The Importance of Internal Control in SMEs: Fraud Prevention &

Detection

Small, medium and micro enterprises (SME) had emerged as an

important area of research especially when it comes to financial and
business management. [ CITATION Moh151 \l 1033 ]

Due to the nature of this business which has a small amount of capital
for investment purposes, it is impossible for them to invest and adopt
such sophisticated internal control in monitoring their business activities.
Therefore, SMEs are unable to set up a proper internal control system by
including a department such as compliance or audit department which
could help in monitoring, preventing and detecting any fraudulent
activities occur in the business. Absence of such controls in the business
could cause the rate of fraud increasing every year and especially toward
SMEs which the market is growing exponentially. Most businesses are
frailty in facing the losses caused by fraud and those which are less is
able to absorb the losses may face bankruptcy which probably affecting
the SMEs as well. [ CITATION Moh151 \l 1033 ]
To help in preventing and detecting fraud, the internal control system
plays a vital role which the process is affected by the management, the
board of directors and other personnel that is designed to minimize risk
exposures to an acceptable level given the company’s objectives.
[ CITATION Moh151 \l 1033 ]

noted that internal control is process oriented which

[CITATION Hop12 \l 1033 ]
focus more on business processes rather than on the outcomes of the
processes.

1
The main components of effective internal control processes are the
control environment, risk assessment and management, control
activities, information and communication, and monitoring.
Therefore, it is good that the business owner could establish a strong and
efficient internal control system as well as an internal audit department
to reduce the chances of fraud occur which may cause the company a
huge loss. [CITATION Sha12 \l 1033 ]

This research found that the five component of internal control which
are control environment, risk assessment, control activities, information
and communication and monitoring need to work together in order to
achieve an effective and strong internal control system. Nevertheless, the
result of the research shows that the SMEs should be able to maintain
such basic internal control system in their company especially in
monitoring and managing their activities through an independent unit
such as internal audit department. Therefore, it is recommended the
SMEs to outsource those departments so that it can be cost effective and
the system will be more reliable as outsourcing company has more
experience in designing the internal control system which is suitable for
the SMEs from different sectors. [CITATION Moh15 \l 1033 ]

Internal control can help an entity achieve its performance and

profitability objectives, and prevent loss of resources. It can help in
ensuring the reliability of financial reporting. And it can help to make
sure that the enterprise complies with government laws and regulations,
avoiding damage to its reputation and other consequences. [CITATION
Moh15 \l 1033 ]

2
THE ROLE OF A COMPANY’S INTERNAL
CONTROL SYSTEM IN FRAUD PREVENTION

The emergence of internal control over specific segments of activities

has been associated with management needs for evaluation of the

3
consistency between the actual situation and development targets.
Monitoring activities should enable detection and timely reaction to
possible target-related deviations. While responding to complex market
needs, companies are exposed to numerous internal and external
influences, some of which may cause significant damage. Companies
have realized that it is safer and cheaper to establish their own internal
control systems in order to prevent such influences. [ CITATION Dra15 \l 1033 ]

An efficient management system is a precondition for achieving

company goals. Such a system indicates careful planning of long-term
goals and coherence in realization. [ CITATION Dra151 \l 1033 ]

However, management is considered responsible for setting up an

adequate control environment and control activities to prevent
undesirable events in business and reporting. [ CITATION Dra151 \l 1033 ]

The emergence of internal control over specific segments of activities

was associated with management needs for information on business
performance and its development. Thus, management was able to more
precisely evaluate consistency between the actual situation and
development targets. [ CITATION Dra152 \l 1033 ]

Among various definitions of internal control probably the most

complete one was provided by the Committee of Sponsoring
Organizations of the Tread way Commission: “Internal control is a

4
process, effected by an entity’s board of directors, management and
other personnel, designed to provide „reasonable assurance” regarding
the achievement of objectives in the following categories: effectiveness
and efficiency of operations, reliability of financial reporting and
compliance with applicable laws and regulations“ [CITATION Rez02 \l 1033 ].
International Standards on Auditing states that internal control system
“means all the policies and procedures (internal controls) adopted by the
management of an entity to assist in achieving management’s objective
of ensuring, as far as practicable, the orderly and efficient conduct of its
business, including adherence to management policies, the safeguarding
of assets, the prevention and detection of fraud and error, the accuracy
and completeness of the accounting records, and the timely preparation
of reliable financial information [ CITATION Međ05 \l 1033 ].

The primary task of internal control is not finding the cause of fraud, but
rather detecting and stopping further fraud expansion. An internal
control system, if well designed and functioning, ensures that it will be
successful in all segments. However, even then it happens that internal
control is not able to find the solution to fraud. To overcome such
problems internal control should cooperate with other controls (external
auditing and forensic accounting) and, as far as it is capable, implement
new methods and techniques for fraud prevention. Preventive techniques
used by internal control ease the job of detecting frauds. [ CITATION Dra153 \l
1033 ]

The considered internal control techniques for fraud prevention may be

practically implemented only when a company has a developed system
5
of internal control which regularly performs the process of control.
Many companies do have internal control but its role in fraud prevention
is marginalized, especially when managers are personally involved in
fraud. [ CITATION Dra153 \l 1033 ]

Role of internal controls in business resilience and growth of small

businesses in Gaborone

Internal control’s responsibility is to ensure that corporate objectives are

being achieved with reliable financial reporting, efficient operations and
compliance with the country laws. [ CITATION Kel19 \l 1033 ]

illustrates that Implementing internal controls

[ CITATION Amy17 \l 1033 ]
provide reasonable assurance of i) Effectiveness and assurance of
operations, ii) reliability of financial reporting and iii) compliance with
laws and procedures; combining all these facilitate safeguarding of
assets as depicted in Figure 1.

6
Figure 1: Internal Controls (original source: [ CITATION Amy17 \l 1033 ]

According to [ CITATION Cun03 \l 1033 ] internal controls assist the organization

in meeting its goals and objectives, therefore, an organization without
internal control means that organization would be without control
toward its desired target, and will soon fall off course, away from the
companies cooperate objective. Internal controls have to be used
consistently and management has to make decisions on which internal
controls to adopt as a small business.

Botswana Institute for Development Policy Analysis (BIDPA) stated

that small and medium enterprises (SME’s), if properly natured,
empower the country’s economy. [ CITATION Rep18 \l 1033 ]
The use and maintenance of resources of small businesses depend on
successful execution of internal controls [ CITATION San14 \l 1033 ].
7
Globally, internal control failure among small businesses often leads to
loss of assets, fraud, waste, mismanagement, inefficiency, loss of client
assurance, and failure to achieve business goals. [ CITATION Kel19 \l 1033 ]

Policies and procedures set up by internal controls also help the

corporate leadership to manage risk which may hinder the corporate
performance or challenge the existence of that company [ CITATION Zak16 \l
1033 ].

Internal control procedures are fundamental and important steps in

reducing theft and fraud. Small businesses should have internal controls
in place to ensure that the organization operates efficiently and
effectively. [ CITATION Kel191 \l 1033 ]

In this era of consistent competitiveness among firms, small businesses

should train their employees on internal controls as play a pivotal role in
resilience and growth of small businesses. [ CITATION Kel191 \l 1033 ]

8
Impact of Internal Controls in Managing Resources of Small
Business: Case Study of Botswana

It is observed that most of small businesses have no internal controls in

place because they are costly to implement. [ CITATION Tum14 \l 1033 ]

Foreign Corrupt Practices Act (FCPA) of 1977 requires companies to

have good internal controls to provide reasonable assurance that access
to assets is at the management’s discretion (Guide to Internal Control
Financial Reporting). [ CITATION Gui \l 1033 ]

From this research scholar found out that internal controls are
moderately expensive to implement and that most businesses have
internal controls. [ CITATION Tum14 \l 1033 ]

9
Even though most small businesses have internal controls the owners
cannot clearly explain how those internal controls are operating. This
could be because of the complexity associated with internal controls
hence owners have to hire an accountant or outsource the accounting
services so they could learn more about internal controls [ CITATION Lon09 \l
1033 ].

Small business owners should engage in training and for their employees
on internal controls. [ CITATION Tum14 \l 1033 ]

Business owners should design the policies regarding internal controls

which will act as a guide to follow internal controls. These policies
should be easy to follow and should be changed every time there is a
breach of internal controls. [ CITATION Tum14 \l 1033 ]

10
The Linear and Non-Linear Effects of Internal Control and Its Five
Components on Corporate Innovation: Evidence from Chinese
Firms Using the COSO Framework

The impact of internal controls prescribed in accounting on corporate

innovation is underexplored.[ CITATION Kam20 \l 1033 ]

The conceptual framework by [ CITATION Lie19 \l 1033 ] argues that high

internal control quality may discourage or limit managers in approving
risky innovative projects, but it may also improve information quality
and reduce financial constraints, which lead to more innovation.

Our results suggest that, while both internal control as an integrated

system and its five individual components contribute positively to
innovation, the magnitudes of the impact differ across individual
components. Among the five components, we find that control
environment, control activities, and information & communication
exhibit a stronger impact on innovation than risk assessment and
monitoring. [ CITATION Kam20 \l 1033 ]

11
Our findings have two major managerial implications. First, we
conclude that a good internal control positively contributes to more
innovation. Correspondingly, firms should actively engage in improving
the quality of internal control and practices in conjunction with their
innovation endeavors. Second, internal control, as an integrated system,
has different components. While these components, on their own, are
important to a firm, their impact on innovation may be different. Our
findings suggest that macro-level components of a firm’s internal control
in terms of control environment, control activities, and information &
communication are more important to innovation than other components
such as risk assessment and monitoring to innovation. [ CITATION Kam20 \l
1033 ]

12
The Impact of Internal Audit Quality on Financial Performance of
Yemeni Commercial Banks: An Empirical Investigation

According to [ CITATION IIA11 \l 1033 ], the IA is an objective and independent

activity to increase the quality of the operation of institutions and work
to add value to them.

Auditing quality plays an important role in protecting companies from

the risks of the crash, which is the goal that all institutions pursue,
meaning that institutions whose operations are audited by professional
auditors face less risk [ CITATION Cha20 \l 1033 ].
IA is one of the most important aspects contributing to adding value to
institutions by improving the monitoring and follow-up process to
improve outputs [ CITATION Cor08 \l 1033 ].
Also, IA is a significant tool to maximize businesses outcomes for
institutions [ CITATION Dro15 \l 1033 ].
The efficiency of IA exerts a high positive impact on adding value to the
work and improving performance [ CITATION Pos20 \l 1033 ].

13
This research recommends that the members of the IA should have
professional and accounting experience, that the number of auditors is
commensurate with the size of the work, they should be given full
independence when performing their work, in addition to the need to
ensure that the auditors’ meetings are specifically designed for issues
that enhance and assist in improving financial performance. [ CITATION
Sad20 \l 1033 ]

INTERNAL CONTROL ACTIVITIES IN SMALL TURKISH

COMPANIES

Thus, the internal control appears a process, integrated with all other
processes, and is established, maintained, and monitored by people at all
levels of the enterprise [ CITATION Bil15 \l 1033 ].

The internal control coordinates the enterprise’s policies and procedures

connected with safeguarding its assets, checking the accuracy and
reliability of data, promoting operational efficiency, and encouraging
adherence to sound management practice. [ CITATION Ism17 \l 1033 ]

The most important is the assurance provided by the internal control in

enterprise, which is linked to the effectiveness and efficiency of
operations, reliability of financial reporting, compliance with applicable
laws and regulations [ CITATION Cur14 \l 1033 ].

The effective system of internal control over financial and managerial

reporting can reduce the risk of such inaccuracies and mistakes in

14
company’s financial statements. Nowadays, the aim of management is to
analyze some of the challenges staying in the way of a modern effective
internal management control system. [ CITATION Ism17 \l 1033 ]

The analysis shows that internal control increases the possibility of an

enterprise to achieve its strategic goals and objectives [CITATION Pap16 \l 1033 ].

The modern internal control in organizations under the COSO

framework (Committee of Sponsoring Organizations of the Tread way
Commission) consists of the following main components: control
environment, risk assessment, control activities, information and
communication, and monitoring activities [ CITATION COS13 \l 1033 ].

The collected information about internal control developments and its

systematization provide an opportunity for the researcher to construct a
SWOT analysis of the internal control system, and thus find typical
features of the complete small business sector in Turkey. The results of
the SWOT analysis are as follows : [ CITATION Ism17 \l 1033 ]

Strengths
• Availability of procedures making accounting true and fair.
• Recognized corporate culture due to the family business characteristics
of the studied enterprises.
• High level of employees’ adaptation to modern IT developments.
15
• Effective coordination between the units of the enterprises with view
of realizing the internal control objectives.
• Complete and timely transfer of changes in the internal control
legislation to the management.

Weaknesses
• Limited number of employees involved in internal control activities.
• There is often no in-depth information about internal control systems
and their application in SMEs.
• Non-differentiation of special internal control departments in the
structure of most enterprises.
• Accent of the internal control mostly on financial reporting.
• Non-existence of written standards based on the analysis of important
business processes and units in most of the enterprises.
• Sporadic observation and evaluation of activities related to internal
control by the management.
• Non-availability of adequate and constantly updated action plans for
minimizing risks and their effects on the enterprise.

Opportunities
• Growth of the national economy and chances to expand enterprises and
develop their control systems.
• Renewal of the fiscal legislation and harmonization processes
according to the good international practice.
16
• Increasing of communication opportunities and development of
information technologies in the country.
• Availability of important common guidelines for procedure, politics
and practice of internal control as a prerequisite for establishing of
internal control systems.
• Chances to revitalize private investments and develop internal control
systems, following modern tendencies, especially in SMEs.

Threats:
• No homogenous evaluation methodology of the control environment of
enterprises.
• Frequent changes in the legislation hindering the adaptation of the
internal control of companies.
• Risk of turbulences in the industry environment, which could have a
negative impact on control activities in SMEs.
A SWOT-based strategy for the designing of a better internal control
system in small enterprises should be developed. The principles
underlining the strategic thinking in this direction can be a matter of
future research.

17
EFFECT OF INTERNAL CONTROL SYSTEMS ON FINANCIAL
PERFORMANCE OF SMALL AND MEDIUM SCALE BUSINESS
ENTERPRISES IN KISUMU CITY, KENYA

Internal controls refer to the measures instituted by an organization so as

to ensure attainment of the entity’s objectives, goals and missions.
[ CITATION Dou14 \l 1033 ]

Internal Controls are processes designed and effected by those charged

with governance, management, and other personnel to provide
reasonable assurance about the achievement of an entity’s objectives
with regard to reliability of the financial reporting, effectiveness and
efficiency of operations and compliance with applicable laws and
regulations [ CITATION Mwi08 \l 1033 ].

An internal control system comprises the whole network of systems

established in an organization to provide reasonable assurance that
organizational objectives will be achieved.[ CITATION Dou14 \l 1033 ]

Benefits of an internal control system include effectiveness and

efficiency of operations, reliability of financial reporting and compliance
with applicable laws and regulations. [ CITATION Dou14 \l 1033 ]

18
Small and medium scale enterprises have operated in total disregard of
internal control systems leading to the mass failure of these business
organizations [ CITATION Lyd11 \l 1033 ].
Studies show that 90% of the business start-ups do not operate beyond
the third anniversary due to lack of sound internal control systems
[ CITATION Kat05 \l 1033 ].

Based on the findings of the study, it is concluded that internal control

systems as supported by the study findings significantly influence the
financial performance of SMEs. However, there are challenges in the
implementation of internal controls especially considering that the
internal audit function which is the backbone of internal controls is not
adequately equipped by the technical manpower required, which clearly
has affected their efficiency as revealed by this study.[ CITATION Dou14 \l 1033 ]

On the levels of business knowledge of entrepreneurs in internal control

systems, proprietors were very dissatisfied with their competence and
yet they happen to be at the helm of most SMEs.[ CITATION Dou14 \l 1033 ]

The final conclusion of this study is that there is a significant positive

relationship between internal control system and financial performance.
[ CITATION Dou14 \l 1033 ]

19
Since it was evident in the study, that the appropriate staffing level in the
internal audit department is not adequate to cover all aspects of internal
controls, evidenced by not conducting regular audit activities, not
operating efficiently as well as their reports not being regular, the study
therefore recommends priority budgeting for this important department
to enable SMEs realize the enormous benefits from this function.
[ CITATION Dou14 \l 1033 ]

Finally, the study recommends that there should be a deliberate attempt

to educate proprietors on the significance of business knowledge in
internal control systems. [ CITATION Dou14 \l 1033 ]

Internal control systems in small and medium-sized medical

practices in the Thulamela municipality, South Africa

20
Among other things, the COSO framework provides criteria for
evaluating internal control. These are : 1) fostering a favorable control
environment, 2) conducting risk assessment, 3) providing for effective
information and communication throughout the organization, 4)
designing and implementing control activities in the form of policies and
procedures, and 5) conducting ongoing monitoring of the effectiveness
of control-related policies and procedures. The overall success of a
system of IC is dependent on how effectively each of the above five
elements function and how well they are coordinated and integrated with
each other [ CITATION DiN08 \l 1033 ].
According to [ CITATION COS92 \l 1033 ], these five components of IC need to be
present to conclude that IC is efficient.

Obviously, small businesses such as medical practices should care about

internal controls to protect their assets, reduce the risk of fraud, and
concomitantly maximize the value of their businesses. [ CITATION Emm15 \l
1033 ]

In a similar study, [ CITATION Noo06 \l 1033 ] analyzed the effectiveness of

internal control over financial reporting in three medium-sized Estonian
manufacturing firms. Both qualitative and quantitative data were
collected using a questionnaire (based on COSO framework). After

21
comparing the three companies’ financial results, the one which scored
the highest score for effectiveness of internal control over financial
reporting, appears to have the smallest and modest growth, compared to
the other two companies.

From that relation the author drew several conclusions. First, that it is
easier to develop a good internal control system in small companies
because of the small size of personnel, more personal contacts and less
administration. This observation was also made by COSO. Second, the
effectiveness of internal control does not automatically mean financial
success for the firm due to the inherent weaknesses of internal control
systems. Lastly, in fast growing businesses, managers’ primary focus is
on growth of sales, and less on strong internal controls. However, the
lack of sound internal control may inevitably become as issue in the
future. [ CITATION Emm15 \l 1033 ]

The Effect of the Internal Audit and Firm Performance: A Proposed

Research Framework

22
The internal audit department is very important inside a firm that the
internal audit is regarded as the key element in the application of
accounting systems which in turn, helps in evaluating the work of the
department. The internal audit is considered as the backbone of the
business accounting as it is the section that records all businesses related
to the sector. The efficiency of internal audit helps develop the work of
the company because the financial reports reflect the internal audit
department’s quality. [ CITATION Ebr14 \l 1033 ]

The internal audit support enhances the system of responsibility that the
executive directors and employees have towards the owners and other
stakeholders [ CITATION Eig02 \l 1033 ].
Taken together, the internal audit department provides a reliable,
objective, and neutral service to the management, board of directors, and
audit committee, while stakeholders are interested in return on
investments, sustainable growth, strong leadership, and reliable
reporting on the financial performance and business practices of a
company [ CITATION Lju11 \l 1033 ].

Internal audit makes a large contribution to the achievement of company

goals, and the implementation of strategies for their achievement
[ CITATION Lju11 \l 1033 ]

In addition, the internal audit function is responsible for reinforcing

management and audit committee [ CITATION Hut09 \l 1033 ].

23
Furthermore, the internal audit function facilitates the operation and
effective working of the audit committee as the audit function goals are
consistent with the former’s financial reporting oversight responsibilities
[ CITATION Goo98 \l 1033 ].

Along this line of argument, [ CITATION AlS10 \l 1033 ] mentioned many factors
of internal audit functions and they are provided below:
1. The internal control systems and arithmetic evaluations in an attempt
to; ensure that the accounting system and internal controls systems are
appropriate, ensure that the systems are suitable for the facility and
propos system enhancements.
2. Assessing plans and procedures to determine weaknesses or defects in
the systems and procedures used by the company and to propose
modifications and enhancements needed, and to provide authority to the
internal auditor for the examination of the aspects of establishment
activity.

3. Taking into consideration the staff commitment to the company

policies and procedures and therefore, internal auditor has to monitor
these policies and procedures’ implementation and to clarify them to the
employees.
4. Safeguarding established funds as the development and
implementation of systems is an attempt to make sure that the facility
safeguards assets and funds against manipulation and fraud, to detect

24
fraud and minimize losses stemming from neglect/abuse (e.g. loss of
proper storage).

The internal audit department is very important inside a firm where the
internal audit is regarded as the key element in the application of
accounting systems and this in turn, helps in evaluating the work of the
department. The internal audit is considered as the backbone of the
business accounting as it is the section that records all businesses related
to the sector. The efficiency of internal audit helps develop the work of
the company because the financial reports reflect the internal audit
department’s quality. [ CITATION Ebr14 \l 1033 ]

INTERNAL CONTROLS AND OPERATING PERFORMANCE

OF SMALL BUSINESSES IN LAGOS METROPOLIS

It is commonly believed that the need for an internal control system

develops as the organization grows. As a small entity, characterized by
the direct involvement of the owner on a daily basis, grows into an

25
organization with specialized and/or departmental operations, the need
for internal controls does increase [ CITATION Bod75 \l 1033 ].

In general this idea is based on an accepted group of controls that are

useful in allowing management to evaluate financial and operational
efficiency from reports. [ CITATION Jam14 \l 1033 ]

These internal controls increase the confidence that the owners or

managers have in the business. Although the need for internal controls
increase in direct proportion to size of the business, the system is very
imperative for the small business. [ CITATION Jam14 \l 1033 ]
The operational standard by the Institute of Chartered Accountants of
England and Whales (ICAEW) define Internal Control as “The whole
system of control, financial and otherwise established by the
management in order to carry on the business of the enterprise in an
orderly and efficient manner, ensure adherence to management
policies, safeguard the assets and secure as far as possible, the
completeness and accuracy of the records” [ CITATION Ola09 \l 1033 ].

emphasized that internal controls are the methods or

[ CITATION Cam091 \l 1033 ]
procedures adopted in a business to safeguard its assets, ensure whether
financial information is accurate and reliable, ensure compliance with all
financial and operational requirements, and generally assist in achieving
the business’s objectives.

26
Internal Control is a management tool used to provide reasonable
assurance that management objectives are being achieved. Thus, it is
clear that internal control is concerned with the controls operative in
every area of corporate activity be it either small or large organization,
as well as with the way in which individual controls inter-relate. COSO
(2012) establishes that an effective system of internal control reduces, to
an acceptable level, the risk of not achieving an objective relating to
these three categories – operations, reporting, or compliance. [ CITATION
COS12 \l 1033 ]

Small businesses are the most vulnerable to fraud because they are
known for having weak internal controls [ CITATION Cam09 \l 1033 ].
The results of this study supported earlier findings which maintained
that there exists a relationship between internal controls and failure rate
[ CITATION Eng05 \l 1033 ] and profitability [ CITATION Lee12 \l 1033 ]. Thus, managers
who have positive perceptions of internal control systems increase profit
margin, lower costs, and increase the return on investment [ CITATION Doy05 \l
1033 ].

The study showed that the extent of practice of internal controls in small
businesses in Lagos State was generally moderate, and the internal
control systems had a significant effect on efficiency of operations of the
selected small businesses. This implies that internal control plays a vital
role in assisting business to manage resources, adequately minimize
risks and promote best practice within small businesses. Thus, the study
concluded that internal controls, grounded in the COSO Model, can have

27
positive effects on the profitability and survivability of small businesses
in Nigeria. [ CITATION Jam14 \l 1033 ]

This study recommended that managers of small business in Nigeria

should boost the control consciousness of the workers in the
organizations, and give adequate attention to the issues of internal
controls in order to maximize the business potentials and minimize the
risk of fraud, error and loss. [ CITATION Jam14 \l 1033 ]

INTERNAL CONTROL IN SMALL AND MICROENTERPRISES

IN THE VHEMBE DISTRICT, LIMPOPO PROVINCE, SOUTH
AFRICA

Internal controls are designed to provide reasonable assurance regarding

the achievement of an organization’s objectives in terms of effectiveness
and efficiency of operations, reliability of financial reporting, and
compliance with applicable laws and regulations. [ CITATION Emm13 \l 1033 ]

28
Thus a major factor that determines the effectiveness (or adequacy) of
internal control systems in a business is the size of that business. [ CITATION
Emm13 \l 1033 ]

The policy implication of these findings is that there is need to

encourage and support small businesses to grow and expand in size in
order to effectively employ internal control measures, the lack of which
is firmly established as a major cause of business failures around the
world. [ CITATION Emm13 \l 1033 ]

Effect of Internal Control System on Employee Performance of

Small-Scale Manufacturing Enterprises in Ondo State, Nigeria

The performance of employees of small businesses tends to depend

largely on their control environment. This is because, the performance
that is guided by clearly established lines of authority and responsibility
plus recruitment and selection of competent staff will be measurable in
an environment where there is control and monitoring. It follows that
compliance with organizational internal control system ensures that
29
employee performance is done in line with policies and procedures.
[ CITATION Ade18 \l 1033 ]

[ CITATION Bra16 \l 1033 ],

stated that a small business is open to different
fraudulent activities, some of which are employee related, such as
embezzlement and workers’ crime. Internal control is important and
ought not to be overlooked no matter the size of a business concern.

According to [ CITATION Ose13 \l 1033 ], majority of business failures has been

attributed to lack of internal control system.
Studies have also shown that most new businesses become moribund
few years after establishment as a result of poor internal control systems
[ CITATION Kam14 \l 1033 ].

[ CITATION Ada15 \l 1033 ],

revealed that weak internal control in small
businesses affects the effectiveness of their employees in the
achievement of organizational goals and objectives.
Small businesses either have weak control system or no control system
at all [ CITATION Cam03 \l 1033 ].
One of the arguments put forward for the absence of effective and
efficient internal control system in small businesses is its costly
implementation [ CITATION Mod13 \l 1033 ].

30
While internal control system is cost bearing, it may protect the assets
and other resources of the organization and may result in organizational
efficiency and effectiveness. [ CITATION Ade18 \l 1033 ]

Perhaps little attention is being paid to the influence of internal control

system on employee performance of small businesses, making it look as
if small businesses operate in total disregard to policies and leading to
their mass failures. [ CITATION Ade18 \l 1033 ]

When internal control is studied, emphasis is mostly on its effect on

profitability, financial standing or organizational performance. The
relationship between internal control and employee performance tends to
be overlooked or underrated in research. [ CITATION Ade18 \l 1033 ]

Internal control and employee performance should come to the fore

since grooming small businesses to take the center stage in driving the
Nigerian economy is the focus of governments at all levels [ CITATION Ola13 \l
1033 ].

Since small businesses including manufacturing enterprises are not too

small for effective internal controls, they can enforce certain controls
that are very effective and impact employee performance. [ CITATION Ade18 \l
1033 ]

31
According to [ CITATION Ste06 \l 1033 ], manufacturing organizations have
become greatly competitive to the extent that customer satisfaction
cannot be achieved without production, planning and control.
The control aspect provides policies and procedures guiding the
accomplishment of organizational goals with minimum cost outlay and
prevention of avoidable wastage. Internal control system is important for
the smooth running of an organization. [ CITATION Ade18 \l 1033 ]

The study has shown that internal control system influences employee
performance of the selected small scale manufacturing enterprises. It is
therefore necessary that owners of small businesses invest in internal
control system instead of emphasizing cost reduction to the detriment of
their enterprises and ensure that employees are punctual and keep their
loyalty to their employers. On this, internal control system should be
strengthened to prevent asset loss and employee indifference to the
achievement of organizational objectives. Small scale manufacturing
enterprises should focus more on the control environment, information
and communication and monitoring components of internal control
system as they will aid employee performance. [ CITATION Ade18 \l 1033 ]

32
CHALLENGES FACED THE INTERNAL AUDIT PROFESSION
IN YEMEN

Improving organization’s operation is an intent and desire of every

firm, however, accomplishing such an objective seems sometimes a bit
challenging. This is because it requires firms to employ systematic and
disciplined approach to assess and improve the effectiveness of risk
management, governance and control processes, which is
unfortunately absent in most of the developing countries. [ CITATION
Mur20 \l 1033 ]

33
[ CITATION Bak13 \l 1033 ],
Internal auditors need to face the challenge of
complex and frequent changes in regulations, as they have to assure the
compliance of the company with those laws.

[ CITATION Mun11 \l 1033 ],

Furthermore, corporate scandals and the global
financial crisis increased the demand for internal auditors to prove the
efficiency and importance of their work, and internal auditors need to
add value to an organization by making sure that the activities of an
organization are performed economically, efficiently and effectively.

The fact that the profession of internal audit is an important part in any
organization, there must be a significant development in this profession,
which would contribute in maintaining the rights of shareholders in
companies and providing sort of confidence for investors and assuring
that principles are held properly, a thing that maintains creditors’ rights. [
CITATION Mur20 \l 1033 ]

Yemen does not have its own established internal auditing standard, and
has not adopted the international standard [ CITATION Abd06 \l 1033 ].

34
As such, auditors work under the shed of basic internal auditing rules, a
thing that requires study and research about the reasons and obstacles of
their absence. [ CITATION Mur20 \l 1033 ]

Independency and Proficiency Challenges Faced Internal Auditors :

[ CITATION Mur20 \l 1033 ]

1- Internal audit department is belongs directly to the highest level in the

organization structure.
2- Internal auditors don’t have any authority or power related to the
activities which they are auditing.
3- After the audit activity Internal auditors provides an objective
suggestions to the managers to improve their departments.
4- Internal auditors have the knowledge, skills, and other competencies
needed to perform their responsibilities.
5- Internal auditors are concern about developing their knowledge,
skills, and other competencies.
6- Internal auditors have sufficient knowledge of the international
internal audit standards.
7- Internal audit director is supervising the performance of the activities
on the base of plan and program of the activities.
8- Internal audit director are communicating to the senior management
when the standards are not applicable.

35
External Challenges Faced Internal Audit Profession : [ CITATION Mur20 \l
1033 ]

1- Lack of professional bodies to carry this responsibility.

2- Inapplicable standards with the Yemeni business environment.
3- Non- mandatory legislation to apply the internal audit standards.
4- Absence of awareness in the originations about the significant of
applying the standards.
5- Lack of understanding and perception of internal audit standards by
internal auditors.
6- Limited availability of professionals in the field of internal auditing.
Overall, the findings of the study show weaknesses in the internal
auditors’ independency and proficiency due to the lack of awareness of
the role internal audit function in the organization, which can be
considered as main challenges, that result from the absent of role of
professional bodies as well as the absence of mandatory guidelines,
standards and regulations to govern the internal audit practice in Yemen.
[ CITATION Mur20 \l 1033 ]

Lack of experts, absence of training providers, moreover the absence of

the educational institutions are additional obstacles facing the
profession. The findings of this study are consistent with the previous
studies that highlight the importance of internal audit as an effective
function to enhance the effectiveness of other functions such as risk
management, governance and internal control. [ CITATION Mur20 \l 1033 ]

36
Overall, it can be concluded that the change and improvement of internal
audit function in the business sector will be a lengthy and slow process if
existing problems are not overcome. Hence, effectiveness of internal
audit function will be easy to say than done. [ CITATION Mur20 \l 1033 ]

Analysis on the Problems in the Internal Control in Small and

Medium-Sized Enterprises and Countermeasures

In today's world, small and medium-sized enterprises have become the

main force in the economy of each region and country and account for
more and more proportion in regional national economy [ CITATION Yur18 \l
1033 ].

The inadequate internal control in small and medium-sized enterprises

causes many troubles for their development, thus making them develop
very slowly. [ CITATION Yur18 \l 1033 ]

37
PROBLEMS IN THE INTERNAL CONTROL IN SMALL AND
MEDIUM-SIZED ENTERPRISES :

A. Weak foundation of internal control environment :

Sound control environment is the foundation of internal control. [ CITATION
Yur18 \l 1033 ]

B. Unsound risk evaluation system ;

With the increasingly growing market economy, the risks small and
medium-sized enterprises face are increasing. [ CITATION Yur18 \l 1033 ]

C. Poor communication within the organization :

It is indispensable to have smooth channels for information
communication in any situations, especially in realization of effective
internal control. [ CITATION Yur18 \l 1033 ]

D. Unsound and poor execution of the design of control activity :

Control activity is the key part of internal control. Its design and
execution have certain impact on the role of internal control. [ CITATION
Yur18 \l 1033 ]

38
E. Ineffective supervision to internal control :
The main function of internal control is to effectively control and
manage various relative risks of operation, guarantee the authenticity
and accuracy of financial accounting data in a proper manner and ensure
the completeness of enterprises' assets. [ CITATION Yur18 \l 1033 ]

STRENGTHENING AND IMPROVING MEASURES FOR

INTERNAL CONTROL OF SMALL AND MEDIUM-SIZED
ENTERPRISES :

A. Improving internal control environment :

Internal control environment of enterprises is the cornerstone for the
successful establishment of enterprises and execution of sound internal
control. [ CITATION LiY15 \l 1033 ]
The improvement of internal control environment for small enterprises
first of all start with senior management who must raise the awareness of
internal control, set up and perfect the system of internal control and set
a good example to execute internal control system. Small and medium-

39
sized enterprises need to establish institutional framework with clear job
responsibility and actively build enterprise culture with unique
characteristics in order to better demonstrate their positive value,
distinctive development vision, innovative enterprise spirit and honest
and trustworthy management ideas and in the meantime create enterprise
brand to facilitate health and sustainable development for small and
medium-sized enterprises [ CITATION LiY15 \l 1033 ].
Enterprises should improve their policies of human resources and
conduct sound management of human resources from recruitment,
training and promotion to improve employees' quality. [ CITATION LiY15 \l 1033 ]

B. Building risk evaluation mechanism :

Perfect risk evaluation mechanism plays a vital role in effectively
implementing internal control. [ CITATION Yur18 \l 1033 ]

C. Regulating internal control activity :

Small and medium-sized enterprises should design control activities
related to their business in accordance with their own characteristics to
strengthen executive force and promote effective execution of control
activities so as to give full play to internal control. First of all,
enterprises should establish and perfect the system of internal control
activity, standardized each business activities, separate duties from
responsibilities and supervise each other. Secondly, the enthusiasm of
40
employees who take part in internal control activities should be
motivated from various aspects. Enterprises should make employees
realize the importance of internal control activities and actively
participate in by training, rewards and other means, thus making
contribution to the improvement of the implementation of development
strategy. Lastly, the execution effect of internal control activities can be
included into performance appraisal system to promote all employees to
effectively execute internal control system. [ CITATION Yur18 \l 1033 ]

D. Strengthening information exchange and communication :

According to the requirements of the system of information
communication, a complete system needs to have latitudinal
communication channels except top-down and down-top ones. [ CITATION
Yur18 \l 1033 ]

E. Intensifying the supervision of the execution of internal control in

small and medium-sized enterprises :
The first thing to build highly independent internal audit organizations is
to intensify the supervision of the execution of internal control in small
and medium-sized enterprises. The existence of internal audit
organizations won't bring great cost burden for small and medium-sized
enterprises, but its effective supervision on internal control will bring
higher earning of management for enterprises. Therefore, it is necessary
for small and medium-sized enterprises to establish internal audit
department to improve its independence, employ auditors with
corresponding abilities to conduct daily and sustained supervision on the
execution of internal control to urge enterprises to timely improve the
system of internal control. What's more, the contents of internal audit
cannot be restricted to the supervision on the standardization and legality

41
of financial activities. It should enlarge its supervision to the whole
process of each economic activities of enterprises and to the matters
before and during the economic activities to improve its effectiveness. In
addition, it should assign special person to execute internal control,
combine internal control with performance assessment, build reward and
punishment mechanism for the execution of internal control and strictly
supervise the effective execution of internal control. Furthermore, it
should introduce outsourcing mechanism of internal audit in which the
third party will conduct objective supervision on each business of
enterprises. [ CITATION Yur18 \l 1033 ]

In brief, small and medium-sized enterprises should intensify their

investment in the construction of internal control, optimize the control
environment, establish and perfect risk evaluation system, strengthen
information system and communication of enterprises and regulate
internal control activities. [ CITATION Yur18 \l 1033 ]

In the meantime, it should conduct effective supervision on the

execution of internal control to guarantee the effective operation of
internal control and realize the goals of internal control, thus promoting
health, sustained and stable development of enterprises. [ CITATION Yur18 \l
1033 ]

42
Discussions on the Improvement of the Internal Control in SMEs

With the development of the economic, the problems of internal control

in SMEs became more and more prominent, Which mainly express at
neglecting of the management, highlighting the internal control
environment, information distortion, ineffective supervision ect, has
become an important reason which constraint the further development of
SMEs.[ CITATION Lin10 \l 1033 ]

1. The necessity of improving internal controls for SMEs :

The Small and Medium Enterprise (SMEs) are very important force for
economic and social development. They played important part in
increasing national income, providing tax revenue and jobs. However,

43
with the development of SMEs, their internal problems are gradually
exposed, especially in the financial crisis, a large number of small and
medium enterprises closed down, the reason is: the construction of
internal control deficiency of SMEs.[ CITATION Lin10 \l 1033 ]

2. The Problems of Internal Control of SMEs :

2.1 The management neglects the internal control and don’t have risk
awareness :
Due to the business scale, human resource, financial and its own
conditions ect, many SMEs under the ownership and franchise’s
restrictions, unwilling to establish the standard internal control system.
[ CITATION Lin10 \l 1033 ]

2.2 Prominent problems within the enterprise environment ;

Internal environment is the general term of various internal factors:
which affected and limited the internal control system established and
implementation, is the basis for the implementation of internal control.
[ CITATION Lin10 \l 1033 ]

2.3 Distortion of accounting information, poor management

communication :
As the basic accounting work for SMEs is poor, financial management
function can not fully play, this made the companies finance department,
custody department, and the use of department can not be mutually
restrict, account statement, account card, account discrepancies made

44
accounting information distortion, which influences management
decisions.[ CITATION Lin10 \l 1033 ]

2.4 lack of effective supervision mechanisms :

At present, most SMEs not set the appropriate internal audit bodies, and
the management take no count of the internal supervision mechanism.
Even if an internal audit agency be set up, as lacks independence, a large
of enterprise employees accept bribes, annexation property by supervise
vulnerabilities within the enterprise, and the phenomenon of
unauthorized diversion of fund is serious, so that internal supervision
become a mere formality.[ CITATION Lin10 \l 1033 ]

3. The measures of improving internal controls for SMEs :

3.1 Strengthening enterprise managements, emphasis on internal
controls, and enhance the risk consciousness :
(1) As a business manager who need to emphasize and propagandize the
nature and importance of the internal control, organize and lead all staff
to set up a rounded, suitable internal control system to make middle
managers and ordinary employees see the importance of the internal
control to enterprise develop, deepen their understanding of the whole
process of the internal control and job descriptions respectively.[ CITATION
Lin10 \l 1033 ]

45
(2) The management personnel should receive a training about legal
knowledge so as to improve competence in solving problems by law,
establish the early-warning mechanism of risk in company and focus on
each transaction contract performance to ensure that transaction contract
fulfill on schedule, establish long-term mechanism of accounts
receivable management, bring advanced inventory system into force in
the enterprise, and strengthen the control of the accounts receivable
turnover and the inventory turnover to prevent the shortage of corporate
funds.[ CITATION Lin10 \l 1033 ]

3.2 Improving the internal environment construction :

Internal environment refers to the basis of the internal control, only
improve the internal environment can reduce the establishment of the
inherent limitations of internal controls effectively, and improve the
efficiency of internal control :
(1) According to the relevant laws and regulations, SMEs should
establish a reasonable internal structure, give full play to the strength of
the collective power to avoid excessive concentration of rights.[ CITATION
Lin10 \l 1033 ]

(2) In fact, any enterprise has its own corporate culture.[ CITATION Lin10 \l
1033 ]

46
(3) SMEs’ human resource building include that description of each
position, a clear division of labor jobs, the choice of targeted personnel
into the post, and ensure that every post employees can have the
corresponding ethical and professional competence. [ CITATION Lin10 \l 1033 ]

3.3 Improving the internal information system strengthening the

internal communication :
Information and communication are important conditions for the
implementation of internal control. SMEs should establish a two-way
information exchange channels within the enterprise, form a top-down
information dissemination channel and a bottom-up information reported
channel. [ CITATION Lin10 \l 1033 ]

3.4 Improving corporate oversight mechanisms, enhance the

management on Supervision :
Supervision and inspection of enterprises is a process which is an
important guarantee to the implementation of internal control, inspect
and assess the viability, rationality and effectiveness of the internal
control, and form a written report ultimately. The internal supervision
not only come true through daily, constantly monitors, but also achieved
by individually, discontinuously monitors. First of all, make
incompatible duties are separated by reform oversight bodies, divide
supervision and the functions of institutions scientifically, set operating
post reasonably, at the same time, a person or a department must
communicate with other people or department, so that the internal
supervision system would be really implemented. Second, under the

47
guidance of the enterprise management, enhancing all staffs’
consciousness of supervision and subject yourself to supervision, so as
to change the way of the management modality. Finally, clear the main
responsibility of several departments, strengthen the sense of
responsibility of the unit people in charge. Meanwhile, SMEs should
increase supervision with the help of social supervision and other
external forces to guarantee the healthy and rapid development of SMEs.
[ CITATION Lin10 \l 1033 ]

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