THE EFFECT OF INTERNAL CONTROL ON FINANCIAL MANAGEMENT IN

SOMALIA BANKING SECTOR

BY

ABDIQANI ABDULLAHI

&

MOHAMED ABDULLAHIN ELMI

A PROPOSAL PROJECT SUBMITTED IN PARTIAL FULFILLMENTS OF THE REQUIREMENTS

FOR THE DEGREE IN BACHELOR
OF ACCOUNTING

FACULTY OF ACCOUNTANCY
SIMAD UNIVERSITY

july, 2022

1
DECLARATION A

We hereby declare that this proposal is the result of our own work and effort, and that it
has not previously been submitted for any award. All information sources used in this
proposal have been cited and referenced.

Name of the Candidate: write your name

Signature: __________________

Date: July 06,2022

Name of the Candidate: write your name

Signature: __________________

Date: July 06, 2022

I
DECLARATION B

I hereby certify that I have officially supervised and studied this proposal and that, in my
opinion, it meets acceptable academic presentation standards and is fully adequate. I also
confirm that the research proposal was carried out in accordance with the degree
requirements and the University Research Project Manual (RPM).

Name of the Supervisor: Ali Ibrahim Mohamed

Signature: __________________

Date: July 06,2022

II
APPROVAL SHEET

This proposal project entitled “the impact of internal control of financial performance
of private banks in mogadishu_somalia” prepared and submitted by:
-------------------------------in partial fulfilment of the requirements for the degree of
Bachelor of accounting has been examined and approved by the panel on oral
examination of the grade PASSED.

Name and Signature of Chairman of the Panellist

_______________________________________________________

Name and Signature of Panellist

_____________________________________________________

Name and Signature of Head of Department

_________________________________________________

Name and signature of Dean

________________________________________________

III
DEDICATION

We dedicate that this research proposal to our family, teachers, and close friends. We
appreciate your help and never-ending encouragement.

IV
ACKNOWLEDGMENTS
We must first express our gratitude to my research supervisor, Mr. Ali Ibrahim
Mohamed. This thesis would never have been finished without his help and diligent
participation in each step of the procedure. We want to express our gratitude for your
help and patience. We also appreciate your generosity and assistance.

The preparation of this graduation project has been profoundly impacted and aided by a
number of individuals, without whose help it would have been challenging to complete.

We would especially want to thank the clients and staff of the commercial banks in
Mogadishu, Somalia, who will be responding to our study questionnaire in order to meet
our goal. We value whatever assistance they provide for us.

Above all, none of this would have been possible without our families. Our families,
who, despite our own modest commitment to correspondence, supplied their support each
week in the form of encouragement and money. Over the years, they had been kind to me
and had their own unique sense of humour. It would be an understatement to say that, as
a family, we have gone through some ups and downs during the past three years, to our
parents and our dear siblings and sisters. We will always be grateful that you persisted
each time we were about to give up. This dissertation is proof of your unwavering
support and encouragement.

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TABLE OF CONTENTS

DECLARATION A..........................................................................................................................I

DECLARATION B.........................................................................................................................II

APPROVAL SHEET.....................................................................................................................III

DEDICATION..............................................................................................................................IV

ACKNOWLEDGMENTS..............................................................................................................V

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

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

1.1 Background................................................................................................................................3

1.3Research problem.......................................................................................................................7

1.4 REREARCH PURPOSE..........................................................................................................8

1.3 Research Objectives...................................................................................................................8

J.3.1 General....................................................................................................................................8

1.3.2 Specific...................................................................................................................................9

1.4 Research Questions....................................................................................................................9

1.5 Hypotheses.................................................................................................................................9

1.6 Scope........................................................................................................................................10

1.6.1 Geographical Scope..............................................................................................................10

1.6.2 content Scope........................................................................................................................10

1.6.3 Theoretical Scope.................................................................................................................10

1.7 SIGNIFICANT OF THE STUDY...........................................................................................10

1.8 Operational Definitions of Key Terms....................................................................................11

CHAPTER TWO...........................................................................................................................13

VI
LETERATURE REVIEW.............................................................................................................13

2.0 Introduction..............................................................................................................................13

2.1.1 Overview of Internal Control................................................................................................13

2.1.2 Role and Purposes of Internal Control..................................................................................13

2.1.3 Types of Internal Control......................................................................................................13

2.1.4 Organizational Control.........................................................................................................13

2.1.5 Segregation of Duties...........................................................................................................14

2.1.6 Physical Control....................................................................................................................14

2.1.7 Arithmetical and Accounting Control..................................................................................14

2.1.8 Personnel Control.................................................................................................................14

2.1.9 Supervision Control..............................................................................................................15

2.1.10 Authorization and Approval...............................................................................................15

2.2.0 relation between, internal Controls Systems and Financial Performance............................15

2.3.0 Functionality of Internal Control Systems............................................................................16

2.3.1 Control Activities Control activities.....................................................................................16

2.3.2 Internal Audit........................................................................................................................17

2.3.3 Control environment.............................................................................................................17

2.4.0 Financial Performance ( DV).............................................................................................18

2.4.1 Measures of Financial Performance.....................................................................................19

2.4.2 Liquidity...............................................................................................................................19

2.4.3 Accountability.......................................................................................................................19

2.4.4 Reporting..............................................................................................................................19

2.4.5 Theorcticalframework...........................................................................................................20

2.7 Conclusion...............................................................................................................................22

CHAPTER THREE.......................................................................................................................23

VII
METHODOLOGY........................................................................................................................23

3.0 Introduction..............................................................................................................................23

3.1 Research Design......................................................................................................................23

3.3 Research Population................................................................................................................24

3.3.1 Sample Size..........................................................................................................................24

3.3.2 sampling Procedures.............................................................................................................25

3.4 Research Instruments...............................................................................................................26

3.4.1 Validity and Reliability of the instruments...........................................................................26

3.5 Data Gathering Procedures......................................................................................................28

3.6 Data Analysis...........................................................................................................................29

Reference.......................................................................................................................................32

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 CHAPTER ONE
1.0 INTRODUCTION

This is the first chapter of the study and the researcher is focus on the following sections:
Background of the study, problem statement, research purpose, research objectives, research
Questions, significant of the study, scope of the study, the study operational definitions and
conceptual frame work.

1.1 BACKGROUND OF THE STUDY

1.1.1 HISTORICAL PERSPECTIVE

Internal controls are the steps a firm takes to guarantee that its goals, objectives, and missions are
met. The processes and tactics of a department are used to guarantee that the transactions of a
company are handled appropriately, reducing waste, robbery, and asset theft. Internal controls
are policies and procedures established and implemented by those in charge of governance,
management, and other employees to provide reasonable assurance that an entity's financial
reporting accuracy, operational effectiveness, and compliance with applicable laws and
regulations will be managed to meet the entity's objectives (Mwindi, 2008). Internal controls, it
should be mentioned, provide an entity's management and board of directors with a reasonable
but not absolute confidence that the organization's goals will be realized (Ndifon Ejoh et al.,
2014).

it has the ability to manage and govern its assets Cash flow, balance sheet, profit-loss, and capital
change can all be used as a foundation for making decisions by corporate directors. In order to
receive the company's budgetary behavior via financial concerns, financial management, and
critical examination and technical analysis, as well as memorize money, it is necessary to obtain
critical examination and technical analysis. and accounting.to (Didin Fatihudin et,
2018).Globally. Malaysia's banks play a significant role in funding development as a developing
country. Commercial banks in Malaysia help in financial intermediation. Commercial banks are
often judged on their ability to utilize their resources. The benefit of commercial banks may be
deduced from their basic commerce, which allows them to convert short-term stores into long-
term ones (Mokhtar, 2006). Goh & Michael (2010) highlighted that financial proportion
methodologies are frequently used to measure the performance of companies or banks because

1
they provide unambiguous data on the firm's financial execution. The question of their relevance
is confusing because each study refers to a different proportion, similar to the best.

evidence of a plausible symptom of impending problems Furthermore, according to previous

research by Kumbirai & Webb (2010), financial proportions enable investors to distinguish
certain banks' strengths and flaws, allowing them to educate the banks' productivity, liquidity,
and credit quality. The capital ampleness theory is linked to bank execution since it established
that banks can act as a 'buffer' of excess capital when their capital ampleness proportion
fluctuates in order to avoid falling below legal capital requirements (Sahaida et al, 2017).

Tanzania, as a developing country, is working to strengthen its internal control system through
institutions like the Central Bank. The Ministry of Finance gives financial institutions the
authority to focus on implementing a sound internal control structure. The board of directors of
each financial institution may prefer legitimate approaches and methods for monitoring and
controlling the risks for each line of business and market served by such bank or financial
institution, including credit, budgetary, market, operations, legitimate, and any other hazard
influencing or likely to influence such bank or financial institution, as well as satisfactory in
general internal control frameworks (BAFIA, 2006).

The People's Bank of Zanzibar Restricted (PBZ) as a financial institution gradually improved its
financial performance during the 2000s after major government reconstructions, such as
redundancies of incompetents and long-term workers and replacement with competent ones,
introduction of the modern managing an account framework called Center Managing an account
Framework, unused banking arrangements and presentation of the unused division called Risk
Management Office, and strengthening of the financial institution ( khamis H. , 2013).

Somalia, for example, Since the breakdown of Somalia's old central government in 1991, there
has been a problem with financial performance and administration. Somalia had a reasonably
simple banking and credit system administered by the Central Bank and a limited number of
(mostly foreign-owned) commercial banking institutions prior to the breakdown of centralized
authority in 1989. The banking industry had minimal influence on or interaction with the lives of
ordinary Somalis even before the collapse of the Barre regime. Following an agreement with the
IMF to construct a free private oriented economy, a new Somali Commercial Bank was

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established in 1990 with a capital of 2 billion Somali Shillings. This cash was divided into 2,000
shares, each representing one million Somali shillings.

Shillings from Somalia One billion was paid jointly by the government and the Somali Central
Bank, with just 22 shares taken up by private investors. As a result of the civil war in 1991, the
bank, along with the country's official financial framework, collapsed (Franklin Amoo ,2009).

However, the impact of internal control on the financial performance of commercial banks in
Mogadishu, Somalia, will be investigated in this study.

1.1 Background Theory of the study

Internal controls can be referred as the ways introduced by a company in order to make certain
the accomplishment of company’s aims, targets, and objectives. They are a set of strategies and
methods taken up by an origination to make sure that all the

company’s deals are dealt in an effective way so as to ignore any kind of scam, wastage, and
exploitation of company’s resources. Internal controls are processes planned and influenced by
those in charge of supremacy, administration, and any other private to offer a sound guarantee of
the accomplishment of a company’s aims regarding consistency of the financial reporting,
efficiency and success of operations and fulfillment of all the rules and regulations
(Menon,2008).

It is very valuable to observe that internal controls only offers sound but not utter deceleration to
a company’s administration and board of directors that the aims of the company will be
accomplished. In order to ignore any wastage of resources, accomplish industrial and
performance objectives, facilitate the making of trustworthy reports and make certain the
fulfillment of rules, control systems are established by an organization (Hayes, 2005).

It is generally believed that establishment and implication of effective internal control systems
will direct towards better financial performance. It is also said that efficient established internal
control systems enhance the reporting procedure and also assist in raising the level of reliable
and trustworthy reports which improves the responsibility task of administration of a company.
However, current context still shows that despite the fact that there Is presence of a system of

3
controls in companies, financial performance is vague in most of these companies (Sarens,
2011).

In this research, internal control systems were taken to mean a procedure influenced by the
organization’s board of managers, administration, and any other workers, planned to offer sound
guarantee related to the accomplishment of the following aims; dependability of financial
reporting, efficiency and value of actions, and obedience of rules.

Internal control is important to all business organizations and more so the banking sector whose
business environment is prone to risks that must be mitigated for performance and profitability.
Commercial banks in Kenya dominate the Financial Sector and therefore have a tremendous
impact on the economic growth and financial stability of this Country. Flamini et al. (2009)
indicated that studies carried out in the last two decades show commercial banks in the Sub-
Sahara Africa are more profitable with an average return on Asset of 2%. In the spirit of finding
out the factors contributing to such performance, this research established that effective Internal
Controls positively affects Financial Performance of the Banking sector in Kenya. Internal
controls are the basic organizational elements that help management effectively deliver services
to stakeholders; helps ensure reliability of financial statements and compliance with the laws and
regulations (COSO, 1992/2004). Organizations with no or weak internal controls run the risk of
failure. This fact is supported by the findings of the Treadway Commission Report of 1987 in
USA which confirmed that the absence of, or weak internal controls is the primary cause of
many cases of fraudulent company financial reporting. The Sarbanes-Oxley(SOX) Act of 2002
was introduced in response to well-publicized accounting scandals of the 21st century that were
witnessed at Enron and WorldCom and required all public companies to disclose internal
controls over financial reporting. Section 404 of SOX requires management of public companies
to issue an internal control report in which they take responsibility for maintaining adequate
internal controls, and make assertions concerning their effectiveness. Kenya has a vibrant
banking sector that is relatively stable and well regulated. It consists of the Central Bank of
Kenya (CBK) that regulates the banking sector. There were 43 registered commercial banks as at
31stDecember, 2014, out of which two were under statutory management by the time of the
research. These banks were classified as Local/Foreign and Public / Private Banks. There were 3

4
publicly owned banks, 27 locally owned banks (26 commercial banks and 1 Microfinance
Corporation (MFC)) and 14 foreign owned commercial banks (this translates to more than 50%
foreign ownership). These banks are further classified into three main peer groups basing on
their market share index. Large banks peer group consisted of banks with a market share index
greater than 5% each. There were 6 banks in this peer. The Medium peer group had 16 banks
with a market share index of between 1% and 5% each. Lastly the small peer group had 21 banks
with a marker share index less than 1% each. The Large peer group had a total market share
index of 49.88%, the Medium peer group with a total market share index of 41.71% and the
small peer group with a total market share index of 8.41%.

The Banking sector in Kenya has continued to register increased profitability, mainly attributed
to the Structural Adjustment Programmes(SAP), such as; regulatory initiative on transparency by
initiation of Kenya Banks’ Reference Rate(KBRR), continued automation, ongoing
infrastructure investment by the government,

higher demand for credit resulting from increased regulated mobilization by the banks in
unsecured segments of

the market and government’s continued growth oriented macroeconomic policies. The total
Asset base rose by 18.5% to stand at 3.2 trillion and customer deposits increased by 18.65% to
stand at 2.29 trillion as at 31st December, 2014.

The internal control system in the banking sector is guided by the framework in banking
organizations issued by the Basel Committee (1998) on Banking Supervision. The Basel
Committee (1998) stipulated that a system of effective internal controls is a critical component of
bank management and a foundation for the safe and sound operation of banking organizations.

Since the industrial revolution, which resulted in factory systems supported by stockholders,
internal auditing has been increasingly vital to global businesses. Globalization and technology
developments are now the standard for businesses, and the banking industry is no exception.
Banks have expanded their operations and activities beyond their home borders as a result of
globalization and improved technology. As a result of their expansion, globalization, and modern
technology, businesses are increasingly vulnerable to danger, fraud, altercations, and other
anomalies. As a result, internal controls have become a vital component for all businesses,

5
including the banking industry. The verification of end use of bank funds when the checks are
cleared for payment at a central place under CBS environment and not at branches. Globalization
of enterprises, technical advancements, the increasing risk of business failures, and the fraud and
manipulations that have evolved in Africa's organizational sector all demand the proper
maintenance of effective internal control systems.

The US and other European countries have urged governments and enterprises to prioritize
internal control systems, internal auditing functions, and risk management. The recent credit
crunch in the world's most industrialized nations is a clear indication of the system's failure to
reign in some of the excesses that have arisen in our haste to satisfy our profit-making objectives
and compete with one another.

Internal control is defined as all policies and procedures adopted by an entity's directors and
management to aid in achieving its goal of ensuring, to the greatest extent possible, the orderly
and efficient conduct of its business, including adherence to internal policies, asset safeguarding,
fraud and error prevention and detection, and the accuracy and completeness of a financial
statement. (Ofori, 2011).

The internal control structure consists of all policies and activities developed by management to
support management objectives, such as adhering to management policies, preserving asset
integrity, preventing and detecting illegal acts and errors,

accuracy and completeness of accounting reports, and timely reporting of reliable financial
information. Policies, processes, organizational structures, staff management, physical and
information security, and the separation of roles are all examples of internal controls. Internal
control systems rely significantly on these types of controls. They are capable of managing all
facets of self-government. Accounting, finance, management, and internal audit are all
exaggerated. They can control all areas of self-government. Internal controls include accounting,
finance, management, and internal audit. This strategy is applicable to the functional areas of the
internal control system. (john 2006).

Internal controls are measures that an organization puts in place to guarantee that its priorities,
goals, and missions are met. They are a set of policies and procedures put in place by a

6
government agency to ensure that an organization's transactions are handled correctly in order to
avoid waste, theft, and abuse of resources.

In the study, Internal control systems were construed to mean “a process effected by the entity’s
board of directors, management and other personnel, designed to provide reasonable assurance
regarding the achievement of objectives in the categories; reliability of financial reporting,
effectiveness and efficiency of operations, and compliance with applicable laws and regulations”
(Whittington & Pany, 2001). While financial performance was considered in terms of measures
like profitability (using absolute and relative measures), liquidity (using liquidity ratios like
current ratio, acid test ratios, the ease with which the entity settles its financial obligations) and
Accountability (in terms of financial accountability) (ACCAManagerial Finance Paper 8; 1998;
and Panday, 1996). It therefore adopts the internal control in such a way that the system checks
itself and any irregularity within the system is been detected and corrected. To ensure that the
system checks itself, management could use devices such as segregations, supervision of work
and acknowledgement of performance. The effective arrangement and Implementation of this
control system would ensure proper management.

1.3Research problem
According to Mawanda (2008), designing and implementation of proper internal controls will
always lead to improved financial performance. Weak internal control systems have been known
to be perfect fertile ground for perpetration of fraud and scandals. Such was the case for financial
scandals of this decade witnessed at Enron and WorldCom.

The response to this scandals has resulted in bringing into the law the "Public Company
Accounting Reform and Investor Protecting Act'' commonly known as the ''Sarbanes-Oxley Act
(SOX Act)''. The SOX Act stipulates clearly that the management should take full responsibility
for internal control system over financial reporting within the company and provide assessment
of its effectiveness. Mawanda (2008) postulates that the Board of directors ought to supervise the
management of an entity, but it has always turned out that the Board merely implements
recommendations made by the management committee of an entity.

This in fact is possible due to information asymmetry existing between the managers and the
Board of Directors. The Agency theory advanced by Jensen & Meckling (1976) stipulates that

7
the principals and the agents use contracting to maximize their wealth. However, the agents may
face a dilemma of acting against the interest of their principals in an effort to maximize their own
wealth. Internal control should be used as a safety net to address this agency problem (Jensen &
Payne, 2003).

In the same light, studies have shown that Internal Controls reduce agency costs (Abedel-
Khalik, 1993) and this has a positive effect on the financial performance of a business. However,
they have not been given the prominence they deserve other than as a regulatory and social
accountability requirement.

Internationally, Ejoh and Ejom (2014) studied the relationship of internal control activities and
financial performance on tertiary institutions in Nigeria, Ayagre, et al. (2014) researched the
effectiveness of internal controls on banks in Ghana and only interrogated two components of
internal control; control environment and monitoring. Boyyoud and Sayyad (2015) studied the
impact of internal controls and risk management on banks in Palestine. Scholars such as Islam, et
al. (2014) used the CAMEL model to proxy financial performance in banks.

Locally empirical studies carried out by Magara (2013) studied the effects of internal controls on
savings and credit cooperative societies(SACCOs) in Kenya; Kamau (2014) studied the effect of
financial performance of manufacturing firms in Kenya; Nyakundi, et al. (2014) researched on
the effect of internal controls on small and medium enterprises (SMEs) in Kisumu. On
profitability: Onuonga (2014) researched on the bank specific factors using bank size, capital
strength, ownership and operations expenses; Ongore and Kusa (2013) used the Capital
adequacy, Asset quality, Management efficiency, Earnings ability and Liquidity(CAMEL) ratios
to proxy bank specific factors and Macroeconomic indicators based on growth domestic
product(GDP), growth rate and inflation; Olweny & Shipho (2011) used bank specific factors
proxied as CAMEL ratios and market concentration and foreign ownership.

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1.4 REREARCH PURPOSE

1.3 Research Objectives

J.3.1 General
To establish the correlation between internal control and financial performance of selected
private bank institutions

Internal controls in an organization are normally introduced to provide reasonable assurance

about the achievement of the entity’s objectives with regard to reliability of the financial
reporting, effectiveness and efficiency of operations and compliance with applicable laws and
regulations. These will finally translate into improved financial performance. The study will
therefore attempt to investigate the impact of internal control system on financial performance in
Mogadishu private banks. In particular the researcher will focus on the following specific
objectives:

1.3.2 Specific
To be sought further in this study were as follows:

1. To examine the effect of controlling environment on financial management in the Somali

banking sector.

2. To establish the effect of risk assessment on financial management in the Somali banking
sector.

3. To assess the effect of monitoring & evaluation system on financial management in the
banking sector of Somalia.

1.4 Research Questions

This study was answered the following research questions:

9
1. What is the effect of controlling environment on financial management in the banking sector
of Somalia?

2. What is the effect of risk assessment on financial management in the banking sector of
Somalia?

3. What is the effect of monitoring & evaluation system on financial management in the banking
sector of Somalia?

1.5 Hypotheses
There is no significant relationship between the levels of internal control and the level of
financial management.

1. H0: the effect of controlling environment on financial management in the Somali banking
sector.
2. Ho2. the effect of risk assessment on financial management in the Somali banking sector.

3. Ho3. the effect of monitoring & evaluation system on financial management in the banking
sector of Somalia.

1.6 SCOPE OF THE STUDY

The study was conducted among Private bank institutions in Mogadishu Somalia, where by
especially focuses on the private bank institutions Salaam Somali bank, Amal Bank, Premier,
and Dahabshil bank because those banks are private large banks that the study will take as
proxies of other banks. The study focused on the level of internal controls and it components;
control environment, control activity, risk assessments, communication, and monitoring. While
the financial performance including Credit risk, liquidity risk management, market risk
management, and operational risk management. Agency theory by (.Jensen and Meckling 1976)
also the other theory Signaling theory was advanced by (Craven and Marston 1 999).

10
1.7 SIGNIFICANT OF THE STUDY

There is no controversy that this research works has been conducted on Internal Controls system,
however much emphasis has been placed on the impact of a good Internal Control system on
financial management of organizations. This research work will go a long way in helping an
organization discover the impact of weakness in internal control and suggest measures in
correcting them. It will also reveal the problems caused by bad internal control system and be
useful to students, scholars, lecturers and other third parties as it shall open new area of further
research work and at same time advance challenges to up-coming researchers. This study will
also be useful for future researchers because it will act as a guideline for them to follow in the
subsequent studies related to the same problem at hand and it will also act as a source of
information.

1.8 Operational Definitions of Key Terms

For the purpose of this study, the following terms are defined as they are used in the study:

Internal Control is the process, effected by the whole entity’s parties, designed to provide
reasonable assurance regarding the achievement of objectives in the firm through Effectiveness
and efficiency of operations It has been defined by the Auditing planning committee (APC) IN
Uk as “the whole system of control financial and otherwise established by management in order
to carry out the business of the enterprise in an orderly and efficient manner to safeguard the
assets and secure as far as possible, the competence and accuracy of records, the prevention and
detection of errors and fraud in accordance with the final preparation of Financial statement.”

Control: Is an exercise performed in the present to achieve a plan drawn up for the future?

Management: is the process of creating an environment in which resources can be used to their
best advantage to realize the organization’s goals.

Financial Management: in the context of this study, wherever it used shall mean the art of
analyzing, recording, summarizing, evaluating, and interpreting financial activities and status and
communicating the results.

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 CHAPTER TWO

LETERATURE REVIEW

2.0 Introduction
This chapter two reviews the previous studies related to this study which was written by other
researchers. This was in respect to the specific objectives of the study of the related area.

2.1.1 Concept of Internal Control

According to the definition by COSO in 1992, an internal control system is defined as a set of

12
methods, designed and controlled by senior management and board of directors to provide a

limited assurance regarding reliability of financial reporting, effectiveness and efficiency of

operations and their compliance with laws and regulations (Aksoy, 2007) .s

2.1.2 Role and Purposes of Internal Control

According to Walter and William (1982:5), the role and purpose of internal control system is

merit able because internal control consists of the measures, record procedures and plan of an

organization that deals mainly with safeguarding asset and ensuring financial records are

accurate and reliable.

2.1.3 Types of Internal Control

The guideline of internal control put forward eight (8) types of internal control system that

should be obtainable in an organization and they are follows:

2.1.4 Organizational Control

An organization should have a plan of its activities which should define and allocate

responsibilities that is every function should be monitored by a specific person who may be

called “responsible officer.” Adequate lines reporting for all aspect the organization

operations, including controls should be clearly stated and the delegation of authority and

responsibility should be clearly specified . (Amaka, 2012)

2.1.5 Segregation of Duties

One of the prime means of control is the separation of duties. This reduces the risk of internal

manipulation, accidental error and increases the element of checking. Functions which should

be separated in an organization financial management include: initiation (officer or person

who decides to give out the loan), Execution (the person who keeps the money to be loan out)

and recording (the person who records the whole process in the book).system development

13
and daily operations have to be considered in mounding the internal control system to be full

proof against fraud (Amaka, 2012).

2.1.6 Physical Control

This concerns the physical custody of assets and involves procedures and security measures

designed to limit access to authorized personnel only. These include both direct and indirect

access via documentations. These controls assume importance in the case of valuable,

portable, exchangeable or desirable assets.” Physical control can also be achieved by

electronic means in a computerized environment for example through the use of electronic

I.D cards, password etc. to restrict access to particular file (Amaka, 2012).

2.1.7 Arithmetical and Accounting Control

These are the controls within the recording function which h checks that the transactions to

be recorded and processed have been authorized and that they are correctly and accurately

processed. Such controls include checking the arithmetical accuracy of the records,

maintenance and checking of totals, reconciliation, control accounts and trial balances and

accounting for document (Amaka, 2012).

2.1.8 Personnel Control

There should be procedure to ensure that personnel have capabilities commensurate with their

responsibility. Inevitably, the proper functioning of any stem depends on the competence and

integrity of those operating it. The qualifications, selection and training as well as the

personal characteristics of the personnel involved are important features to be considered in

setting up any control system especially in financial management (Amaka, 2012).

14
2.1.9 Supervision Control
Any system of internal control should include the supervision by responsible officials of day

to-day transactions and the recording thereof. Al activities performed in the financial

management by all the level of staff should be clearly laid down and communicated to the

person supervising (Amaka, 2012).

2.1.10 Authorization and Approval

All transactions should require authorization by an appropriate responsible person. This is

very important in the financial system of an organization where large amount of money is

handled so therefore it is appropriate for these money which are used for are used for various

transactions to be authorized by a trusted and responsible person (Amaka, 2012).

2.2.0 relation between, internal Controls Systems and Financial Performance.

Internal control is broadly defined as the process put in place by management to provide

reasonable assurance regarding the achievement of effective and efficient operations, reliable

financial reporting, and compliance with laws and regulations

(Petrovits, C., Shakespeare, C., & Shih, A, 2009)

Gupta (2001) drawing from Statements of Standard Auditing Practices No. 6

(SAP 6) defines Internal control as “the plan of organization and all the methods and

procedures adopted by the management of an entity to assist in achieving management

objectives of ensuring as far as practicable, the orderly and efficient conduct of its business,

including adherence to management policies, the safeguarding of assets, prevention and

detection of fraud and error, the accuracy and completeness of accounting records and the

timely preparation of reliable financial information”.

15
2.3.0 Functionality of Internal Control Systems
According to Hayes et al., 2005 (Hayes R. e., 2005) internal control comprises five components;
the control

environment, the entity’s risk assessment process, the information and communication

systems, control activities and the monitoring of controls. Therefore, each of the five

components of an internal control system is important. Here, we will focus on three

components, the control activities, internal audit and control environment. The other

components of the internal control systems will be held constant.

2.3.1 Control Activities Control activities

are the policies and procedures that help ensure management directives are

carried out. They help ensure that necessary actions are taken to address risks to achievement

of the entity's objectives. Control activities occur throughout the organization, at all levels

and in all functions. They include a range of activities as diverse as approvals, authorizations,

verifications, reconciliations, reviews of operating performance, security of assets and

segregation of duties (University of Califonia, Berkeley, 2012).

Control activities are the backbone of the company’s efforts to address the risks it faces,

such as fraud. The specific control activities used by a company will vary, depending on

management’s assessment of the risks faced. This assessment is heavily influenced by the

size and nature of the company (Weygandt, Kimmel, (Weygandt, J. J., Kimmel, P. D., & Kieso,
D. E, 2012)& Kieso, 2012).

The six principles of control activities are as follows.

• Establishment of responsibility

• Segregation of duties

• Documentation procedures

16
• Physical controls

• Independent internal verification

• Human resource controls

2.3.2 Internal Audit

The term audit comes from a Latin word “AUDIRE” meaning to hear in other words it means

official examination of account and records.

Whittington & Pany (2001) suggest that internal auditing is performed as part of the

monitoring activity of an organization. It involves investigating and appraising internal

controls and the efficiency with which the various units of the organization are performing

their assigned functions. An Internal Auditor is normally interested in determining whether a

department has a clear understanding of its assignment, is adequately staffed, maintains good

records, properly safeguarding cash, inventory & other assets and cooperates harmoniously

with other departments. The internal auditor normally reports to the top management.

Gupta (2001) on the other hand asserts that “Internal audit is an independent appraisal

function established within an Organization to examine and evaluate its activities as a service

to the organization.

2.3.3 Control environment

refers to all factors which are effective in determining, increasing or

decreasing the effectiveness of policies, procedures, and methods specific to a process.

Control environment stands out with the basic understanding adopted by senior management

of the corporation to control the organization, its attitude toward problems and approach to

solving problems and their perspective of the importance of moral values. Strictly speaking,

control environment can be perceived as a consciousness of the senior management of a

17
corporation to control the organization and employees (Kaval, 2005).

Whittington and Pany (2001) note that the control environment sets the tone of the

organization by influencing the control consciousness of people. They further assert that

control environment is viewed as the foundation for all the other components of internal

control. Control environment factors include; integrity and ethical values of personnel

responsible for creating, administering, and monitoring the controls, commitment and

competence of persons performing assigned duties, board of directors or audit committees.

2.4 Financial Management ( DV)

2.4.1 Accountability

Those who have invested not just money but also time, effort and trust in the organization, are
interested to see that the resources of the organization are used effectively and for the purpose for
which they were intended. Accountability is the moral or legal duty, placed on an individual,
group or organization, to explain how funds, equipment or authority given by a third party has
been used (Lewis, 2003). In addition, Sing (2009) argues that the institution must explain how it
has used its resources and what it has achieved as a result to all stakeholders, including
beneficiaries. All stakeholders have the right to know how their funds and authority have been
used.

Providing the organization has set a budget and has kept and reconciled its accounting records in
a clear and timely manner, it is then a very simple matter to produce financial reports which
allow the managers to assess the progress of the organization. A system of controls; checks and
balances; collectively referred to as internal controls are put in place to safeguard an
organization’s assets and manage internal risk (Lewis, 2003). Their purpose is to deter
opportunistic theft or fraud and to detect errors and omissions in the accounting records. An
effective internal control system also protects staff involved in financial tasks (Siddika, 2007).

2.4.2Transparency

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Systems must be established whereby all financial information is recorded accurately and
presented clearly, and can be easily disclosed to those who have a right to request it (Lewis,
2003). If this is not achieved, it can give the impression that there is something to hide.
According to Singh (2009), the institution must be open about its work, making information
about its activities and plans available to relevant

stakeholders. Otherwise, if an organization is not transparent, then it may give the impression of
having something to hide.

2.4.3 Controlling

A system of controls, checks and balances are essential to ensure proper application of
procedures and resources during program implementation (Lewis, 2003). The tools in controlling
include; budgets, delegated authority, procurement procedure, reconciliation, internal and
external audit, fixed assets register, vehicle policy, insurance, etc.

2.4.4 Monitoring

This involves producing regular and timely information for managers and stakeholders for
monitoring purposes. Monitoring involves comparing actual performance with plans to evaluate
the effectiveness of plans, identify weaknesses early on and take corrective action if required.
The tools in monitoring could be; evaluation reports, budget monitoring reports, cash flow
reports, financial statements, project reports, donor reports, audit reports, evaluation report, etc.
In addition to the management of daily operations and interactions with other organizations,
managers of non-governmental organizations are also responsible for ensuring the financial
security of their agency. This requires putting systems into place that monitor income generation,
management, and responses to funders. According to Mostashari (2005), all organizations need
money. Alongside staff, money is the one thing that takes up most management time. Good
financial management involves the following four building blocks:

2.4.5 Reporting
Whittington & Pany (2001), talk about the comprehensiveness of internal controls in

addressing the achievement of objectives in the areas of financial reporting, operations and

19
compliance with laws and regulations. They further note that “Internal control also includes

the program for preparing, verifying and distributing to the various levels of management

those current reports and analyses that enable executives to maintain control over the variety

of activities and functions that are performed in a large organization” They mention internal

control devices to include; use of budgetary techniques, production standards, inspection

laboratories, employee training and time & motion studies among others.

According Bakibinga 2001, corporate law requires a divorce between ownership and

management of an entity. Owners normally entrust their resources in the hands of managers.

2.4.6 Keeping Records

The foundations of all accounting are basic records that describe the organization’s earnings and
spending. This means the contracts and letters for money received and the receipts and the
invoices for things that are bought. These basic records prove that each and every transaction has
taken place. They are the cornerstones of being accountable. Management must make sure that
all these records are carefully filed and kept safe (Mostashari, 2005). It is also important to write
down the details of each transaction undertaken. These should be written down in a 'cashbook' -
which is a list of how much is spent, on what and when. If an organization is keeping the basic
records in good order and writing down the details of each transaction in a cashbook, it is
difficult for it to go far wrong (Mostashari, 2005).

2.4.7 Theorcticalframework
Agency theory by (Jensen and Meckling I 976) explains how information asymmetry between
top managers of the banks can be reduced by monitoring the opportunistic attitudes of the
financial managers. The theory assumes that the agency cost will vary with corporate attributes
(e.g. size, leverage, listing status, corporate governance compliance). It is argued that voluntary
disclosures lower agency costs (Chow and Wong-Boren 1987).

2.5 Conceptual Framework

20
A conceptual framework represents the researcher’s synthesis of literature on how to explain a
phenomenon. It maps out the actions required in the course of the study

given his previous knowledge of other researchers’ point of view and his observations on the
subject of research. In other words, the conceptual framework is the researcher’s understanding
of how the particular variables in his study connect with each other. Thus, it identifies the
variables required in the research investigation. It is the researcher’s “map” in pursuing the
investigation. This diagraph illustrates the relationship between Independent variable (internal
control system) and the dependent variable (financial management).

Internal Control Financial Managemen

(Independent Variable) (Dependent Variabl

Ex. Variables

 Accountability
Control Environment
 Transparency

Risk Assessment  Controlling

 Monitoring

Monitoring & evaluation

 Keeping Records

Figure 1.1 Conceptual Framework

2.6 Summary The theoretical basis for establishing a relationship between financial
performance and

internal control systems has been documented in various literatures. Internal control systems

that have been confirmed to have a relationship with business organization financial
21
performance include: organization, segregation of duties, physical authorization and

approval, arithmetical and accounting, personnel, supervision, management,

acknowledgement of performance and budgeting (Weber, 1988).

2.7 Conclusion
In this chapter, it consists of seven sections: in the first part, it discussed, Internal Controls

Systems and Financial Performance, whereas in the second part Functionality of Internal

Control Systems, in the third part Financial Performance discussed, and the fourth part,

Measures of Financial Performance discussed, the fifth part, summary discussed, and

conclusion. However, in Mogadishu, the role of internal control system and the functionality

of Internal Control systems on financial performance still have not received adequate

research. Therefore, this study will attempt to fill this gap by investigating the impact of

internal control system on financial performance in Mogadishu private banks.

22
 CHAPTER THREE

METHODOLOGY

3.0 Introduction
This chapter presents a detailed description of the research methodology, in section 3.1
the research design is presented.3.2 is the research population,3.3 sample size 3.4
research instrument3.5 data collection3.6 data analysis, section 3.7 ethical consideration
and final section 3.8 is presented limitation of the study

3.1 Research Design

This study was used survey design, qualitative, primary and secondary data, survey
design is present oriented methodology used to investigate population by selecting
samples to analysis and discover occurrence the data collected by the questionnaire. This
design is selected for this study because it is effective, less cost and easily accessible for
collecting information from the target population. This design is used to identify the
impact of internal on financial management in the Somali banking sectors.

The researchers’ purpose is to explore the relationship between two characteristics from
the same group and explain how characteristics vary together. Correlation design is
ideally suitable for studies where independent variable have relationship with dependent
variable Further, descriptive surveys are used to discover causal relationships (descriptive
correlation), to provide precise quantitative description and to observe behavior (Oso and
Onen ,2008).

This study was undertaken using a descriptive design and descriptive co relational
research design to determine significance relationship between the level of internal
control practices and the level of financial performance in selected private banks in
Mogadishu Somalia and it was mainly descriptive in nature.

Due to limited time and resources, the researcher chose this method because it would
reduce time wasting and ensure that representation of respondents was done according to
those found at the private banks.

23
 Both qualitative and quantitative data were collected by use of this design and further
subjected to scientific and descriptive analyses.

3.2 Research Population and sample zise

3.2.1Target population

The target population of this study was the Managers and employees of premier banks in
Mogadishu. The researcher was selected 57 Managers and employees as a target population. This
selection is based on the availability of the Managers and employees and their experience of the
field.

3.3.1 Sample Size

3.2.2 Sampling design and size

There searcher used sample of 50 respondents of the among target population, these
sample respondents Managers and employees of premier bank. Since the population of
this study is unknown. n =N / (1 + (N*e^2) Where: n = number of samples N =total
population e=margin of error

3.2.3 Sampling Techniques

The study used stratified random sampling to select the above mentioned fifty (50)
respondents. Formula is written as: n=N/ (1+N (α) 2), Where n=Number of samples, N=
Total population, α= significance level, while the significance level of this study is five
percent (0.05%) therefore: n = (57/ (1+57*0.052) =50 the researcher stratified
respondents according to their important in Somalia and then used systematic random
sampling to select responding in each.

3.3 Sampling procedure

This study was employed purposive sampling technique to select sample. Purposive
sample technique the researcher consciously decided who to include in the sample. The
main reason used is to collect reliable information. It preferred for this study because it
saves time and money.

3.4 Research instrument

24
The study used questionnaire as research instrument to collect the primary data from the
prospective respondents to achieve the primary objective of the research. Questionnaires
are used since the study intends to collect a lot of data about the relationship between the
research variables in the short period of time. Another apartment reason of using
questionnaires was that most of respondents are educated and literate, and the obtained
information can be easy described in writing.

3.5 Sampling procedure

This study was employed purposive sampling technique to select sample. Purposive
sample technique the researcher consciously decided who to include in the sample. The
main reason used is to collect reliable information. It preferred for this study because it
saves time and money. Also, it’s easier to make generalizations about your sample
compared to, say, a random where not all participants have the characteristic your
studying.

Table 3.1 Sample distribution table

Categories Population Sample size

Manager 10 9
Employee 40 35
Others 7 6
Total 57 50

3.6 Data collection/gathering methods

In the data gathering the researchers was requested from the student affairs and
registration office a letter revealing that the researchers are conducting an academic
research. Then, the researchers were gathered data through questionnaire, during data
collecting data the researchers was helped respondents for filling the questionnaire and
was requested to answer all questions(he/she should not leave any item unanswered).
After that the researchers was retrieved questionnaires within one week from the date of
distribution and all questionnaires retrieved was be checked if completely filled out. The
questionnaires focused bank performance and its implication for customer satisfaction

25
 3.7 Data Quality Control

To establish the reliability of questionnaire the researchers will use method of expertise
judgment as best method of reliability after the construction3of the

questionnaire. The researcher approach supervisor and other experts that have great
knowledge about the topic of this study to ensure the reliability and validity of the
researcher instrument. The sample technique and procedure or mechanisms put in place
made the study possible to ensure the validity and reliability as they kicked off the
biasness in the research and the advice of experts: which clearly made the research
relevant, specific and logical. In addition, a pilot test will be conducted respondents in
order to test and prove on the reliability of the questionnaire. To prove the validity of the
data collection instrument scale will use the validity relevance questionnaire and the total
number of questions.

3.8 Research Instruments

In a bid to enhance the reliability of the findings, Different instruments were used for the
data collection. Thus, the major data collections of instruments were used in this study
are namely, questionnaire and interview guide. The choices of these instruments were
guided by the data required and the objectives of the study.

The research tools that utilized in this study include the following: (1)/ace sheet to gather
data on the respondents’ demographic characteristics (gender, age. and qualifications~
number of year’s bank experience) (2) researcher used questionnaires to determine the
levels of financial risk management.

These consist of options referring to credit risk (7 items), liquidity risk (5 items). market
risk (6 items) and Operation Risk (5 items) in terms of managing risks. The response
modes and scoring are as follows: /ör financial risk management in terms of credit risk,
liquidity risk, operational risk, and market risk - strongly agree (4); agree (3); disagree
(2); strongly disagree (I).

26
 While a standardized instrument adopted from internal control adopted by Audit and
Management Advisory ServiceS,(20 items) will be used to determine the level of internal
control in terms of the aspects of the components of internal control, Control
Environment (4 items). Risk Assessments (3 items), Control Activities (3 items).
Information And Communication System (5 items) and Monitoring or self Assessments
(5 items~. The scoring system of this instrument is as follows: strongly agree (4); agree
(3); disagree (2); strongly disagree (1)

3.4.1 Validity and Reliability of the instruments

Content validity ensured by subjecting the researcher devised questionnaires on resource
availability and utilization to judgment by the content experts (who estimated the validity
on the basis of their experience) such as professors

(1), financial expertise

(2) and senior bank advisory

(3) in bank management.

The test-retest technique used to determine the reliability (accuracy) of the researcher
devised instruments to ten qualified respondents. five from bank institutions and five
from academic institutions. These respondents were not included in the actual study. In
this test- retest technique. the questionnaires were administered twice to the same
subjects. If the test is reliable and the trait being measured is stable, the results were
consistent and essentially the same in both times.

Validity is the quality of the test doing what is designed to do (Salkind, 2000). In this
research validity of the respondent’s instruments, questionnaire and interviews are
establishing through a 23 content validity index CVI by consulting finance and
accountant experts.

In validity content concerned with a test’s ability to include or represent all of the content
of a particular construct, is assessed by overview of the items by trained individuals
taking CVI above 0.70 as accepted for social sciences (Amin, 2005). The individuals

27
made their judgments about the relevance of the items. The CVI was established using
the formula: CVI = Number of items declared valid! Total number of items.

The results of the CVI are shown in table 3.2 below

Variable Number of items CVI

Internal control practices 10/10 1

Financial management 18/18 1
Source: Primary data

Table 3.2 shows that internal control will be measured using 10 items and yielded CVI of
1 while financial performance was measured 18 items and yielded a CVI of 1 Since two
variables yielded a CVI above 0.70 accepted for social sciences, it was concluded that the
instrument had a good validity hence relevant.

To achieve accuracy or reliability, pre-testing of the instruments was done. This was done
with similar private banks in Mogadishu, Somalia. Questionnaires were distributed to
those categories of staffs as pilot test.

The results from this pre-testing helped in rephrasing and adjustment of questions that
were unclear so as to bring about clarity and reliability.

Table 3.4: Reliability Test Results

Variables No of Items in the Questionnaire Cronbach’s Alpha

Internal control 10 0.8
Financial performance 18 0.94
The findings in Table 3.4 shows

that computed Cranach Alpha obtained from the reliability test was 0.8 from the variable
of internal control practices, 0.94 from the variable of financial performance and those
were greater than the estimated alpha of 0.70 thus, the instruments were considered
reliable

28
3.5 Data Gathering Procedures
The following data collection procedures were implemented:

 3.5.1 Before the administration of the questionnaires

 3.5.2 During the administration of the questionnaires
 3.5.3 After the administration of the questionnaire

 3.5.1 Before the administration of the questionnaires
 An introduction letter obtained from the Collage of high degree and research
Studies for the researcher to solicit approval to conduct the study from respective
heads of bank institutions.
 When approved, the researcher secured a list of the qualified respondents from the
bank institutiofl5 in charge and select through systematic random sampling from
this list to arrive at the minimum sample size.
 The respondents were explained about the study and requested to sign the
Informed Consent Form (Appendix).
 Reproduce more than enough questionnaires for distribution.
 Select research assistants who would assist in the data collection; brief and orient
them in order to be consistent in administering the questionnaires.

 N 3.5.2 During the administration of the questionnaires

1. The respondents requested to answer completely and not to leave any part of
the questionnaires unanswered.
2. 2. The researcher and assistants emphasized retrieval of the questionnaires
within five days from the date of distribution.
3. 3. On retrieval, all returned questionnaires were checked if all are answere

 3.5.3 After the administration of the questionnaire

The data was gathered collected, encoded into the computer and statistically
treaned using the Statistical Package for Social Sciences ( SPSS).

29
3.6 Data Analysis
After received the questionnaire back, the researcher encoded the data into the computer and
statistically treated using the Statistical Package for Social Sciences (SPSS) .

The frequency and percentage distribution was used to determine the demographic
characteristics of the respondents.

The mean and standard deviations were applied for the levels of financial risk
management and Internal Control. An item analysis was illustrated the strengths and
weaknesses based on the indicators in terms of mean and rank. From these strengths
and weaknesses, the recommendations were derived. The following mean range was
used to arrive at the mean of the individual indicators and interpretation

A. For the level of internal Control

Mean Range Response Mode Interpretation

3.26-4.00 Strongly agree Very satisfactory

2.51-3.25 Agree Satisfactory

1.76-2.50 dis agree Fairly Satisfactory

1.00-1.75 Strong Dis agree unsatisfactory

B. For the level Of Financial Performance

Mean Range Response Mode Interpretation

3.26-4.00 Strongly agree Very satisfactory

2.51-3.25 Agree Satisfactory

1.76-2.50 dis agree Fairly Satisfactory

1.00-1.75 Strong Dis agree unsatisfactory

The correlation utilized to test the relationship between means for hypothesis one (Ho
#1) at 0.05 level of significance.

30
The regression analysis R2 (coefficient of determination) was computed to determine
the influence of the independent variables on the dependent variable.

3.7 Ethical Considerations To ensure confidentiality of the information provided by

the respondents and to ascertain the practice of ethics in this study, the following
activities implemented by the researcher:

1. The respondents coded instead of reflecting the names.

2. Permission through a written request to the concerned officials of the bank

institutions included in the study.

3. Request the respondents to sign in the Informed Consent Form

4. Acknowledge the author of the standardized instrument through citations and

referencing.

5. Present the findings in a generalized manner. e authors quoted in this study and

3.8 Limitation of the Study In view of the following threats to validity, the
researcher will claim an allowable 5% margin of error at 0.05 level of significance.

Measures are also indicated in order to minimize if not to eradicate the threats to the
validity of the findings of this study.

1. Extraneous variables which beyond the researcher’s control such as respondents’

honesty, personal biases and uncontrolled setting of the study.

2. Instrumentation. The research instruments financial risk management and internal

control are not using interview.

3. Testing: The use of research assistants can bring about inconsistency in the
administration of the questionnaires in terms of time of administration,

understandi11g of the items in the questionnaires and explanations given to the

respondents. To minimize this threat, the research assistants were oriented and briefed
on the procedures to be done in data collection.

31
 4. Attrition/morality: Not all questionnaires maybe returned neither completely
answered nor even retrieved back due to circumstances on the part of the respondents
such as travels, sickness, hospitalization and refusal/Withdrawal to participate. In
anticipation to this, the researcher will reserve more respondents by exceeding the
minimum sample size.

The respondents also reminded not to leave any item in the questionnaires
unanswered and closely followed up as to the date of retrieval

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