INTERNAL CONTROL SYSTEMS AND FINANCIAL

PERFORMANCEOF MICROFINANCE INSTITUTIONS:

A CASE STUDY OF RESEAU INTERDIOCESAIN DE

MICROFINANCES LTD IN KIGALI ARCHDIOCESE

BERTHILDE NYANDWI

MBA/0373/12

A Research Project Submitted in Partial Fulfillment for the Award of the

Degree of Master of Business Administration (Finance & Accounting

Option) of Mount Kenya University

June 2017
 DECLARATION

This research Project is my original work and has not been presented to any other Institution.

No part of this research Project should be reproduced without the authors’ consent or that of

Mount Kenya University.

Students Name: Berthilde Nyandwi

Sign ____________________ Date _____________

This research Proposal has been submitted with my approval as the Mount Kenya University

supervisor.

Name: Dr. Nyambane, David PhD

Sign ____________________ Date _____________

ii
 DEDICATION

I thank the Almighty God who continues to guide and help me in this work whose end result

is dedicated to the following individuals:

My loving uncle Thaddeus and my three beloved children, Patrick, Fany and Patrice whose

consistent encouragement, moral support and irreplaceable attention keep making me strong

and confident in all I do.

And to you all those who have participated and will participate in bringing this work to its

fruitful/successful end.

iii
 ACKNOWLEDGMENT

This work is the result of the efforts and support of many individuals. First and foremost, I

would like to express my heartfelt gratitude to Dr. David Nyambane, my supervisor, whose

insight and comments have guided me toward the completion of this research project. I’m

very grateful to him to have been available whenever I needed his support. I would also like

to register my expression to all School of Business and Economic staff at Mount Kenya

University for having streamlined my knowledge. I also extend my appreciation to my

respondents and interviewees who will accept to answer my questionnaires and to take part in

an interview.

Finally to all my friends and colleagues at work, and any other person -including

respondents- who will give useful information in responses to the questionnaire and who

will directly or indirectly contribute to the success of this work.

To you all I unreservedly wish to say that you are very supportive and encouraging. May

God Lord bless you all abundantly!

iv
 ABSTRACT

The present paper was an attempt at investigating the effects of internal controls to the
financial performance of the Rwandan Microfinance. RIMs Ltd operating in Kigali diocese
under the Catholic Church leadership was selected as a case study. The research objectives
are to assess the internal control system components used by RIM Ltd; to examine the
indicators of MFIs’ financial Performance and to examine the relationship between internal
control system and Microfinance institutions financial performance. Research data was
collected through semi structured questionnaire that were distributed to 122 respondents-
though only 115 returned-different employees and managers at different RIMs branches and
sub-branches of Kigali archdiocese and they were supposed to be data-rich sources on the
financial topics notably internal controls. The target population was divided into seven strata
where a representative sample was drawn from each stratum. The seven strata comprised 176
comprising 11managers of RIM ltd branches, 22 loan department employees, 11 marketing
department employees, 11 accounting and finance department, 11 auditing departments, 55
credit committees’ members, and 55 operation department employees and other staff in 11
RIM Ltd branches. Research design was used in order to establish the relationship between
the independent and dependent variables, so as to examine how internal controls were used in
RIMs Ltd I and therefore account for the financial performance levels. The study sought to
establish the relationship between internal control systems and MFIs (Microfinance
Institutions) financial performance of RIM Ltd. After collecting data, the researcher
organized well-answered questionnaire, data were edited and sorted for the following stage.
The data were presented in tabular form, pie charts and bar graphs with frequencies and
percentages. Overall, 93.8% of the respondents confirmed that there is an upper level of
relationship between internal control system and profitability. Moreover, 84.5% of the
respondents confirmed that there is an upper level of relationship between internal control
system and objectives attainment. The study also revealed that 67% of the respondents
pointed out that there is an upper relationship between internal control system and return on
assets. Finally, 62% of the respondents indicated that there is a relationship between internal
control system and return on equity. The study recommends that the identified components of
effective internal controls: internal audit; supervision; information review and monitoring be
applied in a synergistic linkage to form an integrated system that reacts dynamically to
changing conditions. The study recommended that the management should constantly train
the staff to implement the internal control systems and supervise their implementation to
achieve objectives and thus profitability.

v
 TABLE OF CONTENTS

DECLARATION ............................................................................................... ii

DEDICATION .................................................................................................. iii

ACKNOWLEDGMENT .................................................................................. iv

ABSTRACT .........................................................................................................v

TABLE OF CONTENTS ................................................................................. vi

LIST OF TABLES ............................................................................................ ix

LIST OF ABBREVIATIONS AND ACRONYMS ........................................ xi

OPERATIONAL DEFINITIONS OF KEY TERMS .................................. xii

CHAPTER ONE: INTRODUCTION ...............................................................1

1.0 Introduction ..................................................................................................................... 1

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

1.2 Statement of the Problem ................................................................................................ 5

1.3 Objectives of the study.................................................................................................... 7

1.3.1 General objective ..................................................................................................... 7
1.3.2 Specific objectives ................................................................................................... 7

1.4 Research questions .......................................................................................................... 7

1.5 Significance of the study................................................................................................. 8

1.6 Limitation of the Study ................................................................................................... 8

1.7 Scope ............................................................................................................................... 9

1.7.1 Content scope ........................................................................................................... 9

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 1.7.2 Geographical scope .................................................................................................. 9

1.8 Structure of the study .................................................................................................... 10

CHAPTER TWO: REVIEW OF RELATED LITERATURE ...................11

2.0 Introduction ................................................................................................................... 11

2.1 Theoretical Literature.................................................................................................... 11

2.1.1 Overview of internal control .................................................................................. 11
2.1.2 Components of internal control system ................................................................. 12
2.1.3 Indicators of Financial performance of Microfinance Institutions ........................ 14
2.1.5 Types of internal control systems .......................................................................... 20

2.2 Empirical Literature Review ......................................................................................... 24

2.3 Critical review and research gap identification ............................................................ 33

2.4 Conceptual Framework ................................................................................................. 34

2.5 Summary ....................................................................................................................... 35

CHAPTER THREE: RESEARCH METHODOLOGY ...............................36

3.0 Introduction ................................................................................................................... 36

3.1 Research design ............................................................................................................ 36

3.2 Target Population .......................................................................................................... 36

3.3 Sample Design .............................................................................................................. 37

3.3.1 Sample Size............................................................................................................ 37
3.3.2 Sampling Technique .............................................................................................. 38

3.4 Data collection Methods ............................................................................................... 39

3.4.1 Primary Data .......................................................................................................... 39
3.4.2 Secondary Data ...................................................................................................... 40

3.5 Validity and reliability of the instrument ...................................................................... 42

3.6 Data processing and Analysis ....................................................................................... 42

3.7 Ethical considerations ................................................................................................... 43

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CHAPTER FOUR: RESEARCH FINDINGS AND DISCUSSION ............44

4.0 Introduction ................................................................................................................... 44

4.1 Demographic characteristics of respondents ................................................................ 45

4.1.1 Response rate ......................................................................................................... 45
4.1.2 Age bracket of the respondent .............................................................................. 45
4.1.3 Education attainment ............................................................................................. 47
4.1.4 The Duration that the Institution had been in operation ........................................ 47
4.2.1. The internal control system components as per used within RIM Ltd ................. 48
4.2.2 Indicators of RIM Ltd’s Financial Performance .................................................... 64
4.2.3: The relationship between internal control system and microfinance institutions
performance .................................................................................................................... 69

CHAPTER FIVE: SUMMARY CONCLUSIONS AND

RECOMMENDATIONS..................................................................................76

5.0 Introduction ................................................................................................................... 76

5.1 Summary of Findings .................................................................................................... 76

5.1.1 The internal control system components used within RIM LTD ......................... 76
5.1.2 The indicators of RIM LTD’s financial Performance........................................... 77
5.1.3 The relationship between internal control system and MFIs financial performance
......................................................................................................................................... 77

5.2 Conclusions ................................................................................................................... 78

5.3 Recommendations ......................................................................................................... 80

5.4 Suggestions for Further study ....................................................................................... 80

REFERENCES..................................................................................................82

APPENDIX 1: Questionnaire ..........................................................................93

APPENDIX 2: Iinterview guide ....................................................................102

APPENDIX 3: A sheet note for Interview and questionnaire)...................104

viii
 LIST OF TABLES

Table 3.1: Target population of the study ............................................................................... 37

Table 3. 2: Sample size ........................................................................................................... 39

Table 4.1: Response rate ......................................................................................................... 45

Table 4.2: Education attainment ............................................................................................. 47

Table 4.3: The duration by which the RIM LTD had been in operation ................................ 48

Table 4.4: Internal audit practices with RIMs LTD ................................................................ 50

Table 4.5: Risk assessment ..................................................................................................... 52

Table 4.6: Control activities .................................................................................................... 55

Table 4.7: Information and communication............................................................................ 59

Table 4.8: Monitoring ............................................................................................................. 61

Table 4.9: Indicators of financial performance ....................................................................... 64

Table 4.10: Tools for effective internal control for Microfinance Institutions ....................... 65

Table 4.11: Tools for effective internal control of Microfinance Institutions ........................ 68

Table 4.12: Why it is needy to institute internal control system with MFI ............................ 70

ix
 LIST OF FIGURES

Figure 3.1: Conceptual framework ......................................................................................... 34

Figure 4.1: Distribution of respondents ‘age bracket.............................................................. 46

Figure 4.2: Components of internal control ............................................................................ 49

Figure 4.3: Need for internal control systems within RIM Ltd to grow financially ............... 69

Figure 4.4: Relationship between the internal control system and financial performance ..... 71

Figure 4.5: Relationship between internal control and profitability ....................................... 72

Figure 4.6: Relationship between internal control system and objectives attainment ............ 73

Figure 4.7: Relationship between internal control system and return on asset ....................... 73

Figure 4.8: The relationship between internal control and return on equity ........................... 74

x
 LIST OF ABBREVIATIONS AND ACRONYMS

ACCA: Associate of the Charted Association of Certified Accountant

AMIR: Association of Microfinance Institutions

BAFIA: Banking and Financial Institution Act

CIPFA: Chartered Institute of Public Finance and Accountancy

COSO: Committee of Sponsoring Organization

EFQM: European Foundation for Quality Management

ERM: Enterprise Risk Management

IIA: Institute of Internal Auditors

ISA: International Standard of Auditing

NBAA: National Board of Accountancy and Auditors

PBZ: People’s Bank of Zanzibar

RIM: Réseau Interdiocésain de Microfinances (Inter-diocesan Microfinance)

SPSS: Statistical Package for Social Science.

xi
 OPERATIONAL DEFINITIONS OF KEY TERMS

Internal control: refers to all the policies and procedures established and maintained by the

managers of an entity to help ensure, as far as is practical, the orderly, efficient and profitable

conduct of its business.

Microfinance: It is the term that has been used interchangeably with micro-credit.

Microfinance refers to loans or credit, savings, insurance, transfer services, micro-credit

loans and other financial products targeted at low–income clients.

The internal control system: extends beyond matters relating directly to the accounting

system and comprises the control environment and control systems.

xii
 CHAPTER ONE: INTRODUCTION

1.0 Introduction

This study seeks to investigate if the internal control system in Microfinance Institutions

(MFIs) could be a tool to improve their financial performance. The chapter one discusses the

background to the study, statement of the problem, research objectives, and research

questions, significance of the study, limitations, and scope of the study.

1.1 Background of the Study

This study is about internal control and financial performance of microfinance institutions,

taking a case of RIM Ltd branches in Kigali Archdiocese between 2009 and 2013. RIM Ltd

is a microfinance institution, registered as a private company limited by shares based in

Rwanda, established by Catholic Church of Rwanda on May 6, 2004 (Association of

Microfinance in Rwanda [MIR], 2010). The mission of RIM Ltd is to contribute to the

poverty alleviation by mobilizing saving and lending services, contribute to the economic

growth of the country by strengthening entrepreneurship spirit among population and

promotion of human dignity. RIM Ltd is the biggest microfinance in Rwanda and is most

rural focused microfinance targeting the poor clientele where the main methodology is the

group lending. The RIM Ltd’s clients are solidarity groups, cooperatives, associations,

societies, and individuals. It offers saving and lending services. Different loans financed by

RIM are agriculture, livestock, commerce, artisan, equipment, social loans (health, school

fees…). RIM Ltd operates both in rural and urban area. AMIR points out that RIM Ltd

cover currently 9 Catholic Church dioceses and 74 parishes. At the moment, it has 34

counters and 11 branches (AMIR).

1
MFI failures and widespread losses over the past two decades have elevated the importance

of effective risk management and internal control within the financial sector worldwide. In

the United States, bank failures rose over 200 percent in the 1980s partly due to fraud and

mismanagement.

Furthermore, the findings of the Tread way Commission Report of 1987 in the United

States (USA) confirmed that the absence of internal controls or the presence of weak internal

controls is the primary cause of many cases of fraudulent company financial reporting.

The widespread global corporate accounting scandals in recent years inform this study.

Internationally, the collapse of Barings Bank and Yamaichi Securities further focused the

financial sector’s attention on risk management and internal control (Bishop, 1991). The

Basle Committee analyzed the problems related to these losses and concluded that they

probably could have been avoided if the banks had maintained effective internal control

systems (Basoln, 2002). In addition, 38 active British businesses went into liquidation in the

third quarter of 1992 and in 1991 a total of 21,827 businesses failed compared to 15,051 in

1990, majorly because of weak Internal control systems (Galloway, 1994). Furthermore, in

Uganda, about 90% of Ugandan SMEs collapse within 3 years (Katuntu, 2005) due to lack of

internal control. Lack of or weak internal control is therefore an indicator of poor financial

performance. In Nigeria, the managing director and chief financial officer of Cadbury

Nigeria were dismissed in 2006 for inflating the profits of the company for some

years before the company’s foreign partner acquired controlling interest. These scandals

emphasize the need to evaluate, scrutinize, and formulate systems of checks and

balances to guide corporate executives in decision-making

2
In Rwanda, the microfinance sector has received more emphasis with the development of

PRSP [Poverty Reduction strategy paper] in 2008. Microfinance was among the priorities

that would help the government to encourage the people to start small businesses by giving

them skills and loans, and also encourages banks and institutions that lend money to reach

many people in all parts of Rwanda. However, due to the poor management of MFIs, some of

them started to fall down. In fact, 8 MFIs were closed down in June 2008 due to corruption

scandals, the lack of good practices and the poor management of funds.

The French Institute of Chartered Accountants defines internal control systems as a

set of security measures which contribute to the control of a company. Its aim is to ensure

the security and safeguard of assets and the quality of information. It plays an important role

in preventing and detecting fraud and protecting the organization's resources, both physical

(machinery and property) and intangible (reputation or intellectual property such as

trademarks).

Despite the fact that internal control system is expensive to install and maintain, it gradually

evolved over the years with the greatest development occurring at the beginning of

1940s. Not only have the complexities of the business techniques contributed to this

development but also the increased size of business units which have encouraged the

adoption of methods which while increasing efficiency of business, acts as a safeguard

against errors and frauds.

Basoln (2002) notes that an internal control is a set of instructions, guidelines and procedures

that a company's senior leadership establishes to prevent operating losses resulting from

theft, error, technological malfunction and employee neglect or carelessness. An internal

control also helps an organization/company prevent adverse regulatory initiatives, such as

3
fines or litigation. Accounting principles and internal audit rules require that organizations or

companies establish adequate and functional internal control to improve corporate

governance processes.

Juheno (1999) further notes that internal control system helps an organization prepare

accurate and complete financial statements at the end of each month and quarter. A firm may

also hedge, or protect against, operating risks by implementing internal control system.

According to Krishnan (2005), proper application of internal control procedures and policies

improves on the financial performance of MFI. According to Stevenson (2004) performance

is the outcome of an individual or group contribution of development in any activity leading

to results (positive / negative). The financial statements users, regulators, directors and

managers view internal control function as a key component of an organization’s corporate

governance.

The study at hand is important because of the role played by RIM Ltd in ensuring that the

population is living a better health life thanks to saving and lending services provided to

them. According to RIM Ltd strategic Plan (2005), RIM Ltd overriding mission is to

contribute to the economic growth of the country by strengthening entrepreneurship spirit

among the population, and improve the health of the world’s poorest and most vulnerable

people by closing the gap resulting from the lack of the funds.

One of the objectives to achieve the above mission is through establishment of sound

financial management systems for accountability, measurement of the financial performance

and provision of timely information and to provide sound governance and oversight of the

RIM Ltd activities. The above objective therefore implies that the organization should set up

4
proper books of account and financial management and measurement systems including the

setting up of an internal control system to ensure proper financial performance.

Southworth and Mritunjay (1995) revealed that for the financial institution to perform

financially, they should see to it that financial responsibilities and authority are defined in

employee job descriptions; written procedures are maintained regarding financial and

accounting practices. They further found out that written policies on travel, personnel and

procurement practices; safeguards and policies should be in place to guard against conflict of

interest. Cash and expenses are segregated, and if applicable financial records are subject to

internal or external audit routinely, at least once per year. More importantly, cash receipts are

deposited promptly; payments are executed only with the appropriate approval and upon

submission of the required documentation: detailed invoices, copies of purchase orders and

shipping documents, etc.

Microfinance financial performance is measured in terms of customer satisfaction, through

reduced customer complaints (Rezaee, 1995), number of clients, through liquidity, efficiency

effectiveness of operations, accuracy and reliability of accounting information, and thus

profitability. This study sets out to investigate if the sound internal control within MFIs could

enable them to be profitable, efficient, effective, in short, goals attainment.

1.2 Statement of the Problem

There is a general consensus that internal Control systems are used as management tools in

financial management (Spira& Page, 2003). In Rwanda, the microfinance institutions are

under obligation of establishing Internal Control measures in order to enhance their

financial reporting systems, check on their efficiency and effectiveness of operations as

5
well as enhance adherence to the prescribed rules and regulations. However, the latest

AMIR (Association of Microfinance Institutions, 2010) shows that management of

Microfinance institutions in Rwanda are performing below expectations and this is

exemplified in the poor returns and the number of MFIs closed down. Indeed, as pointed

out by AMIR, 8 MFIs were closed down in June 2006 due to corruption scandals, the lack of

good practices and the poor management of funds.

The absence of adequate internal control measures exposes the financial management of an

MFI to certain threats such as incorrect financial statement and /loss of the company’s assets,

stealing and mismanagement of organizational vital documents which may be done by an

employee to take undue advantage, incorrect and unreliable financial records which may lead

to loss of organizational integrity, non-implementation of accounting policies in consistent

with the applicable legislation appropriate in presentation of financial statement, faulty

systems, bad loans, fraud, theft or poor financial management amongst other potential causes,

to name but only a few (Coso, 2011).

While not new to the commercial banking sector, these topics have not been widely

discussed or researched within the microfinance industry. Yet as demonstrated by Cuevas

(2000), MFIs are not immune to the dangers of weak internal controls. In recognition of the

dangers of weak internal control systems, and the fact the MFI, most specifically in Rwanda

are prone to lose funds, the researcher opted for working out this area to contribute to

improving internal control system of MFIs, and thus cater for their financial performance.

Therefore, it is from this background that the researcher was inspired to analyze the impact of

internal control system to MFI financial performance, the focus being RIM Ltd branch and

sub-branches.

6
1.3 Objectives of the study

The researcher has one general objective and three specific as indicated here below:

1.3.1 General objective

The general objective of this study is to examine the impact of internal control systems to

Microfinance Institutions’ financial performance.

1.3.2 Specific objectives

i. To assess the internal control system components used by RIM Ltd.

ii. Examine the indicators of MFIs’ financial Performance;

iii. To examine the relationship between internal control system and Microfinance

institutions financial performance.

1.4 Research questions

The study will be guided by the following questions:

i. What are the internal control components used by RIM Ltd?

ii. What are the indicators of financial performance of Microfinance Institutions?

iii. Is there any relationship between internal control system and Microfinance

Institutions’ financial performance?

7
1.5 Significance of the study

This study could be used as an initiation for those who are interested to conduct a detailed

and comprehensive study regarding the performance of micro finance institutions through

internal control system. It will enable the governing body, specifically the managements, and

the higher responsible body, risk management department of the institutions to be aware of

the roles of internal controls and its effect on growth of institutions income. The study will

enrich the researcher’s knowledge on the variables under study and help the researcher fulfill

the requirements that lead to the award of the degree of MBA from Mount Kenya University.

The study results will be useful to management, board of governors, and all stakeholders of

RIM Ltd as they will use findings from the study to redesign policies. Last but not the least;

findings will also be available for reference to academicians, researchers who seek to conduct

further research in any of the variable under this study

1.6 Limitation of the Study

The researcher believes that the findings of this study would be more productive if it were

conducted on all micro finance institutions in Rwanda. However, due to time and financial

constraints, it is out of the reach of the researcher to incorporate all micro finance institutions

in this study. Due to this, the study was limited to 10 RIM Ltd Sub-branches and 1 RIM Ltd

branch in Kigali Diocese.

In as much as the respondents had little or no knowledge in the English language, the

researcher translated the questionnaires in Kinyarwanda. The researcher also translated the

respondents ‘responses from Kinyarwanda into English to ensure that there is no language

barrier whatsoever. Another limitation was due to the fact that there is a scanty literature

8
about the relationship between internal control system and RIM Ltd financial performance.

To address this, the researcher borrowed quite often other countries experiences and applied

them to the Rwandan context.

1.7 Scope

1.7.1 Content scope

The study is confined on internal control system as an independent variable and the financial

performance as dependent variable. Therefore, internal control system as independent

variable comprises control environment, risk assessment, control activities and information

system. On the other hand, financial performance-dependent variable- is encapsulated in

proper use of asset and fund loss prevention, reliable and accurate financial reporting,

efficiency and effectiveness of operation, profitability, among others.

1.7.2 Geographical scope

Geographically, the study was conducted at RIM Ltd, in Rwanda. Put another word, the

study was carried out within 11 branches located in Kigali city, Eastern and Northern

provinces. I picked one branch in Kigali city, 7 in Eastern province and 3 in Northern

Province.

9
1.7.3 Time scope

The study was conducted in Rwanda specifically in the 11 RIMs Ltd Branches and it was

cover the years ranging between 2009 and 2016.

1.8 Structure of the study

This study was organized into five chapters. The first chapter is background of the study and

it includes introduction about the study, statement of the problem, general and specific

objectives, scope of the study, significance of the study and limitation of the study. The

second chapter is related literature review and it encompasses theoretical concept and

empirical studies focused on the topic. The third chapter contains the research methodology

detail used by the researcher. Chapter four is related to research findings and their

descriptions which are presented through the tables and graphs. The fourth chapter refers to

the summary of findings, conclusions and recommendations.

10
 CHAPTER TWO: REVIEW OF RELATED LITERATURE

2.0 Introduction

This chapter provides a critical review of related literature on the study variables, definition

and understanding of internal control system, tools for effective internal control systems,

types of internal control, element of good internal control system and more importantly

earlier studies on internal control system and financial performance will be critically

reviewed.

2.1 Theoretical Literature

This section focuses on reviewing the literature related to the internal control system. This

will provide profound insight into the topic and facilitate the interpretation of the findings.

The source of this literature has been academic journals, the internet, newspapers and

magazines, newsletters and reports of specific institutions.

2.1.1 Overview of internal control

Internal control is a set of integrated methods and procedures translated into regular and

periodic activities that preserves safety of asset (e.g. loan portfolio, cash and other physical

assets etc), improves client service, ensures reliability of financial information and staff

adherence to management policies and guidelines ( Committee of Sponsoring Organization

of the Treadway Commission , [COSO], 2011). It ensures, (i) systems of accountability along

with prevention of errors, fraud and irregularities, and (ii) systems of detecting errors and

irregularities. Management must ensure that a proper internal control structure is instituted,

reviewed, and updated to keep it effective.

11
Colbert and Bowen (1996) pointed out that the internal control must satisfy three basic

criteria: (1) They must be appropriate (that is, the right control in the right place and

commensurate to the risk involved), they must function consistently as planned throughout

the period (that is, be complied with carefully by all employees involved and not bypassed

when key personnel are away or the workload is heavy), they must be cost effective (that is,

the cost of implementing the control should not exceed the benefits derived).

There has been a misconception about the use of the work internal audit and internal control

and a clarification has been deemed necessary. Aguolu (2002) defined internal audit as “An

independent review of operations and records, sometimes continuously undertaken within a

business by a specially assigned staff” ,while he defined internal control as “A system which

comprises the plan of organization and all of the co-ordinate methods and measures adopted

within a business to safeguard its assets, check the accuracy and reliability of its accounting

data, promote operational efficiency and encourage adherence to prescribed managerial

policies”.

Furthermore, he explained that an efficient internal control embraces internal audit. Also,

internal audit is carried out on the basis of the internal control system in place while internal

control focuses solely on evaluating risk management ‘ex-post (before and after operations)

measures to control risks. In other words, internal audit is just one component of internal

control process (William, 2009)

2.1.2 Components of internal control system

Internal control comprises the internal audit, the supervision, the information review, and the

monitoring of controls (Hayes, 2005).

12
To start with the control environment, it sets the tone of an organization, influencing the

control consciousness of its people. It is the foundation for all other components of internal

control, providing discipline and structure. Control environment factors include the integrity,

ethical values and competence of the entity’s people; management’s philosophy and

operating style; the way management assigns authority and responsibility, and organizes and

develops its people; and the attention and direction provided by the board of directors

(Rwanda Cooperative Agency [RCA], 2013).

The second component of internal control is risk assessment. According to Myers and

Gramling (1997), risk assessment is the identification and analysis of relevant risks to

achievement of the objectives, forming a basis for determining how the risks should be

managed. Because economic, industry, regulatory and operating conditions will continue to

change, mechanisms are needed to identify and deal with the special risks associated with

change.

The third component is the control activities. Lannoye (1999) pointed out that control

activities are the policies and procedures that help ensure management directives are carried

out and 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, veri-

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

segregation of duties.

Then come the fourth component of internal control. That is none other than the information

and communications. This component is not a stand-alone component. It intersects, interacts

13
with, and is part of each of the other 4 elements. Lannoye points out that strong MFI and

portfolio management at all levels is highly dependent on good information, particularly

financial information and portfolio information. In order to be useful, it must be relevant,

correct, and timely. Loan officers who do not know the status of their portfolio at any given

time cannot be held fully accountable for their performance. Branch managers need to know

their branch’s financial status – its revenues and costs need to be known to be managed and

controlled.

Last but not the least; monitoring is the fourth component of internal control. In fact, part of

the management function involves supervision and monitoring. Through segregation of

duties and independent checks and verification, an element of ongoing monitoring takes

place in every day operations of an MFI. It is not uncommon for MFIs to undergo separate

evaluations or ratings from time to time as well. Perhaps the strongest and most effective

monitoring in the internal control process takes place through the internal audit function

(Myers & Gramling, 1997). The Internal Auditor is independent of other business processes

in the MFI, reports to the Board of directors (usually the Audit Committee) and is focused on

detective controls -- testing for compliance to policies, procedures and controls, the reliability

of financial reports and on risk identification.

2.1.3 Indicators of Financial performance of Microfinance Institutions

Financial performance of MFIs can be gauged via the degree of attainment of their

organizational objectives like meeting both short-term and long-term objectives as and

whenever they fall due. The scarce resources of the organization are not supposed to

14
be pumped into white elephants. Optimal resource utilization should ensure maximum

output in the projects named in the organizational objectives.

Organizations cannot afford to waste their limited financial and skilled man power resources

on unproductive ventures. Investment projects must be chosen not only on the basis of

partial productivity of overall development program which takes account of external

economics indirect repercussion and long term objectives. Skilled manpower must be

utilized where its contribution will be widely felt. Economic planning is assumed to help

modify the restraining influence of limited resources by recognizing the existence of a

particular constraint and by choosing and coordinating investment projects so as to channel

the scarce resources into their most productive outlets (Whittington & Pany, 2004).

However, financial performance in this study will be gauged by profitability/surplus, degree

of goal attainment, return on asset, return on equity and return on sales. Whittington and

Pany found out that objective performance measures include indicators such as profit

growth, revenue growth, return on capital employed.

Financial consultants Stern Stewart and Co. created Market Value Added (MVA), a measure

of the excess value a company has provided to its shareholders over the total amount of their

investments (Bishop, 1991). This ranking is based on some traditional aspects of financial

performance including total returns, sales growth, profit growth, net margin, and return on

equity. Myers and Gramling (1997) however, mention other financial measures to include

value of long term investment, financial soundness, and use of corporate assets. He also

mentions accounting based performance using three indicators: return on assets (ROA),

return on equity (ROE), and return on sales (ROS). Each measure is calculated by

dividing net income by total assets, total common equity, and total net sales, respectively.

15
2.1.4 Tools for effective internal control for Microfinance Institutions

Internal control is a process; it is a means to an end, not an end in itself. Internal control

systems are fundamental to the success and survival of MFIs. It is a moving target. It must

be monitored and adapted to fit the circumstances. Internal control is geared to the

achievement of objectives in one or more separate but overlapping categories (Parveen,

2008). Microfinance management may be defined as “an operational system of microfinance

services that starts from organizing groups, mobilizing savings, selecting borrowers,

disbursing microcredit, collecting repayment, recycling loan, preventing defaulters and

defalcation as well keeping systematic records and reports towards the end of poverty

alleviation” (Rittenberg, 2006). In designing effective internal control system for MFIs the

following criteria needs attention as viewed by Rittenberg: segregation of duties,

authorization and execution of transactions and events, documentation, monitoring and

supervision, as well as the internal audit.

To begin with segregation of duties, Armour pointed out that key duties and responsibilities

in authorizing, processing, recording, and reviewing transactions and events should be

separated among individuals. Internal control is affected by people. It is not merely

producing and distributing policy manuals and forms, it is monitoring people at every level

of the organization. According to Colbert and Bowen (1996), the separation of tasks not only

helps ensure accurate compilation of data, but also limits the chances for fraud that would

require the collusion of two or more persons. Colbert and Bowen assert that this extremely

important and often neglected element can be subdivided into four parts.

16
The first one is separation of operational responsibility from record keeping responsibility.

The entire accounting function should be separated from operating departments so that

objective, independent records may be kept either by other operating people or by clerks.

For example, cash and other ledgers should be kept by accountant, not by the cashier or field

workers. The accountant/store clerk, not store keeper, should keep inventory records. The

second is separation of the custody of assets from accounting: this practice reduces

temptation and fraud. For example, the bookkeeper should not handle cash, and the cashier

should not have access to ledger accounts such as the individual records of micro-credit

clientele.

The third is computerized system. In a computerized system, a person with custody of assets

should not have access to programming or any input records. Similarly, an individual who

handles programming or input records should not have access to tempting assets. Separation

of the authorization of transactions from the custody of related assets: To the extent feasible,

persons who authorize transactions should not have control over the related asset. For

instance, the same individual should not authorize the payment of a supplier’s invoice and

also sign the check in payment of the bill. Nor should an individual who handles cash

receipts have the authority to indicate which accounts receivable (e.g. loan outstanding)

should be written off as uncorrectable. Fourth, there is separation of duties within the

accounting function. In fact, an employee should not be able to record a transaction from its

origin to its ultimate posting in a ledger. Independent performance of various phases will

help ensure control over errors.

As for authorization and execution of transactions and events, transactions and significant

events are to be authorized and executed only by persons acting within the scope of their

17
authority. All transactions will require approval and authorization by a responsible official

(Canadian Institute of Chartered Accountants [CIC], 1995). The limits of delegation of

approving authority and financial power limits should be clearly defined and who approves

what should also be defined specifically. Authorization can be either general or specific.

General authorization must be given in written form. It often sets definite limits on loan

ceiling, savings instruments, and rate of service charge, daily/travel allowance, and so forth.

There may also be complete prohibitions (against taking extra fees or any facility from

microcredit borrowers, etc). Specific authorization usually means that a superior manager

must permit (typically in writing) any particular deviations from the limits set by general

authorization. For example, the chief executive, rather than the branch manager, may have to

approve any distress loan (i.e. interest free loan given from disaster management fund).

Another example is the need for approval from the board of directors/executive committee

regarding expenditures for capital assets in excess of limits specified in the budget.

As far as the documentation is concerned, Southworth and Mritunjay (1995) emphasized the

fact that the internal control structure and all transactions and significant events are to be

clearly documented, and the documentation is to be readily available for examination.

Transactions and significant events are to be promptly recorded and properly classified e.g.

loan proposals along with group resolutions and savings-loan collection-sheet to journals and

ledgers. Immediate, complete, and tamper-proof recording is the aim. To this end pre-

numbered source documents and registers should be in practice to ensure recording.

Monitoring and supervision is another type tool for effective internal for Microfinance

Institutions. Competent supervision is to be provided to ensure that internal control

18
objectives are achieved. Southworth and Mritunjay asserted that to be effective, controls

should fulfill their intended purpose in actual application. A set of controls designed to

operate in a manual environment may not be effective in an automated environment.

Therefore, the controls selected should provide the coverage they are supposed to provide

and operate when intended.

As for efficiency, controls should be designed to derive maximum benefit with minimum

effort. Controls tested for effectiveness and efficiency should be those in actual operations

and should be evaluated over time to ensure that they are continually used (Vijayakumar &

Nagaraja, 2012). Operations staff / managers are to continually monitor their savings and

loan operations through field visits and take prompt, responsive action on all findings of

irregular, uneconomical, inefficient, and ineffective operations. COSO (2011) held the views

that in the supervision, the following considerations are to be taken into account: (1)Use of

loan outside the proposed IGA/ unproductive activity, (2) Hidden Overdue, (3)Violation of

Traditional Micro Credit Culture, (4)False Vouching, (5)False Disbursement, (5)Fictitious

Cash in Hand, (6)Social motivation to recover the default loan, (7)Find out the causes of

defalcation of loan, (8)SWOT analysis for default loan recovery (9)Insufficient MIS, AIS and

poor record keeping.

The last tool for effective internal control for Microfinance Institutions is internal audit.

Parveen (2008) pointed out that the internal auditing is an independent appraisal function

established within MFI’s, which examines and evaluates its activities as a service to the

organization. Internal auditing is essential for ensuring the operation and appropriateness of

controls (therefore essential for good management), but frequently neglected for financial

reasons. It is unwise to be dogmatic about the detailed responsibilities of internal auditors, as

19
these will vary a great deal between MFI’s and even through time for the same entities.

Parveen goes further to say that responsibilities might include: (1) evaluating the

effectiveness of internal controls, (2) ensuring the reliability and integrity of financial

management system of record keeping and reporting (3) ensuring safeguard of assets, (4)

promoting orderly, economical, efficient, and effective operations and quality products and

services consistent with the organization's mission; (5) ensuring adherence to laws,

regulations, and management directives.

2.1.5 Types of internal control systems

The guideline of internal control put forward eight types of internal control system that

should be obtainable in an organization and they are follows: organization control,

segregation of duties, physical control, arithmetical and accounting control, personnel

control, supervision control, management, and authorization and approval.

To start with organization control, it is worth pointing out that 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 (Basoln,

2002)

As for segregation of duties, it is worthy of note to state that 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

20
out the loan), Execution (the person who keeps the money to be loaned out) and recording

(the person who records the whole process in the book). System development and daily

operations have to be considered in moulding the internal control system to be full proof

against fraud (Bishop, 1999).

Physical control is of course another type of internal control. Indeed, 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 (Bou-Raad, 2000). 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.

Furthermore, arithmetical and accounting control is a type of internal control systems. 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 (Cahill, 2006).

More to types of internal control systems is personal control. As a matter of fact, 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

21
personal characteristics of the personnel involved are important features to be considered in

setting up any control system especially in financial management.

As far as supervision control is concerned, any system of internal control should include the

supervision by responsible officials of day-to-day transactions and the recording thereof. All

activities performed in the financial management by all the level of staff should be clearly

laid down and communicated to the person supervising.

Management is another type of internal control system. These are the controls exercised by

management outside the day-to-day routing of the system. They include the overall

supervisory controls exercised by management, the review of management accounts and

comparison thereof with budget internal audit function and other special review procedures.

It is also the duty of the management to review the internal control from time to time in order

to accommodate changes in the financial management operations.

Lastly, authorization and approval is the type of internal control system. 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. Therefore it

is appropriate for this money which is used for various transactions to be authorized by a

trusted and responsible person (Cai, 1997).

There are mainly two elements of a good internal control system. These elements are internal

audit and internal check as well.

Leslie (1973) writing on internal audit said that it is a review of operation and records

sometimes continuous which is been looked into by specially assigned staff. Leslie went

22
further to say that where internal audit exist, internal controls is greatly facilitated and in

order to achieve the planned objectives, management must have to set reasonable procedure

for the internal audit department to apply. He went further to state that if the internal auditor

would achieve the aim of management that is profit maximization, independence is also a

necessity. Also Eze (1975) defined internal audit as a review of operation and records

sometimes continuous, undertaken within a business by specially assigned staff. A situation

where the external auditor, there could be unnecessary duplication of work which stands to

tamper the financial management of the organization.

He went further to say that if management set up a strong internal audit department with its

own autonomy, the scare fund of an organization would be adequately and effectively

managed. Internal auditors have responsibilities to carry out some of which are: 1) Providing

management with information about the adequacy and effectiveness of the organization

system of internal control, 2) review and improvement of the system of internal check, the

examination and review of the organization policies and activities to ensure compliance with

statutory legislative requirement, internal auditors should be able to undertake at all times

special investigation at the management request.

As far as internal check is concerned, it has also been deemed necessary to explain the

principles of internal checks which also forms part of the system internal control embrace.

The institute of chartered accountant of England Wales defined internal check as the

allocation of authority and work in such manner as to afford checks on the routine transaction

of day to day work by more of the work of an individual being proved independently by

another. According to Aguolu (2002), internal check covers the detection of fraud or errors

and interior quality of work. It also involves a number of principles among which are:

23
(a) Work is divided so that no single person has sole control over a complete cycle of work.

Thus, for example a cashier should not post the ledger instead these functions should be

carried out by an independent person responsible to the accountant.

(b) The work flows from one person to another, and in the process each stage is subjected to

an independent check. This is done with a minimum amount of duplication, (c) When checks

are not automatically out as part of the system, special checks should be carried out by senior

officials and proper lines of authority should be established for dealing with such

transactions.

2.2 Empirical Literature Review

Empirical literature review involves citing researchers and recent books and journals or

recent time observations and experiments. This section discusses the impacts of internal

control systems to the financial performance of financial institutions.

Mawanda (2008) conducted a research on effects of internal control systems on

financial performance in institution of higher learning Uganda. In his study he

investigated and sought to establish the relationship between internal control systems and

financial performance in an Institution of higher learning in Uganda. Internal controls

were looked at from the perspective of Control Environment, Internal Audit and Control

Activities whereas Financial performance focused on liquidity, accountability and

reporting as the measures of Financial performance. The Researcher set out to

establish the causes of persistent poor financial performance from the perspective of

internal controls. The study established a significant relationship between internal

control system and financial performance. The investigation recommends competence

24
profiling in the Internal Audit department which should be based on what the

University expects the internal audit to do and what appropriate number staff would be

required to do this job. The study therefore acknowledged role of internal audit

department to establish internal controls which have an effect on the financial

performance of organizations.

In another study, case studies on internal controls in Belgium illustrate the importance of the

control environment when studying internal auditing practices. Cunningham (2004) found

that certain control environment characteristics like tone-at-the-top, level of risk and

control awareness, extent to which responsibilities related to risk management and

internal controls are clearly defined and communicated are significantly related to the

role of the internal audit function and fraud detection within an organization.

Moreover, using the analytical approach and focusing on control activities and monitoring,

Amudo and Inanga (2009) investigated the effect of penalties and other internal controls on

employees’ propensity to be fraudulent. Data was collected from both managerial and non-

managerial employees. The results showed that the presence of the control activities,

separation of duties, increases the cost of committing fraud. Thus, the benefit from

committing fraud has to outweigh the cost in an environment of segregated duties for an

employee to commit fraud. Further, it was established that segregation of duties is a “least-

cost” fraud deterrent for non-managerial employees, but for managerial employees,

maximum penalties are the “least-cost” fraud disincentives. The results suggest the

effectiveness of preventive control activities such as segregation of duties is dependent on

detective controls.

25
Ewa and Udoayang (2012) carried out a study to establish the impact of internal control

design on banks‟ ability to investigate staff fraud and staff life style and fraud detection in

Nigeria. Data were collected from 13 Nigerian banks using a four point likert Scale

questionnaire and analyzed using percentages and ratios. The study found that Internal

control design influences staff attitude towards fraud such that a strong internal control

mechanism is deterrence to staff fraud while a weak one exposes the system to fraud and

creates opportunity for staff to commit fraud.

Park (2007) evaluated the level of effectiveness of internal controls of enterprises operating

in Nairobi. The study was quantitative and was conducted between September 2007 and

June 2009 using a sample of 30 small businesses as listed in the National Social Security

Fund (NSSF) Register of Kenya. Primary data was collected from the managers of the

small business using interviews and examination of documents pertaining to internal

controls. The study established that there are deficiencies in the systems of internal

controls, with the degree of deficiencies varying from one enterprise to another. The

components of internal control that were missing in most businesses surveyed were: firstly,

risk analysis, and secondly lack of proper flow of information.

Amudo and Inanga (2009) also carried out a study in Uganda to evaluate the internal control

systems that the regional member countries of the African Development Bank Group

institute for the management of the Public Sector Projects that the Bank finances.

There are 14 projects of the bank’s public sector portfolio in Uganda. The data received and

analyzed is for eleven projects. Three projects were omitted because they were not fully

operational to install effective internal control systems. The study identified the following

six essential components of an effective internal control system: control environment,

26
risk assessment, control activities, information and communications, monitoring and

information technology. The outcome of the evaluation process was that some control

components of effective internal control systems were lacking in those projects. These

rendered the control structures ineffective and thus less profitability.

Wee Goh (2009) studied 208 firms on audit committees, boards of directors, and

remediation of material weaknesses in internal control. He measured the effectiveness of the

audit committee by its independence, financial expertise, size, and meeting frequency,

and the effectiveness of the board by its independence, size, and meeting frequency, and by

the duality of the chief executive officer (CEO) and chair positions (CEO duality). He also

examined other factors that can affect firms' timeliness in the remediation of material

weaknesses, such as the severity of material weaknesses, firms' profitability, the

complexity of firms' operations, and so on. He found out that the proportion of audit

committee members with financial expertise is positively associated with firms'

timeliness in the remediation of material weaknesses. Second, firms with larger audit

committees are more likely to remediate material weaknesses in a timely manner. Third,

that a more independent board is less susceptible to the undue influence of

management and more likely to exert pressure on management to remediate material

weaknesses.

The research work by Bowrin (2004) tries to investigate on the relationship between the

internal control and financial performance. He provides a stronger test than prior studies

which shows that there is a connection between control environment, risk assessment, control

activities and financial performance of financial institutions. In his study, firstly he used data

taken directly from interview rather than through questionnaires; secondly they employed a

27
key internal control characteristic (management integrity). In the study by Weisbach (1988),

it was revealed that internal control and financial performance correlate positively. To test

this hypothesis, Chi-square was used and value of 161.1 (P=0) at 0.05 significant level

indicates that there is relation between internal control and financial performance. Weisbach

also used multiple regression analysis to find out the impact of the internal control on reliable

financial reporting, and it was revealed that the control systems in sample MFI is

contributing to determine the reliable financial reporting by 81.8%.

Amudo and Inanga (2009) revealed that there is the positive relationship between internal

control and fraud prevention using chi-square test with value of 161.1 (P=0) at 0.05

significant level. Kinney (2000) found that 72% of the respondents agreed that internal

control lead to the financial institutions’ profit, while 18% said that it leads to efficiency of

operations.

Lannoye (1999) analysed the relationships between internal control and financial

performance. He had control environment, risk assessment and control activities, accounting

information, and monitoring as independent variable and liquidity as dependent variable. He

found therefore that control environment is highly rated item contributing to liquidity by a

mean of 12.57, then accounting information with 12.55, risk assessment with 12.32,

monitoring with 12.27 and control activities with 12.23. Robinson pointed out that profit,

efficiency and liquidity are the most commonly used variable for measurement of financial

performance.

Colby (1978) in the study of the impact of internal control system on the financial

Management of an organization (a case study of the Nigeria bottling company plc,

28
enugu), internal control measure does ensure proper use of organization fund and assets.

The Z value at 3 degree of freedom and 5% significant for two tailed test was 0.9989

which is less than table value 2.6. The study also found that fraud perpetration and losses

of revenue in an organization are not a result of internal control system.

COSO (2011) developed an additional framework to address more specifically the risk

management issues in an organization called Enterprise Risk Management (ERM); the frame

encompasses all component of internal control frame work, but adds also the components of

objective setting, event identification and risk response (Rittenberg 2005) and the result was

that the internal control influenced significantly the profitability of the financial institutions.

In evaluating the financial performance of the internal control environments, Dhamankar and

Khandewale (2003) argued that there was need to consider whether the following control

objectives are met; management conveys the message that integrity and ethical cannot be

compromised, the organization structure provides a moral framework for planning, directing,

and controlling operations, management ensures that appropriate responsibility and

delegation of authority is assigned to deal with goals and objectives and the Board of

Directors and audit committee are sufficiently independent from management to construct a

challenge to management decision and take an active role in ensuring that an appropriate

“tone at the top exists”.

Financial institutions with internal control systems are observed to be significantly larger,

more highly regulated, more competitive, more profitable, more liquid, more conservative in

their accounting policies, more competent in their management and accounting, and subject

to better management controls (Simmons, 1995). A study by simmons using a sample of

29
Australian listed companies, showed that the existence of an internal control system is

positively associated with firm size, profitability, sales growth and commitment to risk

management.

According to Bald (2000), strong performing firms are those that have strong internal control

systems and can therefore stay in business for a good number of years. He also found out

that, the ability of a firm to survive in business is an indicator of good financial performance.

38 active British businesses went into liquidation in the third quarter of 1992 and in 1991 a

total of 21,827 businesses failed compared to 15,051 in 1990, majorly because of weak

Internal control systems (Galloway, 1994). In Uganda, about 90% of Ugandan SMEs

collapse within 3 years (Katuntu, 2005) due to lack of internal control. Lack of or weak

internal control is therefore an indicator of poor financial performance.

Findings by Katuntu showed a strong relationship between effectiveness of internal controls

and return on equity as revealed by a correlation coefficient of 0.893, with a standard error of

0.032. The results seem to agree with Roth (1997)’s assertion of the effectiveness of internal

controls setting the pace for organization’s performance. This suggests that the effectiveness

of internal controls is related with financial performance and therefore hypothesis one (Ha1);

there is a relationship between return on investment and internal control system(s) among

SMEs is accepted.

Results by Park (2007) revealed that respondents felt that there is a strong relationship

between effectiveness of internal controls and growth in profits at a correlation coefficient of

0.936. It was also revealed that respondents averagely agree on the effectiveness of internal

controls as shown by a mean of 2.89. Simarly, Study by Parveen (2008) also revealed that

30
there exists a strong relationship between review and verification of internal controls and

growth in profits at a correlation coefficient of 0.927. It also reveals that respondents

averagely agree on the review and verification of internal controls as shown by a mean of

2.87. However a significant standard deviation of 1.267 is a clear indication of varied

responses from respondents as far as review and verification of internal controls is

concerned. Therefore, the dimensions of internal control systems; effectiveness of internal

controls, adherence to authorization procedures and review and verification of internal

controls affect financial performance, thus hypothesis three (Ha3), There is a relationship

between growth in profits among SMEs and the strength of internal control systems is

accepted.

It is good for local financial institutions to improve the effectiveness of their internal control

system in order to enhance their performance. The main responsibilities of internal control

system in financial institutions ‘covers; ensuring full protection of council’s assets; ensuring

proper utilization of councils resources; proper authorization of revenue and expenditure;

proper expenditure monitoring; removal of any misconduct in finances (Kwanbo, 2010).

Due to the world recognition of the importance of effective internal control system

establishment at financial institutions, some countries still have weak internal control system

in banking organizations. For instance; Baltaci and Yilmaz (2006) discovered some of the

world countries that has weak internal control system in their financial institutions and this

includes; Argentina, Bosnia, China, Columbia, India-Karnataka State, Indonesia and

Philippines. Vijayakumar and Nagaraja (2012) argued that governing bodies of public sector

entities need to ensure effective system of internal control because is one of the several

31
factors that influence the performance of an organization and it plays a vital role in achieving

management intended objectives that would lead to the successful operations.

According to William (2009), the role and purpose of internal control system is meritable

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. They further explained that the need for internal control can be seen in

its roles and purposes which are financial internal control and administrative internal control.

As far as financial control system is concerned, it ensures the assets of the company is

protected, it protects against improper disbursement of the assets for the company, it assures

and secures the accuracy and reliability of all accounting, financial and other operating

information of the company.

As the coin has two sides, there are some limitations of internal control systems. According

to Eze (2005) the inherent limitations of internal control include: (1)Management overdoing

controls whenever the control does not suit their selfish ambitions, (2)fraud committed by

someone who has carefully studied the system of a particular organization, abuse of

responsibility i.e taking advantage of the position held to do or carryout illegal acts,

(3)Cleverness of some people who specialize in gelding computer codes of an organization

which are designed to prevent public access, no matter how secure they might be and

(4)Employees of an organization making potential human errors caused by sheds of excess

worked alcohol, carelessness, distractions etc. All these are factors that can limit the

effectiveness of internal control system in the financial management of an organization

32
2.3 Critical review and research gap identification

Several studies have been conducted on internal control system and organization

performance across the world (Aikins 2011; Baltaci & Yilmaz, 2006; Eko & Hariyanto,

2011; Feng et al, 2009; Kwanbo, 2009; Nilniyom & Chanthinok, 2011) but none of them

study the impact of internal control to organisations on Rwandan landscape. For example,

the study carried out by Baltaci and Yilmaz showed that internal control systems are the key

components of public financial management systems for increasing efficiency and

effectiveness in organisations operations. In another study conducetd by Nilniyom and

Chanthinok (2011), it was revealed that internal control system has a positive relationship

with organization performance. Feng et al (2009) also carried out a study on internal control

and organization performance and they indicated that internal control quality has an

economically significant effect on the accuracy of financial reports. Similarly, Aikins (2011)

undertake a research on an examination of organisation internal control’ role in improving

financial performance, the research results indicate significant relationship between internal

control and financial performance.

Research on internal control and financial performance has proliferated over the past two

decades, particularly within the social, economic, and political aspects. These researchers

now understand the internal control as a potential tool to help organizations grow favorably.

However, looking at the above studies that have been conducted on internal control system,

none of the above studies examined the relationship between internal control system with

financial performance particularly at MFIs level, therefore this research extend the previous

research through examining the relationship between internal control system and financial

performance of MFIs in the Rwandan context.

33
2.4 Conceptual Framework

The conceptual framework is the foundation on which the entire research project is based. It

identifies the network of relationships among the variables considered important to the study

of a given problem. A conceptual framework is a tool the researchers use to guide their

inquiry; it is a set of ideas used to structure the research, a sort of map that may include the

research question, the literature review, methods and data analysis. Hamilton (2006) put that

researchers use a conceptual framework to guide their data collection and analysis.

Figure 2.1: Conceptual framework

INDEPENDENT VARIABLES DEPENDENT VARIABLES

Internal control systems Financial performance

1. Objectives attainment
1. Internal audit
2. Increased return on equity
2. Supervision

3. Information review 3. Increased return on asset

5. Monitoring and evaluation 4. Increased profitability

INTERVENING
VARIABLES
1. Technology
2. Skilled staff
3. Ethical practice

Source: Researcher

34
x
3. Management will
The conceptual framework above describes a relationship between the two variables namely

the independent in this case internal control and the dependent that is financial performance

in MFIs. The independent variable comprises control environment, risk assessment, control

activities and information system which when well-tackled can lead to better financial

performance measures which include return on assets, return on equity, goals attainment and

profitability. It is important however to note that the financial performance would be

achieved if MFI had skilled staff, good technology and employees with ethical practice.

2.5 Summary

This chapter has provided a critical review of related literature on the study variables,

definition and understanding of internal controls systems, earlier studies on internal control

elements, and common weaknesses of internal control systems, determinants of internal

control strength and components of an internal control system. It has been also discussed a

link between the variables of this study. In this regard, this chapter has most importantly

established the relationships between internal controls and financial performance of MFIs. It

has been revealed that the internal controls could lead to better financial performance.

Indeed, internal controls have been found to enable the financial institution to achieve their

objectives, that is, profitability, return on asset, return on equity, efficiency and effectiveness

of operations, reliable financial reports, compliance with regulation and laws, liquidity and

accountability.

35
 CHAPTER THREE: RESEARCH METHODOLOGY

3.0 Introduction

This chapter presents mainly the methodology to be used in this study. It discussed the

instruments of data collection, research design, area of the study, the population and sample of

the study, sampling techniques, instruments and procedures of data collection, and finally

methods of data analysis.

3.1 Research design

The researcher followed quantitative and qualitative approaches. A case study research design

was used in order to establish the relationship between the independent and dependent variables,

so as to examine how internal controls are used in RIMs Ltd and therefore account for the

financial performance levels. Data was collected using both primary and secondary sources.

Qualitative approach was also followed to get responses from different respondents.

3.2 Target Population

The population is the target of the study. The study was carried out to investigate some pertinent

characteristics of the population relevant to the study. The populations to be used here were

drawn from the finance departments, internal audit departments, and loan departments,

accounting departments, operation department and other staff, all mentioned branches

managers.

36
Table 3.1: Target population of the study

Stratum Population size

Branch managers in 11 RIM Ltd 11

Loan department employees 22

Marketing department employees 11

Accounting and Finance department 11

Auditing department 11

Credit members committee 55

Operating department in charge and other staff 55

Total 176

Source: Primary data

3.3 Sample Design

3.3.1 Sample Size

A sample size is a complete set of individuals, objects and requirement having some common

features (Lock, as cited in Krathwohl, 1999). This is a number of respondents that was chosen

from the target population. Therefore, the target population was divided into seven strata where

a representative sample was drawn from each stratum. The seven strata comprised 176

comprising 11managers of RIM ltd branches, 22 loan department employees, 11 marketing

department employees, 11 accounting and finance department, 11 auditing departments, 55

credit committees’ members, and 55 operation department employees and other staff in 11 RIM

Ltd branches. Under this study, the sample size was obtained using Yamane (1967) technique as

follows:

37
Where n = total size of sample

N= Target population= 176

e = Margin of error = 0.05, in using the formula above the sample size is calculated as follows:

n= = 122

3.3.2 Sampling Technique

The statistical sampling method called stratified sampling was used within this study. It is used

when representatives from each subgroup within the population need to be represented in the

sample. In this study, there are 7 strata or subgroups. Systematic sampling is another statistical

sampling method and it is used in this study. In this method, the researcher chose the first nth

elements from the list of each stratum. Random samples are then taken from each subgroup.

The sampling fraction for each subgroup may be taken in the same proportion as the subgroup

has in the population. For this study a sample size using Yamane formula was 122 from 176 as

a whole population. To get the sample size from each stratum the researcher used percentage as

follows:

38
Table 3.2: Sample size
Population size % sample size

Branch managers in 11 RIM Ltd 11 6.25 8

Loan department employees 22 12.5 14

Marketing department employees 11 6.25 8

Accounting and Finance department 11 6.25 8

Auditing department 11 6.25 8

Credit members committee 55 31.25 38

Operation in charge and other staff 11 RIM Ltd 55 31.25 38

Total 176 100 122

Source: Primary data

3.4 Data collection Methods

The researcher used both primary and secondary data.

3.4.1 Primary Data

This is the type of data, which was collected by the researcher to help him in solving a specific

problem when carrying out the study. The primary data is vital whenever one is carrying out the

research analysis and is unable to access sufficient secondary data to complete the study

(Martin, as cited in Krathwohl, 1999). In fact, it is the first hand information collected from the

field by the researcher using questionnaires. In order to collect primary data, the researcher used

such tools as questionnaire

39
and interviews. It is worth noting however that questionnaires were the main tool to generate

basic quantitative data. The key informant supplemented the semi-structured questionnaire and

generated the qualitative information.

3.4.2 Secondary Data

This is data that was gathered by making use of the existing data. The main source was review

of the field research records about internal control system and financial performance of MFIs.

Secondary data were meant to supplement primary data by comparing what was done, what is

being done and therefore bridge the information gaps in information that was got from

respondents as it is expected that some information may not be readily provided.

To carry out this study, a questionnaire was designed to collect information from the

respondents located in the study area. The questionnaire in this study is a form containing a

series of questions and providing space for their replies to be filled in by the respondent

themselves. The questionnaire contained both closed ended questions and open-ended

questionnaire. This is a direct consultation to the concerned staff, concerning variables of

interest to an investigation. This is an easiest way of collecting data that can help to get response

from unreachable persons and give respondent enough time to think and give well thought out

answers.

Questionnaires were distributed to concerned staffs, and these questionnaires contain both

closed and open questions so as to facilitate coding and data analysis. The questionnaires were

provided to selected staffs from head office and at the branches level to both finance department

and internal audit department. The researcher had time to give the questionnaire to selected

40
staffs by hand due to the samples being easily reachable by researcher the physically and thus

collected in the same way.

The researcher opted to use the questionnaire thanks to many reasons. Krathwohl (1999) points

out that the advantages of using the questionnaire as a data collection tool are that

questionnaires are useful where a large amount of data needs to be; they are quick and

economical. In addition, questionnaires, as one of the most common forms of data collection

tools, can easily be assessed in terms of reliability. In this respect, reliability refers to the ability

of questionnaire to produce the same results in different implementations, leading to a

consistency and dependability of the results (Leftwich, 2007). The other strengths of

questionnaires lie in accuracy, generalizability, and convenience (Marshall & Rossman, 1999).

All of the above advantages motivated me to choose a questionnaire for this study. However,

besides these strengths, the questionnaires usually fall short in examining complex social

relationships or intricate patterns of interaction. The questionnaires were administered face to

face.

It is also worth pointing out that the interviews were used in this study. The main purpose of

using key informant interview is to complement the main instrument, the questionnaire. The

respondents were interviewed face to face and clarifications on questions were provided as may

be needed by the respondents. In total, 38 members in board of directors will be interviewed.

According to Henk and Joanna (2004), key informants interview should be held with specially

selected individuals with specialized knowledge and information on certain topic. It is assumed

that the members of board of directors are versatile about the role of internal control system.

Data collected from the respondent through the use of key informants’ interview was to shed

light on the reality of things.

41
3.5 Validity and reliability of the instrument

According to Ochieng (2009), for a study to be of real meaning, it ought to apply valid and reliable

instrument. Before, actual research is done, the researcher has to make sure that the instrument is

checked for validity and pre-tested to determine its reliability. Reliability refers to the consistency

with which repeated measures produce the same results across time and across observers. In order to

ensure reliability of the data in this study, three methods of data collection were used. These were an

interview, documentary review and the questionnaire. Questionnaires were developed in line with

the research objectives and questions. Also a pre testing of the questionnaires were conducted to

guarantee common understanding of the questionnaires items among the respondents. In fact, to

ensure reliability of the instrument, the study was done in two phases: In the first phase, the research

used 20 respondents who were not part of the major respondents but with similar characteristics. In

the second phase, after making the necessary corrections, the instruments were re-administered to

the major respondents. To ensure validity of the instrument, Research advisors and experts checked

the questionnaires for the consistency of the items, conciseness, intelligibility and clarity. Their

inputs helped make necessary adjustments so that the instrument measures adequately what it

intended to measure.

3.6 Data processing and Analysis

Data analysis is the ways of sorting the data so as to establish statistical patterns and

identification of relationships. Mostly descriptive statistics were used to analyze data from

respondents through questionnaire. Descriptive statistics included percentages and frequencies

and they were used to describe the basic features of the data in the study. They also provided

the simple summaries and measures.

42
3.7 Ethical considerations

The researcher considers the research values of voluntary participation, anonymity and

protection of respondents from any possible harm that could arise from participating in the

study. Thus the respondents were made aware of the purpose of the study, which was actually as

a result of fulfillment of a Masters’ study programme and not for any other hidden agenda by

the researcher and requested them to participate in the study on a voluntary basis and refusal or

abstaining from participating is permitted. The researcher also assured the respondents of

confidentiality of the information given and protection from any possible harm that could arise

from the study since the findings would be used for the intended purposes only.

43
 CHAPTER FOUR: RESEARCH FINDINGS AND DISCUSSION

4.0 Introduction

The general objective of this study is to examine the impact of internal control system to

Microfinance Institutions financial performance. This chapter deals with the analysis,

presentation and interpretation of data gathered during this study. The researcher analyzed data

considering the relationship of research problem and research questions. Questionnaires

collected from RIMs Ltd, interviews made with the RIMs Ltd managers and various reports

collected from different stakeholders were analyzed and compared with research

questions/objectives to find out if there is any impact of internal control system on Microfinance

Institutions financial performance. During the research, a sample of 122 respondents was

chosen from staff of RIMs working there from the period ranging between 2009 and 2013. It is

worth mentioning, however, that 115 questionnaires were returned as mentioned here below.

To start with, the findings are presented in percentage tables. The presentation is guided by the

following objectives: (1)To assess the internal control system components as per used within

MFIs, (2) Examine the indicators of MFIs’ financial Performance , (3)To investigate on the

tools for effective internal control for Microfinance Institutions, (4) To examine the relationship

between internal control system and Microfinance institutions financial performance.

44
4.1 Demographic characteristics of respondents

This section presents the general characteristics of the respondents. These include the response

rate, age brackets education attainment and the duration by which the institution had been in

Operation. These are presented in the subsequent sections.

4.1.1 Response rate

It is worth noting that 122 questionnaires were distributed to the respondents but 115 were

returned. The response rate was 94.2% as revealed in the table 4.1 below:

Table 4.1: Response rate

Distributed questionnaires Responses collected Responses Response

rates error

122 115 94.2% 5.8%

Source: Researcher

4.1.2 Age bracket of the respondent

The study examined the age bracket of the staff to know the age group that most accesses the

job and why. Figure 4.1 below shows the outcomes of the survey.

45
Figure 4.1: Distribution of respondents ‘age bracket

Source: Researcher

It follows from the figure 4.1 that 41.7 % of the respondents represent the age bracket of (20-

40) years while 49.74% of them represent the age bracket of (40-49) years. Surprisingly, no

respondent was below 20 years. It is not by any chance that the majority of the respondents

represent the age bracket of 20-40 years and 40-49 years respectively. As a matter of fact, the

data collected from the respondents is appropriate since all the respondents have attained work

age, which ranges from 18-64 years. According to the International Confederation of free trade

Union (as cited in Nkurunziza, 2010); the legal working minimum age is 18 in Rwanda whereas

an employee is retired at 65.

46
4.1.3 Education attainment

The respondents were asked to report on their education degree and the result is as follows:

Table 1.2: Education attainment

Education level Frequency Percent

Masters 5 4

Bachelors 35 30

Advanced diploma 3 3

A2 certificate 72 63

Total 115 100

Source: Researcher

From the findings in table 4.2 above, the results showed that most of the employees were A2

certificate at 63%. Further, 30 % of the respondents had attained Bachelors degree, 4% of the

respondents were masters holders whereas 3% had attained advanced diploma. Needless to say,

most of the employees in RIM Ltd were A2 certificate holders.

4.1.4 The Duration that the Institution had been in operation

The respondents were requested to indicate the period by which the RIM Ltd had been in

operation in order to establish whether the effect of internal controls on financial performance

had any relationship with the duration that the RIM Ltd had been in operation.

47
Table 4.3: The duration by which the RIM LTD had been in operation

Duration in years Frequency Percent

Less than 5 years 0 0

Between 5-10 years 5 45

Between 11-15years 6 55

Over 15 years 0 0

Total 11 100

Source: Researcher

From the Table 4.3, the respondents were requested to indicate the period by which the

institution had been in operation. From the findings, the majority of the respondents pointed out

that the organization had been in operation between 11-15 years. In fact, 55 % of the

respondents indicated that the organization had been in operation between 11-15 years, 45 % of

the respondents pointed out that the organization had been in operation for a period between 5-

10 years. It was concluded that the most RIMs LTD had been in operation for a period of more

than 10 years.

4.2 Presentation of Findings

4.2.1. The internal control system components as per used within RIM Ltd

The respondents were asked to state the internal control systems they use in their respective

MFI and of course this is the result:

48
Figure 4.2: Components of internal control system

Source: Researcher

From the figure 4.2, it is evident that the RIMs LTD considers internal audit, supervision,

information review and monitoring as ones of the functionality of internal controls of the

organization that greatly impacts on the financial performance of Microfinance Institutions.

Indeed, 29 % of the respondents accepted that they use internal audit within RIMs LTD, 23.3%

pointed out that they use supervision whereas 19.1% and 22.6% said they use motoring and

information review respectively, while some respondents pointed the others at rate of 6% . What

is clear from the figure 4.2 is that all RIMs LTD branches use all components of internal control

with internal audit coming at the first position with 29 % followed by supervision. Furthermore,

the research has showed that RIMs LTD pay less attention information review. This component

should not be overlooked in as much as it describes presence of integrity and ethical values,

commitment to competence, human resource practices and organization structure that every

organization should get hold off.

49
To investigate further, the researcher probe more by asking questions related to how the

respondents practice some of the principles of components of internal control system. In this

regard, the Tables 4.4 up to Tables 4.11 give the summary.

Table 4.4: Internal audit practices within RIMs LTD

N Internal audit Frequency Percent

1 Our organization has an accounting and financial

management system

1. Very great extent 61 53

2. Great extent 32 28

3. Moderate extent 12 10

4. Little extent 9 8

5. No extent 1 1

Total 115 100

2 Management is committed to the operation of the system

1. Very great extent

2. Great extent 54 47

3. Moderate extent 32 28

4. Little extent 20 17

5. No extent 6 5

Total 3 3

115 100

3 Management closely monitors implementation of internal

control systems in our institution

50
 1. Very great extent 7 6

2. Great extent 5 4

3. Moderate extent 12 10

4. Little extent 42 37

5. No extent 49 43

Total 115 100

4 The appropriate measures are taken to correct misfeasance in

operation of our Accounting & Finance Management System
1. Very great extent 28 24
2. Great extent 31 27
3. Moderate extent 22 19
4. Little extent 15 13
5. No extent 19 17
115 100
5 Management acts with a great degree of integrity in execution
of their roles
1. Very great extent 17 15
2. Great extent 22 19
3. Moderate extent 11 10
4. Little extent 51 44
5. No extent 14 12
Total 115 100
6 Ethical values are upheld in all management decisions

1. Very great extent 12 11

2. Great extent 20 17

3. Moderate extent 9 8

4. Little extent 51 44

51
 5. No extent 23 20

Total 115 100

Source: Researcher

The table 4.4 showed that most of the RIMs LTD used internal audit at different extent. The

findings showed that the organization had an accounting and financial management system very

great extent with 53%, great extent with 28%, moderate extent with 10% , the management was

committed to the operation of the system here very great extent 47%, great extent 28%,

moderate extent at 17% and little extent 5%, the management acts with a greater of integrity in

execution of its actions at rate of very great extent with 15% great extent with 19%, moderate

extent with 10%, little extent with 44%, no extent with 2%).

From the above findings, it was evident that the RIMs LTD consider internal audit as one of the

functionality of internal controls of the organization that greatly impacts on the financial

performance of microfinance institutions in Rwanda. However, it is worth pointing out that

there are some aspects of internal audit, which have been ignored as it is evidenced from the

table 4.4. In other words, they hardly practice these principles in their MFIs.

The researcher examined the effects of risk assessment through supervision as functionality of

internal control system of the organization as they affect the financial performance of RIM

LTD. Below are the results of the findings:

52
Table 4.5: Risk assessment
N Supervision Frequency Percent
1 Management has defined appropriate objectives for
the organization
1. Very great extent 61 53
2. Great extent 32 28
3. Moderate extent 10 9
4. Little extent 4 3
5. No extent 8 7
Total 115 100
2 Management identifies risks that affect achievement
of the objectives
1. Very great extent 8 7
2. Great extent 3 2
3. Moderate extent 40 36
4. Little extent 52 45
5. No extent 12 10
Total 115 100
3 Management has a criteria for ascertainment of
which fraud-related risks to the organization are
most critical
1. Very great extent 16 14
2. Great extent 26 23
3. Moderate extent 23 20
4. Little extent 36 31
5. No extent 14 12
Total 115 100
4 Management has put in place mechanisms for
mitigation of critical risks that may result from fraud
1. Very great extent 20 17
2. Great extent 14 12

53
 3. Moderate extent 41 36
4. Little extent 31 27
5. No extent 9 8
Total 115 100

Source: Researcher

From the findings in Table 4.5 was observed that most of the RIMs LTD carried out regular risk

assessment procedures trough supervision. From the results RIMs LTD defined appropriate

objectives for the organization, this had a very great extent at 53%, great extent with 28%,

moderate extent with 9%, little extent with 3%, no extent with 7%, the management identifies

risks that affect achievement of the objectives a very great extent with 7%, great extent with

2%, moderate extent with 36%, little extent with 45%, no extent with 10%, the management has

a criteria for ascertainment of which fraud-related risks to the organization are most critical had

a very great extent with 14%, great extent with 23%, moderate extent with 20%, little extent

with 31%, no extent with 12%, the management has put in place mechanisms for mitigation of

critical risks that may result from fraud had a very great extent 17%, great extent with 12%,

moderate extent with 36%, little extent with 27%, no extent with 8%. These results are clear

indication that most RIMs LTD observed risk assessment procedures trough supervision as

functionality of internal control of RIMs LTD but with tendency to little extent or no extent.

This implies that RIMs LTD do not attach much importance to risk assessment component.

The study also examined the effect of information review in control activities on the financial

performance of RIMs LTD as per reflected in the table 4.6

54
Table 4.6: Control activities
N Information review Frequency Percent

1 Our organization has clear separation of roles

1. Very great extent 69 60

2. Great extent 32 28

3. Moderate extent 6 6

4. Little extent 4 3

5. No extent 4 3

Total 115 100

2 Every employee’s work check on the others

1. Very great extent 22 19

2. Great extent 40 35

3. Moderate extent 29 25

4. Little extent 21 18

5. No extent 3 3

Total 115 100

3 Corrective action is taken to address weaknesses

1. Very great extent 43 37

2. Great extent 45 39

3. Moderate extent 10 9

4. Little extent 11 10

5. No extent 6 5

Total 115 100

55
4 Staff are trained to implement the accounting and

financial management system

1. Very great extent 11 10

2. Great extent 11 10

3. Moderate extent 13 11

4. Little extent 47 41

5. No extent 33 28

Total 115 100

5 It is impossible for one staff to have access to all

valuable information without the consent of senior

staff

1. Very great extent 42 37

2. Great extent 41 36

3. Moderate extent 22 19

4. Little extent 6 5

5. No extent 4 3

Total 115 100

6 Departments have budget reviews where actual

expenditure is compared with budgeted expenditure

and explanations for the variances given

1. Very great extent 12 10

2. Great extent 14 12

3. Moderate extent 23 20

56
 4. Little extent 41 36

5. No extent 25 22

Total 115 100

7 Our security system identifies and safeguard

organizational Assets

1. Very great extent 8 7

2. Great extent 4 3

3. Moderate extent 11 10

4. Little extent 52 45

5. No extent 40 35

Total 115 100

Source: Researcher

From the above findings it was revealed that control activities were carried out regularly by

most RIMs LTD. The findings showed that most RIMs LTD had clear separation of roles very

great extent with 60%, great extent with 28%, moderate extent with 6%, little extent with 3%,

no extent with 3%, Every employee’s work check on the others very great extent with 19%,

great extent with 35%, moderate extent with 25%, little extent with 18%, no extent with 3%,

corrective actions were taken to address weaknesses very great extent with 37%, great extent

with 39%, moderate extent with 9%, little extent with 10%, no extent with 5%.The results also

found that the staff were trained to implement the accounting and financial management system

where respondents’ views show that very great extent with 10%, great extent with 10%,

moderate extent with 11%, little extent with 41%, no extent with 28%, the security system

identified and safeguarded organizational assets very great extent with 7%, great extent with 3

57
%, moderate extent with 10%, little extent with 45%, no extent with 35%, it is impossible for

one staff to have access to all valuable information without the consent of senior staff (very

great extent with 37%, great extent with 36%, moderate extent with 19%, little extent with 5%,

no extent with 3%), departments have budget reviews where actual expenditure is compared

with budgeted expenditure and explanations for the variances given (very great extent with

10%, great extent with 12%, moderate extent with 20%, little extent with 36%, no extent with

22%). It was concluded that RIMs LTD carried out control activities as a functionality of

internal control of the microfinance institutions in Rwanda. However, some aspects had less

attention than others. For example, element like ‘staff were trained to implement the accounting

and financial management system and departments have budget reviews where actual

expenditure is compared with budgeted expenditure and explanations for the variances given’

have been given less attention as the rate tend to be higher at little or no extent. The same is true

for the aspect like “the security system identified and safeguarded organizational assets”. This

implies that they are overlooked by most RIMs LTD in as far as control activities are

concerned.

The study also sought to establish the effect of information and communication as one of the

control activities on financial performance of RIM LTD. The results of this analysis are as per

provided in table 4.7 below:

58
Table 4.7: Information and communication

N Information and communication Frequency Percent

1 Management has identified individuals who are

responsible for coordinating the various activities

within the entity

1. Very great extent 35 30

2. Great extent 23 20

3. Moderate extent 31 27

4. Little extent 16 14

5. No extent 10 9

Total 115 100

2 All employees understand the concept and

importance of internal controls including the

division of responsibility

1. Very great extent 9 8

2. Great extent 15 13

3. Moderate extent 27 23

4. Little extent 33 29

5. No extent 31 27

Total 115 100

3 Communication helps to evaluate how well

guidelines and policies of the organization are

working and being implemented

59
 1. Very great extent 32 28

2. Great extent 27 24

3. Moderate extent 39 34

4. Little extent 13 11

5. No extent 4 3

Total 115 100

4 The reporting system on organizational structures

spells out all the responsibilities of each

section/unit in the organization

1. Very great extent 30 26

2. Great extent 24 21

3. Moderate extent 33 29

4. Little extent 19 16

5. No extent 9 8

Total 115 100

Source: Researcher

From the above findings it was revealed that information and communication were carried out

regularly by RIMs LTD. The findings revealed that information and communication were

conducted by RIMs LTD as a functionality of internal control. The findings to a large extent

exhibit that most RIMs LTD identified individuals who are responsible for coordinating the

various activities within the entity (a very great extent at 30%, great extent at 20%, moderate

extent at 27%, little extent at 14%, no extent at 9%), the employees understand the concept and

importance of internal controls including the division of responsibility (a very great extent with

60
8%, great extent with 13%, moderate extent with 23, little extent with 29%, no extent with

27%). Communication helps to evaluate how well guidelines and policies of the organization

are working and being implemented (a very great extent with 28%, great extent with 24%,

moderate extent with 34%, little extent with 11%, no extent with 4%). The study concluded that

most RIMs LTD implemented information and communication in their activities and functions

through established police and procedures.

The study also sought to establish the effect monitoring on financial performance of

Microfinance Institutions in Rwanda. The results of this analysis are as per provided in

Table 4.8:

Table4.8: Monitoring

N Monitoring Frequency Percent

1
There are independent process checks and

evaluations of controls activities on ongoing basis

1. Very great extent 12 10

2. Great extent 12 10

3. Moderate extent 25 22

4. Little extent 32 28

5. No extent 34 30

Total 115 100

2 Internal reviews of implementation of internal

controls in units are conducted periodically

1. Very great extent 8 7

61
 2. Great extent 9 8

3. Moderate extent 20 17

4. Little extent 37 32

5. No extent 41 36

Total 115 100

3 Monitoring has helped in assessing the quality of

performance of the organization over time

1. Very great extent 16 14

2. Great extent 11 10

3. Moderate extent 15 13

4. Little extent 38 33

5. No extent 35 30

Total 115 100

4 The reporting system on organizational structures

spells out all the responsibilities of each section/unit

in the organization

1. Very great extent 8 7

2. Great extent 13 11

3. Moderate extent 12 10

4. Little extent 41 35

5. No extent 42 37

Total 115 100

5 Management has assigned responsibilities for the

62
 timely review of audit reports and resolution of any

non-compliance items noted in those audit reports

1. Very great extent 5 4

2. Great extent 5 4

3. Moderate extent 6 5

4. Little extent 50 44

5. No extent 49 43

Total 115 100

Source: Researcher

From the above findings in table 4.8 it was found that that monitoring was a functionality of

internal control of RIMs LTD. This was demonstrated by the results of the study which showed

that there was independent process checks and evaluations of controls activities in the operation

of the firm (very great extent with 10%, great extent with 10%, moderate with 22%, little extent

with 28% , no extent with 30%,), internal reviews of implementation of internal controls in units

were conducted periodically (very great extent with 7%, great extent with 8%, moderate with

17%, little extent with 32% , no extent with 36%) , monitoring has helped in assessing the

quality of performance of the organization over time (very great extent with 14%, great extent

with 10%, moderate with 13%, little extent with 33% , no extent with 30%). Some of RIMs

LTD did not assign their responsibilities in a timely manner and this negatively affected

compliance in audit report, this is explained by (very great extent with 4%, great extent with

4%, moderate with 5%, little extent with 44%, no extent with 43%). This shows that even

though monitoring is an important functionality activity of the internal control of the firm in its

63
operation, Most RIMs LTD pay less attention to it. This therefore could negatively impact on

the financial performance of Microfinance Institutions.

4.2.2 Indicators of RIM Ltd’s Financial Performance

The respondents were asked to air their views as to how they measure the financial performance

in their MFI and their responses are hereby presented in the table 4.9:

Table 4.9: Indicators of financial performance

Indicators of financial performance Frequency Percent

Degree of objectives attainment 89 41.2

Return on equity 23 10.6

Return on assets 11 5.1

Profitability 91 42.1

Others 2 0.9

100

Source: Researcher

The table 4.9 showed 41.2 % of the respondents said they measure the financial performance

through the degree of attainment of objectives, 10.6% of them through return on equity, 5.1% of

them through return on asset, and 42.1% of the respondents through profitability. Interestingly

0.9 % of the respondents said that they use other measures but unfortunately they could not

indicate which measures. Return on asset shows the percentage of how profitable a company’s

assets are generating revenues.

As for return on equity, it measures a corporation’s profitability by revealing how much a profit

a company generates with the money the shareholders have invested.

64
The respondents were also asked to rank with strongly agree, agree, disagree and strongly

disagree the statements pertaining to the tools for internal control for MFIs and the responses

have been exhibited in the table 4.10 below:

Table 4.10: Tools for effective internal control for Microfinance Institutions

N Statement/Questions Frequency Percent

1 The separation of tasks i.e. segregation of duties not

only helps ensure accurate compilation of data, but

also limits the chances for fraud that would require

the collusion of two or more persons

1. Strongly agree 69 60

2. Agree 30 26

3. Disagree 10 9

4. Strongly disagree 6 5

Total 115 100

2 Competent supervision and monitoring should be

provided to ensure that internal control objectives are

achieved

1. Strongly agree 62 54

2. Agree 28 25

3. Disagree 19 16

4. Strongly disagree 6 5

Total 115 100

3 Transactions and significant events are to be

65
 authorized and executed only by persons acting

within the scope of their authority. All transactions

will require approval and authorization by a

responsible official

1. Strongly agree 43 37

2. Agree 42 36

3. Disagree 19 17

4. Strongly disagree 11 10

Total 115 100

4 The internal control structure and all transactions and

significant events are to be clearly documented, and

the documentation is to be readily available for

examination. Transactions and significant events are

to be promptly recorded and properly classified e.g.

loan proposals along with group resolutions and

savings-loan collection-sheet to journals and ledgers.

1. Strongly agree 71 62

2. Agree 37 32

3. Disagree 6 5

4. Strongly disagree 1 1

Total 115 100

66
 5 Internal auditor report address weakness in

Microfinance institution’s internal control system

1. Strongly agree 70 61

2. Agree 32 28

3. Disagree 8 7

4. Strongly disagree 5 4

Total 115 100

6 Authorization, duty segregation, reconciliation and

documentations are the most important tools in safe

guiding public funds at the microfinance institutions

1. Strongly agree 76 66

2. Agree 33 29

3. Disagree 4 3

4. Strongly disagree 2 2

Total 115 100

Source: Researcher

The findings in table 4.10 showed that 60%, 54%, 37%, 62%, 61%, 66% of the respondents

strongly agreed respectively with the first 6 items of the questionnaire which sought to affirm

that segregation of duties, documentation, internal audit, supervision and monitoring and

authorization and execution of transactions and events are tools for effective internal control for

Microfinance Institutions. Put another word, over 57% of the respondents strongly agree with

the statements, which means that segregation of duties, documentation, internal audit,

supervision and monitoring and authorization and execution of transactions and events are tools

67
for effective internal control for microfinance. This is in consistent with what (Rittenberg, 2006)

pointed out. In designing effective internal control system for MFIs the following criteria needs

attention He views it as: “segregation of duties, authorization and execution of transactions and

events, documentation, monitoring and supervision, as well as the internal audit”. The other

questions related to tools for effective internal control of MFI are here below discussed:

Table 4.11: Tools for effective internal control of Microfinance Institutions

Statements Frequency Percent

Is the organizational structure in RIM Ltd clearly defined

Yes 92 80

No 23 20

Is the management committed to the operation of the internal control system

Yes 96 83

No 19 17

Does the management closely monitor implementation of existing internal

control system in your institution?

Yes 34 30

No 81 70

It follows from the table 4.11 that 80% of the respondents asserted that there is the clearly

defined organizational structure in RIM. Moreover, 83% of the respondents stated that the

management committed to the operation of the internal control system. However, 70% of the

respondents pointed out that the management does not closely monitor implementation of

existing internal control system in their institution.

68
 4.2.3: The relationship between internal control system and microfinance institutions

performance

The respondents were asked to express their views as per related to the relationship between

internal control system and microfinance institutions performance.

To start with, the respondents were requested to air their views as to why there is a need for

internal control systems within RIM LTD to grow financially. The result was presented below.

Figure 4.3: Need for internal control systems within RIM Ltd

Source: Researcher

From the figure 4.3 it was indicated that there is a need for internal control system within

microfinance institutions. Indeed 82 respondents representing 71% pointed out that there is a

need for internal control systems within microfinance institution to grow financially.

The researcher also requested the respondents to express their views as to why there is a need to

institute the internal control system with their respective MFI. The findings are presented

below:

69
Table 4.12: The need to institute internal control system with RIM Ltd
The need to institute internal control system with MFI Frequency

Percent

The MFI is in its embryonic phase, so there is need for sound

internal control to avoid losses 54 65

Experiences have shown some MFIs collapsing because of the

lack of internal control 61 74

Internal control brings out the profitability 67 81

Internal control leads to RIMLtd’s return on equity 51 62

Internal control leads to RIMLtd’s return on assets 52 63

Internal control helps prevent fraud and any fraudulent attitude 65 79

Others 12 14

Source: Researcher, 2016

The table 4.12 indicated that 81% of the respondents confirm that the internal control brings out

the profitability. The table 4.12 also showed that 79% of the respondents think that is needy to

institute internal control system within their MFI because internal control helps prevent fraud

and any fraudulent attitude. This is not far from what is said by Altanmuro and Beatty (2010),

who found internal control to be significant for producing a quality financial statement and

preventing financial statement fraud. Further, 74% of the respondents assert that it is necessary

to institute internal control system within microfinance because the experiences have shown

some MFIs collapsing because of the lack of internal control. 65% of the respondents think that

when the MFI is in its embryonic phase, there is therefore need for sound internal control to

avoid losses. In addition to this, 63% of the respondents pointed out there is a need to put in

70
place internal control within their microfinance simply because internal control leads to MFI’s

return on assets. In the same line of reasoning, 62% assumed that internal control leads to MFI’s

return on equity. Surprisingly, 14 of the respondents pointed out other reasons than what has

been mentioned in the table 4.12. Indeed, some said that the internal control in the MFI is

expected to provide the effectiveness and efficiency of the business operation and the reliability

of the issued financial statements. Others said that the internal control is also expected to

safeguard the company’s assets and its compliance with the laws and regulations in every aspect

of business operation.

The informants were furthermore requested to point out the relationship between the internal

control system and financial performance.

Figure 4.4: The relationship between the internal control system and financial

performance

Source: Researcher

It follows from the figure 4.4 that the overwhelming majority i.e. 97 respondents representing

84% confirmed that there is a relationship between financial control system and financial

performance. The following point discussed the level of relationship between internal control

71
system and financial performance of microfinance institutions. Put another word, it was

discussed the level of relationship between internal control system and profitability, objectives

attainment, return on asset and return on equity

The respondents were also asked to express their views about the relationship between internal

control system and financial performance i.e. profitability

Figure 4.5: Relationship between internal control system and profitability

Source: Researcher

The figure 4.5 showed that 93.8% of the respondents reported that there is an upper level of

relationship between internal control system and profitability. Only 2.1% of the respondents

believe that there is a middle relationship between internal control system and profitability.

Furthermore, 2.1% of the respondents believe that there is a little relationship between the two

variables.

72
The respondents were asked to level of relationship between internal control system and

objectives attainment.

Figure 4.6: Relationship between internal control system and objectives attainment

Source: Researcher

The figure 4.6 showed that 84.5% of the respondents said that there is an upper level of

relationship between internal control system and objectives attainment. 12.6% of them said that

there is a middle level of relationship between the two variables. More to this, 2.1 of the

respondents said that there is a lower level of the relationship between internal control system

and objectives attainment. Furthermore, the respondents were also requested to point out the

level of relationship between internal control system and return on asset.

73
Figure 4.7: Level of relationship between internal control system and return on asset

Source: Researcher

The figure 4.7 indicated that there is a relationship between internal control system and return

on asset. Indeed, 67% of the respondents pointed out that there is an upper relationship between

internal control system and return on assets. 22.7% of them said that there is a middle level of

the relationship between internal control system and return on asset while 7.2% and 3.1 % of the

respondents said there is a lower and none of the level between the two variables respectively.

More to this, the respondents were requested to point out the level of relationship between

internal control and return on equity.

74
Figure 4.8: The level of relationship between internal control and return on equity

Source: Researcher

The figure 4.8 revealed that there is a relationship between internal control system and return on

equity. As a matter of fact, 62.9% of the respondents said that there is an upper level of

relationship between internal control system and return on equity. 25.8% of them said that there

is a middle level of relationship between the two mentioned variables whereas 7.2 % and 4.1%

of them said respectively that there is a lower and none of the relationship between the two

variables.

75
 CHAPTER FIVE: SUMMARY CONCLUSIONS AND

RECOMMENDATIONS

5.0 Introduction

The study aimed at examining relationship between the internal control systems and financial

performance of Microfinance Institutions, taking a case study of RIM LTD. This chapter

highlighted the summary of the major findings in line with the objectives of the study. From the

findings of the study, conclusions and recommendations were set out, and last but not the least,

the suggestions for further study were made.

5.1 Summary of Findings

In this section, the researcher described the specific objectives in order to assess their

relationship with the views and opinions of the respondents. The findings were drawn from the

questionnaires administered to different 115 respondents and the interviews made with 12 key

informants. The general objective was to investigate the impact of internal control systems on

financial performance of Microfinance Institutions. The specific objectives derived from the

above general objective. The rest of the researcher’s job was simply to match these objectives

with the views of the respondents and other researchers who might have investigated the same

field as the researcher’s.

5.1.1 The internal control system components used within RIM LTD

The objective one was to assess the internal control system components as per used within RIM

LTD. Generally, the findings got through a questionnaire revealed that-see figure 4.2- that all

RIMs LTD branches use all components of internal control with internal audit coming at the

76
first position with 29% followed by supervision with 23.3%, and then monitoring with 22.6 %

and last information review and others with 19.1% and 6. % respectively. The study through the

interviews held with key informants supplemented the above findings. In fact, it was revealed

by the most interviewees that they practice internal audit. Responding on the question pertaining

to the most important internal control systems to monitor to ensure financial performance.

5.1.2 The indicators of RIM LTD’s financial Performance

In the table 4.9 the fequences showed that 77 % of the respondents measure the financial

performance through the degree of objectives attainment, 20% through return on equity, 10%

through return on asset, and 79% through profitability. Interestingly 2% said that they use other

measures but unfortunately they could not indicate which measures. As mentioned in internal

control components, the most observed performance indicators is profitability due to the

strength of internal audit used to reduce fraud and errors in accounting transactions. Hence

increased profitability.

5.1.3 The relationship between internal control system and MFIs financial performance

On the relationship between internal control systems and financial performance, the figure 4.4

indicated that the overwhelming majority i.e. 97 respondents representing 84% confirmed that

there is a relationship between internal control systems and financial performance.

The study tried to investigate on the level of relationship. In this regard, the study revealed

through the figure 4.5 that 93.8% of the respondents confirmed that there is an upper level of

relationship between internal control system and profitability. Moreover, the study showed

through the figure 4.6 that 84.5% of the respondents confirmed that there is an upper level of

relationship between internal control system and objectives attainment. The figure 4.7 also

77
indicated that there is a relationship between internal control system and return on asset. Indeed,

67% of the respondents pointed out that there is an upper relationship between internal control

system and return on assets. Finally, the figure 4.8 revealed that there is a relationship between

internal control system and return on equity. As a matter of fact, 62.9% of the respondents said

that there is an upper level of relationship between internal control system and return on equity.

Discussing on the relationship between internal control systems and financial performance, the

most of the interviewees did not go away from the findings from the questionnaires. To this end,

the most of them said that the internal control system enables the RIM LTD to achieve some of

its objectives.

5.2 Conclusions

In the current study the researcher investigated findings in the field of internal control systems

and its relation with financial performance of Microfinance Institutions. The study has

conclusively confirmed that internal control system had positive impact on financial

performance of microfinance institutions. Indeed, the internal control brings out profitability.

More to this, they lead to return on assets, equity and to microfinance institutions’ objectives

attainment.

Overall, this study supports the idea that the internal control systems leads to microfinance

institutions’ financial performance. In the line with objective one; generally, the study revealed

that most RIMs LTD use such components as internal audit, supervision, information review

and monitoring. However, it is worthy of note to point out that most RIMs LTD attach more

importance to the internal audit.

78
In the line with research question two where about the indicators of financial performance of

Microfinance Institutions, the research revealed through that the table 4.9 that 41.2 % of the

respondents measure the financial performance through the degree of objectives attainment,

10.6% through return on equity, 5.1% through return on asset, and 42.1 % through profitability.

The research question number three sounded as: relationship between internal control systems

and RIM LTD’s financial performance; Overall, the study revealed that there is a positive

relationship between internal control systems and financial performance. In this regard, the

study revealed through the figure 4.5 that 93.8% of the respondents confirmed that there is an

upper level of relationship between internal control system and profitability. Moreover, the

study showed through the figure 4.6 that 84.5% of the respondents confirmed that there is an

upper level of relationship between internal control system and objectives attainment. The

figure 4.7 also indicated that there is a relationship between internal control systems and return

on asset. Indeed, 67% of the respondents pointed out that there is an upper relationship between

internal control systems and return on assets. Finally, the figure 4.8 revealed that there is a

relationship between internal control system and return on equity. As a matter of fact, 62.9% of

the respondents said that there is an upper level of relationship between internal control systems

and return on equity.

Most importantly, as exhibited by key informants, who held an interview with the researcher, it

was revealed that internal control lead to financial performance i.e. return on asset, return on

equity, objectives attainment, fraud detection, efficiency and thus profitability. This is not far

from what other authors found that there is a positive and significant relation between internal

control system and financial performance with the reliability of 95%, correlation coefficient of

0.246 and standard deviation of 0.04 ( Ewa & Udoayang, 2012).

79
5.3 Recommendations

Since it was evident in the study that there are some aspects in each internal control components

that have been given less attention, the study recommends that each aspect in every internal

control systems should be given a due attention. To start with information review, aspects like

“Staff is trained to implement the accounting and financial management system”. This showed

that the staff is not adequately trained to implement the accounting and financial system. This

renders the current internal control structure at RIM Ltd ineffective. The study recommended

henceforth that the RIM Ltd management should constantly train the staff to implement the

accounting and financial management system.

The study further recommended that the governing body of MFI, possibly supported by the

audit committee, should ensure that the internal control systems are periodically monitored and

evaluated. The actual assessment can be executed by the organization management to help them

ascertain whether they are on the right truck as per set out in the MFI policies and procedures.

Finally, researcher recommends the shareholders of MFIs to facilitate the internal control

system during its execution by sharing the information.

5.4 Suggestions for Further study

The study was focused on 11 microfinance institutions only while we have many MFIs in

Rwanda, it would not therefore be fair that these findings may be used for generalizations on all

MFIs in Rwanda. It is therefore important for a study to be conducted using wider scope and

coverage then, the findings can be compared and conclusions drawn.

Needless to say, no researcher can pretend to exhaust all the areas related to a field study due to

the limited time. The present study has focused on the effects of internal control system on MFI

80
financial performance but anyway has not explored the determinants of internal control system

and financial performance. It would be interesting to conduct a study on the determinants of

internal control systems and their implications on financial performance; this will shed more

light on the appropriate model to choose when implementing better internal control systems that

enhance financial performance of MFIs.

81
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Yamane, T. (1967). Statistics: An Introductory Analysis, 2nd Ed., New York: Harper and Row.

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APPENDICES

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 APPENDIX 1: Questionnaire

Questionnaire introduction

Dear Respondent,

This questionnaire has been designed to solicit your views on Contribution of Internal Control

System to the Financial Performance of Financial Institution. The case study of that has been

designed is RIM Ltd in Rwanda. This field work is part of the preparatory work for the award of

Masters of Business Administration (MBA) degree at Mount Kenya University. This study is

purely academic and as a matter of fact, the information you provide here would be kept

confidentially.

The researcher will therefore be grateful if you spare just a few moment of your time to respond

to these questions frankly and honestly.

Please feel free to contact the researcher undersigned in case of any inquiry, and accept my

sincere appreciation for your valuable time and participation.

Thank you for your support

Yours sincerely

Berthilde NYANDWI

Researcher/Student, Mount Kenya University

Phone Number: 0788855526

I. PERSONAL GENERAL INFORMATION

Instructions: Please tick the right and appropriate answer or write answers in words where

necessary.

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1. As a worker who has benefited working for RIM Ltd, how old are you? (age in years):

A) Below 20

B) 20 – 40

D) 40 – 49

E) 50+

(F)Others (specify)……………………………………………………………

2. Educational Attainment: (A) A2 certificate B) Advanced diploma

(C) Bachelor’s degree D) Masters ‘degree

(F)Others (specify)……………………………………………………………...

4. Indicate the period by which The RIM LTD you are working with had been in operation?

(a) Less than 5 years (c) Between 11– 15years

(b) Between 5years- 10years (d) More than 15 years

II. DETERMINATION OF THE INTERNAL CONTROL SYSTEM COMPONENTS

AS PER USED WITHIN MFIS

5. What are the internal control components do you use within your MFI?

a) Internal audit

b) Supervision

c) Information

d) Monitoring

e) Others (Specify…………………………………………..)

6. Functionality of Internal Controls of MFIs in Rwanda

Rank the extent to which your organization controls the environment. (1-Very great

extent, 2- Great extent, 3-Moderate extent, 4-Little extent, 5- No extent)

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N Internal audit 1 2 3 4 5

1 Our organization has an accounting and financial

management system

2 Management is committed to the operation of the

system

3 Management closely monitors implementation of

Internal control systems in our institution

4 The Appropriate measures are taken to correct

misfeasance in operation of our Accounting & Finance

Management System

5 Management acts with a great degree of integrity in

execution of their roles

6 Ethical values are upheld in all management decision

Rank the extent to which your organization’s management is involved in risk assessment

(1- Very great extent, 2- Great extent, 3- Moderate extent, 4- Little extent, 5- No extent)

N Risk assessment through supervision 1 2 3 4 5

1 Management has defined appropriate objectives

for the organization

2 Management identifies risks that affect

achievement of the objectives

3 Management has a criteria for ascertainment of

which fraud-related risks to the organization are

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 most critical

4 Management has put in place mechanisms for

mitigation of critical risks that may result from

fraud

Rank the extent to which your organization practices the following control activities (1-

Very great extent, 2- Great extent, 3- Moderate extent, 4- Little extent, 5- No extent)

N Control activities 1 2 3 4 5

1 Our organization has clear separation of roles

2 Every employee’s work check on the other

3 Corrective action is taken to address weakness

4 Staff are trained to implement the accounting and

financial management system

5 It is impossible for one staff to have access to all

valuable information without the consent of senior

staff

6 Departments have budget reviews where actual

expenditure is compared with budgeted expenditure

and explanations for the variances given

7 Our security system identifies and safeguard

organizational Assets

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Rank the extent to which the following statements relate to your organization ‘information

and communication system (1- Very great extent, 2- Great extent, 3- Moderate extent, 4-

Little extent, 5- No extent)

N Information and communication 1 2 3 4 5

1 Management has identified individuals who are

responsible for coordinating the various activities

within the entity

2 All employees understand the concept and

importance of internal controls including the

division of responsibility

3 Communication helps to evaluate how well

guidelines and policies of the organization are

working and being implemented

4 The reporting system on organizational structures

spells out all the responsibilities of each

section/unit in the organization

Rank the extent to which the following statements relate to your organization “monitoring

procedures (1- Very great extent, 2- Great extent, 3- Moderate extent, 4- Little extent,

5- No extent)

N Monitoring 1 2 3 4 5

1
There are independent process checks and

evaluations of controls activities on ongoing basis

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 2 Internal reviews of implementation of internal

controls in units are conducted periodically

3 Monitoring has helped in assessing the quality of

performance of the organization over time

4 The reporting system on organizational structures

spells out all the responsibilities of each

section/unit in the organization

5 Management has assigned responsibilities for the

timely review of audit reports and resolution of

any non-compliance items noted in those audit

reports

7) Please rank the following statement on likert scale ranging from strongly agrees to strongly

disagree. Where; 1) Strongly agree 2) agree 3) Disagree 4) Strongly disagree

N Statement/Questions 1 2 3 4 5

1 The separation of tasks i.e. segregation of duties not

only helps ensure accurate compilation of data, but also

limits the chances for fraud that would require the

collusion of two or more persons

2 Competent supervision and monitoring should be

provided to ensure that internal control objectives are

achieved

3 Transactions and significant events are to be authorized

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 and executed only by persons acting within the scope of

their authority. All transactions will require approval

and authorization by a responsible official

4 The internal control structure and all transactions and

significant events are to be clearly documented, and the

documentation is to be readily available for

examination. Transactions and significant events are to

be promptly recorded and properly classified e.g. loan

proposals along with group resolutions and savings-loan

collection-sheet to journals and ledgers.

5 Internal auditor report address weakness in

Microfinance institution’s internal control system

6 Authorization, duty segregation, reconciliation and

documentations are the most important tools in safe

guiding public funds at the microfinance institution

II. EXAMINE THE INDICATORS OF FINANCIAL PERFORMANCE OF MFIS

8. How do you examine the financial performance within your MFIs?

a) Degree of objective attainment

b) Return on equity c) Return on asset d) Profitability

e) Others (specify…………………………………………………………………….)

9) Is the organizational structure in RIM Ltd clearly defined? Yes No

10) Is the management committed to the operation of the internal control system?

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 Yes No

11) Does the management closely monitor implementation of existing internal control system in

your institution? Yes No

III. TO EXAMINE THE RELATIONSHIP BETWEEN INTERNAL CONTROL

SYSTEM AND MICROFINANCE INSTITUTIONS PERFORMANCE.

12. Is there any need for internal control systems within your RIM Ltd to grow financially?

Yes No

If yes, why do you think it is needy to institute internal control with your MFI?

a) The MFI is in its embryonic phase, so there is need for sound internal control to

avoid losses

b) Experiences have shown some MFIs collapsing because of the lack of internal

control

c) Internal control help prevent fraud and any fraudulent attitude

d) Internal control brings out financial risk management to protect MFIs against

losses

e) Internal control brings out the profitability

f) Internal control leads to MFI’s return on equity

g) Internal control leads to MFI’s return on assets

h) Others (please specify)…………………………………

13) Thanks to your experience in RIM LTD, specifically from the period after you have

introduced the internal control system- specifically between 2009 and 2013-do you think there

is any relationship between internal control systems and financial performance?

Yes No

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If yes, what is the level of relationship between two following variables?

A) Internal control system and profitability

Upper level/strong Middle level Lower level none

B) Internal control system and return on assets

Upper level/strong Middle level Lower level none

C) Internal control system and objectives attainment

Upper level/strong Middle level Lower level none

D) Internal control system and return on equity

Upper level/strong Middle level Lower level none

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 APPENDIX 2: Interview guide

Interview guide for key informants

I am studying for a Master’s Degree Program (MBA) at Mount Kenya University, School of

Business and Public Management and I’m carrying out research entitled “Internal control

systems and Financial Performance of Microfinancial Institutions” A case of RIM Ltd in Kigali

Diocese. This research is a requirement to complete my postgraduate studies in Mount Kenya

University and researcher consider your cooperation in this interview and invite you to answer

the questions herewith. The purpose of this study is purely academic. Your responses will be

treated confidentially, and will not be used in any way against you.

Interview date: ___________________________

Interviewer name: ________________________

Interviewee

Age: __________________________________ Sex ___________________

Title__________________________ Marital Status _________________

Role in microfinance institution _________________________________

Name of microfinance institution __________________________________

1. Do you practice any control system components in your Microfinance Institutions?

If yes, what are they?.........................................................................................................

2. What internal controls systems are most important to monitor to ensure financial

performance of your organization?

…………………………………………………………………………………………

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3. Thanks to your experience in your RIMs after you have introduced the internal control

system-specifically between the year 2019 and 2013-explain the relationship between internal

control system and financial performance

Thank you for your cooperation.

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 APPENDIX 3: A sheet note for Interview and questionnaire)

Internal control components

Items Explanation

 Integrity and ethical values

 Importance of board of directors

Internal audit  Management philosophy and operating

styles

 Organizational structure

 Authority and responsibilities

 Human resource policies and practices

 the policies and procedures that help

ensure that management directives are

 reviews and analyses of actual

performance versus budgets

 forecasts, and prior period performance

Risk assessment/Supervision  Assessment of fraud risk

 Identification and analysis of risk

Information review  Information needs

 Information control

 Upstream communication

 Board communication

 Communication with outside party

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 Monitoring
 Ongoing monitoring

 Separate evaluation

Financial performance

Items Explanation

Return on Equity Net Income /Shareholders fund * 100

Return on equity measures a corporation’s

profitability by revealing how much a profit a

company generates with the money the

shareholders have invested.

Return on Assets Net Income /Total Assets*100

Return on asset shows the percentage of how

profitable a company’s assets are generating

revenues.

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A