University of Perpetual Help System Laguna

College of Business and Accountancy

“EFFECTIVENESS OF
INTERNAL CONTROL
SYSTEM
ON PROFITABILITY OF SMES
IN BIÑAN CITY”
Bachelor of Science in Accountancy
ASPA, AUSTIN LLOYD M.
ESCAÑO, JERILYN C.
VALENCIA, MAE O.
VINOYA, HARLY E.
 Statement of the Problem
This study determined the effectiveness of internal control system
to the profitability of the SME's. This topic sought answers specifically to
the following questions:
1. What is the level of effectiveness of internal control system of SMEs in
terms of:
1.1 Risk Assessment
1.2 Control Environment
1.3 Control Activities
1.4 Information and communication
1.5 Monitoring
2. What is the level of profitability of SMEs in terms of:
2.1 Return on Assets
2.2 Return on Equity
2.3 Gross Profit Ratio
3. Is there any significant relationship between the level of effectiveness
of internal control system and level of2 profitability of SMEs?
 Statement of the Hypothesis
This study tested the null hypothesis.
H0: There is no significant relationship
between the level of effectiveness of
internal control system and the level of
profitability of SMEs.

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 Synthesis
From the review of related literature and studies done, it has been
found out that realization of affirmative financial performance and
profitability depends on whether firms implement internal control system or
ICS. Accounting Tools (2016), UHY Haines Norton Chartered Accountants
(2014), Emirates Chartered Accountants Group (2013), Patience (2013),
Debora, et al. (2013), Giriunas (2015), Beukes (2014), AICPA Employee
Benefit Plan Audit Quality Center (2015), Marks (2012), Paraskevi (2016),
and Ayagre, et. al. (2014) discussed the definition of internal control system,
its importance and effectiveness. Accordingly, ICS is intended to safeguard
assets, limit errors, and ensure that tasks are led in an affirmed way, also ICS
is a prerequisite for effective and efficient management. Moreover, ICS is also
considered as an essential element to operate in good practices and is vital for
good financial accounting. But then, the implementation of internal control
system must also be cost effective that is it should not exceed the benefit as
stated in the study of Demi and Ababa (2015).
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 Findings
The conspicuous findings of the study are enumerated below after gathering,
formulating, tabulating, and statistically analyzation of data.
Level of effectiveness of internal control system of SMEs
The respondents’ risk assessment, control environment, control activities,
information and communication, and monitoring had very high level of effectiveness
with a weighted mean of 3.61, 3.53, 3.53, 3.62, and 3.61 respectively. The indicator with
the highest value was information and communication with a weighted mean of 3.62.
Level of profitability of SMEs
The respondents’ return on assets, return on equity, and gross profit ratio had
very high and high level of profitability with a weighted mean of 3.44, 3.28, and 3.62
respectively. The indicator with the highest value was the gross profit ratio with a
weighted mean of 3.28.
Relationship between the level of effectiveness of internal control system and level
of profitability of SMEs
The relationship between the level of effectiveness of internal control system
and level of profitability reflected a Pearson r value of 0.625, a p value of 0.0000 which
was lower than the 0.01 level of significance shows that there is a significant relationship
of SMEs. This indicates that the higher the level of effectiveness of internal control
system, the higher the level of profitability of5 SMEs.
 Conclusion
Based on the enumerated summary of findings
above, the researchers arrived with the following
conclusions:
1. Majority of the internal controls used among
SMEs located in Bñan City, Laguna reflect a very
high level of effectiveness.
2. The level of profitability earned by SMEs
located in Biñan City, Laguna reflects a high level
of profitability.
3. The higher the level of effectiveness of internal
control system, the higher the level of profitability.
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 Recommendation
1. The SMEs should maintain the very high effectiveness of internal control system throughout the life
of the company because an organization that builds up a viable internal control can enhance their
proficiency in conveying esteem and accomplishing its key objectives. For risk assessment
procedures, management are recommended to have their specialized unit tasked to monitor and
review risks internally and externally. The said unit must also construct plans to guarantee the
continuity of the business operations. However, the analysis also showed lack of seriousness in
applying risk management concept and policies specifically for the purpose of identifying significant
accounts and disclosures. In this case applying other policies aside from setting a materiality threshold
must be observed. It could be analyzing the existing policies adopted and currently used by other
entities within the same industry or exercising superb professional judgment. For the organization’s
control environment procedures, the researchers highly recommended management of SMEs to
promote activities that may satisfy employees’ interest which in turn may increase the level of their job
satisfaction. The management are also encouraged to continue on establishing policies adequately
within the organization. Lastly, it must also take in consideration the review of independence among
the board members to avoid conflict of interest. In understanding the control activities of SMEs, proper
physical controls were maintained and performing periodic review of policies and procedure to
determine its relevance must always be practiced to prevent risks and as a warning for exceptional
occurrence of errors. It is also recommended that management should maximize the use of
information technology or business intelligence for it largely benefited the company such as a useful
tool for faster and efficient recording and interpreting data or activities engaged by the firm. SMEs
must improve the process on how they disperse important information within the organization. The
communication with the personnel must be an on-going process. They must keep current strategies
and systems known throughout the organization so that they can relate what their exercises’ effect
have on the business’ objectives and goals accomplishment. Lastly, even though the decentralized
parts of the SMEs have their own managers, the top level management must do surprise visits or
essential inspecting procedures. This is to ensure7whether the executed policies and procedures set
by the company were properly observed and maintained.
 Recommendation
2. The researchers recommend the SMEs to improve the inventory
planning system of their firm which is considered to be a big help in
achieving a faster return on assets. Production level of inventories that
keeps on inflating assets must be reduced. The SMEs are also
recommended to engage into activity that will increase the number of
investors and to maintain its cost while increasing its revenues to result
in a faster ROE. Lastly, management needs to cut some low-margin
client, products, and services and focus on higher-producing parts of
the business in order to increase its gross profit margin.
3. Since the study concluded that there is a significant relationship
between the level of effectiveness of internal control system and
profitability, management are then recommended to strengthen the
internal control system by strictly and properly implementing its
components to maintain its effectiveness because it will yield to a
higher profit.