study concluded
that internal control has a significant impact on financial performance. He adds that the better
the ”performance of risk assessment, control activities and monitoring of the internal control”
the greater the financial performance.
2.5 Summary and Research Gap

A good internal control system ensures that functions/duties are properly defined and that
duties are properly assigned to qualified staff and that there is an inbuilt control in the system
to ensure feedback, detection and correction of errors in good time. The internal audit is one
such unit established by the management to ensure compliance to policy instructions and for
correcting deviation from the management set guidelines. It objectively examines, evaluates
and reports on the adequacy of the internal control, thereby ensuring efficient and effective
application of limited resources. This study aimed at trying to determine the link between the
internal control and financial performance of Saccos within this area of Bungoma County.
The research gap is that there is need to find out the contribution of internal control on
financial performance. Therefore, this study was carried out to examine the effects of internal
control on financial performance of Saccos in Kenya. It was a survey on Saccos that have
been registered and licensed to operate within Bungoma County.
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2.6 Conceptual Framework

A conceptual framework according to Orodho (2009) is a type of a model that illustrates the
nature of relationships between independent and dependent variables under investigation. The
conceptual framework in Figure 2.1 hypothesizes the relationships between independent
variables and the dependent variables identified for the purposes of the present study.
Independent variables Dependent variables
Segregation of duties
Control
Environment Financial Performance of
Saccos
Control Activities • Growth in capital and
Savings
• Increase in revenue
Risk Assessment Streams
• Enhanced Cost efficiency
Monitoring • Increase in profits
• Returns on investment
• Increase in assets

• SASRA
• Inflation
• Competition from
Formal financial
Institutions
Moderating Variables

Figure 1: Conceptual Framework

Source: Author (2024)

2.6.1 Independent Variables

2.6.1.1 Control Environment

Control Environment has 7 components which if present and enforced well will point to an
effective internal control system. The first is communication and enforcement of integrity and
ethical values i.e the values exist and are communicated effectively to employees and

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enforced. The second one is commitment to competence; management and board of directors
should ensure that employees have the necessary skills to accomplish tasks that define the
individual’s job. The third component is participation by those charged with governance; that
is those charged with governance should get involved in the day to day activities, this will
have a pervasive effect on the internal control. The fourth element is management’s
philosophy and operating style, this involves management’s approach to taking and managing
risk; their attitudes and actions toward financial reporting; and finally their attitudes toward
information processing and accounting functions. The fifth element is the organizational
structure, here we are going to look at whether the organizational structure of the Sacco in
terms of authority, responsibility and lines of reporting meet desired objectives of the Sacco.
The sixth element is the Sacco’s assignment of authority and responsibility; what this means
is that the appropriate levels of authority are assigned to appropriately qualified and
experienced individuals. Additionally individuals need to be properly resourced and made
fully aware of their responsibilities. Last element of the control environment is the human
resources policies and practices; they should be sound both in design and implementation
over a range of matters. If all this components are well enforced, there will be reduced risk of
material misstatements and fraud ( Member of Audit Team, 2004).

2.6.1.2 Control Activities

Implementing internal control by enforcing segregation of duties is important in the area of
cash management because of the diverse nature of the processes involved, that is, billings,
collections, deposits, and disbursement processes, as well as the fragmented oversight
responsibilities generally associated with these processes. Some of the other major factors,
which impose a need for a consistent application of segregation of duties are: The prevalence
of a high turnover rate of operating personnel and supervisors in cash management functions;
the assignment of cash handling responsibilities to personnel with limited fiscal experience or
understanding; the fragmentation of billing and cash handling functions which makes
monitoring the whole process difficult; and the inherent risk of loss, or opportunity for
personal gain, created by the nature of cash transactions. Lack of segregation of duties
reflects poor cash management policies and lack of control in cash handling which provides
opportunity for high rates of fraud and errors in book and record keeping. It will also possibly
even impact an auditor’s perception of your accounting practices. Good controls using
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segregation of duties on cash policies and procedures that are clearly communicated and
regularly audited internally indicate to external auditors that cash controls are working (Hsien
& Chao, 2004)..

Rotation of jobs another internal control activity is key as regardless of the ranks of the
employees, all employees should be assigned to a different task every so often. This will
invariably result to reduction of fraud and errors. It may also lead to more productivity which
will be caused by more productive employees due to reduction in burnout and boredom
caused by working in one station indefinitely. This therefore means that senior management
should ensure the staff is well trained in all aspects of the business to facilitate them to make
well-informed decisions with financial-related laws, rules, policies, processes, and
procedures. The areas of responsibility for the management include: identifying areas that
need training on financial operations and commodity management; and supervising financial
transactions (Hurst, 2005).

Other challenges taken care of by control activities include recruiting and retaining qualified
employees, this leads to mediocrity in the work place due to employees being unqualified.
(Ike, 2006). An appropriate internal check system is crucial to Saccos’ operations. An internal
check system reduces fraud and errors which will lead to reduction in loss of assets, capital
and clients’ savings. This too will lead to increased performance of the Sacco if enforced well
(Buckhoff, 2002). Auditing both internal and external if enforced well will work to incredibly
reduce frauds and errors. Internal Audit, will ensure policies and procedures are put in place
and enforced. It will also advises the management on any risks and ways to mitigate the risks.
External auditing will ensure that the financial books are in order and if not it will report on
any cases of fraud or errors in the financials, hence exposing the vices (Member of Audit
Team, 2004).

2.6.1.3 Risk Assessment

This involves a review and analysis of program operations to determine where risks exist and
what those risks exists. This then allows one to target high risk areas and mitigate those that
stand in the way of achieving the objective of the organization. Risk identification occurs as a
result of finding from audits, evaluations and other testing (Member of Audit Team, 2004).
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2.6.1.4 Monitoring
Monitoring performance is important. This involves measuring the quality of performance
over time and ensuring that the findings of audits and other reviews are promptly resolved.
Monitoring includes policies and procedures for tracking audit findings. Its aim is to
determine whether controls are effective. Proper monitoring and review allows one to track
the progress of one’s improvements and to determine if deficiencies are corrected. (Butici,
1994).

2.6.2 Dependent Variables

2.6.2.1 Financial Performance of Saccos
As a result of applying internal controls, the Saccos may be able to have adequate capital.
This may be as a result of elimination or reduction of wastages of resources and loss due to
errors, also through the reduction of fraud not only in their day-to-day business operations but
also in totality. This may lead to more increased confidence by their members, thus
encouraging them to deposit more of their incomes with their Saccos. The ultimate goal that
will be realized will be increased profits at the end of each financial year.
Also, the outcome of effective internal controls will be reduced costs of operations. Revenues
will be recorded properly with reduced leakages. Increased revenue growth and reduced costs
leads to improved profitability performance. Members will enjoy increased dividend pay
outs. The value of shares of members will increase.
Internal control leads the management of Saccos to be more accountable to their members’
resources. By placing specific roles and responsibilities to every official members of their
board of directors, the management team and other employees, a better administration
structure will be realized. And it would be easy for each office holder to be held accountable
in the event either any mismanagement if noted or misappropriation of financial resources
hence adequate capital, savings mobilization and increased profits.
Proper management can be measured by innovative and creative strategies that are aimed at
cost reductions in a Sacco’s business operations. Regular internal checks or audits are
required so as to detect, investigate and recommend action plans whenever an error or
omission or commission is suspected in any department. Also, it will mitigate chances of
fraud within that organization, by way of highlighting any internal weaknesses.

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As the rate of fraud is reduced this will result in reduction of loss of money and other assets
through dubious means by employees and other stake holders. This will in the end result in
more money within the Sacco and therefore a positive impact in the financial performance of
the Sacco. (Amyx, 2005)
Reduction in rate of errors will also result in a positive impact on the financial performance of
the Sacco. This is as records will show a true reflection of what is happening in the finances
of the Sacco. Additionally, there will be a reduction of loss of money that comes by way of
errors in the day to day financial activities of the Sacco. (Ike, 2006)

2.6.3 Intervening Variables

2.6.3.1 SASRA Regulations
The co-operative societies act has governed all Saccos since 1966 with several amendments.
Given the rapid changes happening in the co –operative sector the government enacted the
sacco societies act 2008 which established SASRA to license regulate, supervise and promote
sacco societies development in Kenya (SASRA, 2011).
2.6.3.2 Inflation
Inflation is the persistent increase in the general price level of goods and services in an
economy over a period of time. Inflation impacts Saccos performance as it increases
opportunity cost of holding money; this translates to reduced savings and investments (North,
1994).

2.6.3.3 Competition from Formal Financial Institutions

The formal financial sector is comprised of licensed commercial, regional and rural banks. These
institutions give competition to semi informal institutions like Saccos. if they offer a low interest
rate, low charges and fees than Saccos, people will tend to prefer them to Saccos. this results in
lower profitability for Saccos

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