CHAPTER ONE

THE PROBLEM AND ITS BACKGROUND

1.0  Introduction

According to Nalukenge, Tauringana, & Mpeera Ntayi (2017), Internal Control over Financial Reporting (ICFR) refers to controls intended to deal with risks that are connected to financial reporting and may include all the controls designed to provide assurance that the financial statements of entities are free from material misstatements. To achieve better reporting quality, organizations and regulators are now putting much emphasis on improving Internal Controls to enhance financial reporting (Chalmers, Hay, & Khlif, 2019). Internal control has to do with every activity by the organization that controls risks. They are necessary for financial reporting to be reliable. In this regard, the study of internal control over financial reporting (ICFR) in the Ghanaian banking sector is very important (Oladapo, Arshad, Muda, & Hamoudah, 2019) since banks contribute immensely in achieving economic growth and development.

 

This chapter provides a general introduction of the research. It begins with a background to the study and its context. Again, the problem statement, forming gaps in the existing corporate governance and internal control literature that motivate this study are identified. Also, the key objectives of the study are conveyed. The chapter further incorporates the relevance as well as the expected theoretical and managerial contributions of the study. Finally, it concludes with the organization of the study, including the remainder of the chapters.

 

1.1 Background of the Study

Every institution requires an adequate degree of governance system to achieve its organizational goals and to provide true confidence about the accomplishment of organizational objectives linked to operations, reporting, and compliance (Afriyie, Kong, Danso, Ibn Mensah, & Akomeah, 2019). Internal control and corporate governance success are intimately connected at the entity level, precisely because effective corporate governance cannot be provided on the basis of a flaw-ridden internal control system. As a result, corporate control activities serve as rules, techniques, strategies, and systems for detecting and evaluating risks (Afriyie, Kong, Danso, Ibn Mensah, & Akomeah, 2019).

As a result, the reasons and economic importance of internal control quality and financial reporting are critical problems that have gained traction in academic study in recent years (Chalmers, Hay, & Khlif, 2019). For example, the adoption of the Sarbanes-Oxley (SOX) Act in 2002 has resulted in improved corporate reporting and transparency. The measure was made to control IC reporting by management and creditors in the United States (Chalmers, Hay, & Khlif, 2019).

Following a succession of corporate scandals that shook the business world over the past decade, the SOX Act evolved into a globally known legislation aimed at enhancing financial reporting accuracy. According to Hassan, Nassar, and Whitherspoon (2019), the SOX rules are intended to promote transparency in reporting while also assisting businesses in avoiding financial reporting errors and, ultimately, eliminating fraud. In this respect, corporate executives often use the Committee of Sponsoring Organizations (COSO, 1992 & 2013) Framework to develop and evaluate internal control mechanisms, resulting in governance process improvements (Koutoupis & Pappa, 2018). Internal control may be described as the integration of an organization's plans, operations, policies, and activities of its human resources working together to provide an acceptable assurance that helps the company achieve its purpose and objectives (Thabit, Solaimanzadah, & Al-abood, 2017). Internal control, according to Khlif and Samana (2016), is an essential tool for investors to assess the efficiency of company reporting systems. The strength of internal controls has a significant effect on the performance of a good financial reporting strategy (Bentley-Goode, Newton, & Thompson, 2017). Firms with a poor degree of internal controls are more likely to fail. Agyei-Mensah (2016) The author confirms that internal control reports meet the information requirements of financial statement consumers. According to Sharma and Senan (2019), for internal control to be successful, five components must be interconnected: the control environment, the system of accounting information and communication systems, risk assessment, control actions, and monitoring. Internal controls, on the other hand, are used to direct, monitor, and measure an organization's resources in areas such as financial reporting, operations, and compliance with laws and regulations.

As a result, the primary objective for this study is to help enhance internal control over financial reporting in order to create a better way of financial reporting. According to Nalukenge, Tauringana, and Mpeera Ntayi (2017), internal control over financial reporting refers to controls designed to deal with financial reporting risks and may include all controls activities designed to provide assurance that entities' financial statements are free of material misstatements.

Some studies show that failure of internal controls systems and efforts by business leaders to bypass internal controls are to blame for many corporate crises in the recent past (Ayagre, Appiah-Gyamerah, & Nartey, 2014). As a consequence, reporting on a company's internal controls is a sign of responsibility, which some recent research show is positively related to corporate governance (Tumwebaze, Mukyala, Ssekiziyivu, Tirisa, & Tumwebonire, 2018). As a result, a strong corporate governance framework is likely to help organizations enhance their accountability, often known as accounting for and reporting on their actions (Tumwebaze, Mukyala, Ssekiziyivu, Tirisa, & Tumwebonire, 2018). According to several previous research, corporate governance is a cornerstone of trust, transparency, accountability, ethics, and risk management, which promotes financial stability, integrity, and internal controls of both listed and unlisted state-owned businesses (Nerantzidis & Filos, 2014).

 

In Ghana, the corporate board of directors is required to guarantee that corporate organizations' annual reports include a statement about the sufficiency of internal control systems and procedures (Agyei-Mensah, 2016). Furthermore, Act 179 of the Businesses Act of 1963 requires companies to produce and present financial accounts to owners. As a result, it serves as a foundation for openness and transparency in corporate internal matters (Agyei-Mensah, 2016). Strong corporate governance may be regarded as a suitable and useful instrument for managing and regulating the internal affairs of organizations, including the necessary control mechanisms, these days. According to certain research, corporate governance and quality internal controls play comparable functions based on agency theory, with the goal of resolving principal-agent interactions of self-interest (Nalukenge, Tauringana, & MpeeraNtayi, 2017).

Agency theory, the dominant theoretical paradigm in corporate governance studies, stresses that managers are self-interested rational maximizers who may attempt to circumvent internal protections (Ge, Li, Liu, & McVay, 2021). However, according to rival stewardship theory, managers are seen as excellent corporate stewards and therefore strive to work closely with the principals in regard to internal controls in order to achieve appropriate alignment (Sirois, 2021). This implies that corporate governance is critical in terms of internal control systems. According to Arun (2019), good corporate governance is required for a business to be accepted and registered on stock market platforms across the globe. Similarly, when the board of corporate directors fulfills its responsibilities as a result of excellent corporate governance, it leads to high-quality internal control over financial reporting (Arun, 2019). (Al-Baidhani, 2014). Furthermore, it is argued that, under good corporate governance norms, reporting on internal control flaws is a critical responsibility for a corporation's leadership (Ezelibe, Nwosu, & Orazulike, 2017).

 

Under this perspective, the board of directors and other corporate governance characteristics are the focus of this study.  For instance, Aifuwa & Embele  (2019) and Al-Baidhani (2014) posit that board members who possess financial skills can influence constant financial reporting and also be able to deal with financial reporting complications. Supporting this claim, Assenga, Aly, & Hussainey (2018) and Nkundabanyanga, Tauringana, and Muhwezi, (2015) found a link between the board role in relation to provision of resources, monitoring services and control in relation to better performance of schools.  Another finding from the literature is that board independence improves the ability of the board to monitor management, which can affect financial statement reporting and fraud reduction (He, Labelle, Piot, & Thornton, 2009; Fuzi, Halim, & Julizaerma, 2016). Similarly, Agyemang Badu and Appiah (2017) found that board independence and skills as well as board size play an important role to improve the effectiveness of board monitoring in English speaking countries in West Africa.

Khlif and Samaha’s (2016) findings revealed that audit committee activity can influence corporate transparence. They argue that audit committee thoroughness is likely to provide numerous corrective as well as preventive actions, in relation to internal control weaknesses (ICWs) which in turn may translate into higher internal control quality (ICQ). Equally, Amartey, Yu, & Chukwu-lobelu’s (2019) study reveals that both the internal and external auditors, as well as audit committee, constitute key instruments used by the listed banks in Ghana to improve board answerability to investors. However, according to the authors what is realized is that a number of banks are not effectively using these mechanisms. Likewise, a study by Tumwebaze, Mukyala, Ssekiziyivu, Tirisa, & Tumwebonire (2018) on Uganda's public enterprises discovered a link between internal auditing and accountability..