CHAPTER TWO

LITERATURE REVIEW
2.1 Conceptual Review
2.1.1 Overview of Internal Control Systems
Internal control systems play a pivotal role in ensuring the effective governance and management
of organizations. According to COSO (Committee of Sponsoring Organizations of the Tread way
Commission), internal control is defined as "a 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" (COSO,
2013). This definition underscores the multifaceted nature of internal control systems and their
significance in achieving organizational objectives.

The purpose of internal control systems is multifaceted and encompasses several key objectives.
Firstly, internal control systems are designed to safeguard assets by minimizing the risk of theft,
misuse, or loss. By implementing controls such as segregation of duties, authorization
procedures, and physical security measures, organizations can protect their assets from both
internal and external threats (Onoja, Ajanya and Audu, 2013).

Secondly, internal control systems aim to ensure the accuracy and reliability of financial
reporting. By establishing controls over financial transactions, recording, and reporting
processes, organizations can detect and prevent errors, misstatements, and fraudulent activities.
This is crucial for maintaining the integrity of financial information and fostering investor
confidence (Ishola, Abikoye amd Olajide, 2015).

Moreover, internal control systems contribute to the effectiveness and efficiency of operations by
promoting adherence to policies, procedures, and guidelines. By streamlining processes,
eliminating inefficiencies, and optimizing resource utilization, organizations can enhance
productivity and achieve operational excellence (Badmus Olusegun and Edegbe David’s 2003).
The components of internal control systems encompass various elements that work together to
achieve the overarching objectives. These components, as delineated by COSO, include the
control environment, risk assessment, control activities, information and communication, and
monitoring (COSO, 2013).

The control environment sets the tone at the top and establishes the organizational culture
regarding the importance of internal control and ethical conduct. It encompasses factors such as
management's integrity, ethical values, competence, and commitment to compliance.

Risk assessment involves identifying, assessing, and mitigating risks that may impede the
achievement of organizational objectives. This process entails evaluating internal and external
factors that may pose risks to the organization and developing strategies to manage these risks
effectively (Okoli, 2012).

Control activities are the policies, procedures, and practices implemented to mitigate risks and
achieve control objectives. These activities may include segregation of duties, authorization and
approval procedures, physical controls, and IT controls.

Information and communication ensure that relevant information is identified, captured, and
communicated in a timely manner to facilitate decision-making and accountability. This
component encompasses the flow of information within the organization and with external
stakeholders.

Monitoring involves ongoing assessment of the effectiveness of internal control systems to

ensure they are operating as intended. This may include internal audits, management reviews,
and periodic evaluations of control activities.

The importance of internal control systems in organizational governance cannot be overstated.

Effective internal control systems promote transparency, accountability, and integrity, thereby
enhancing stakeholder confidence and trust. By establishing robust internal control mechanisms,
organizations can mitigate risks, safeguard assets, and achieve their objectives efficiently and
effectively.

2.2. Theoretical Review

Theoretical frameworks provide conceptual foundations for understanding the complexities of
internal control systems and their relationship to fraud prevention. Two prominent frameworks in
this regard are the COSO framework and the Fraud Triangle theory.

2.2.1. COSO Framework

The Committee of Sponsoring Organizations of the Tread way Commission (COSO) developed a
comprehensive framework for internal control, which has become widely adopted by
organizations worldwide. The COSO framework consists of five interrelated components:
control environment, risk assessment, control activities, information and communication, and
monitoring.

Control Environment: This component emphasizes the importance of organizational culture,

ethical values, and governance principles in shaping the effectiveness of internal control systems.
A strong control environment fosters a culture of integrity, accountability, and compliance
throughout the organization.
Risk Assessment: Risk assessment involves identifying, analyzing, and mitigating risks that
may hinder the achievement of organizational objectives. By systematically assessing risks,
organizations can prioritize control activities and allocate resources effectively to address areas
of greatest vulnerability.
Control Activities: Control activities are the policies, procedures, and practices implemented to
mitigate risks and achieve control objectives. These activities encompass a wide range of
controls, including preventive, detective, and corrective controls, aimed at safeguarding assets
and preventing fraudulent activities.
Information and Communication: Effective information and communication processes ensure
that relevant information is identified, captured, and communicated in a timely manner to
facilitate decision-making and accountability. Clear communication channels enable
stakeholders to understand their roles and responsibilities regarding internal control and fraud
prevention.
Monitoring: Monitoring involves ongoing assessment of the effectiveness of internal control
systems to ensure they are operating as intended. This component encompasses internal audits,
management reviews, and periodic evaluations of control activities to detect deficiencies and
implement corrective actions.

The COSO framework provides a structured approach to designing, implementing, and

evaluating internal control systems, thereby enhancing organizations' ability to prevent and
detect fraud.

2.2.2. Fraud Triangle Theory

The Fraud Triangle theory, developed by criminologist Donald Cressey, offers insights into the
psychological and situational factors that contribute to fraudulent behavior. According to the
Fraud Triangle, three elements must be present for fraud to occur: opportunity, pressure, and
rationalization.

Opportunity: Opportunity refers to the conditions or circumstances that enable individuals to

commit fraud without detection. Weak internal controls, lack of oversight, and inadequate
segregation of duties create opportunities for individuals to exploit vulnerabilities and engage in
fraudulent activities.
Pressure: Pressure, also known as motivation or incentive, represents the financial or personal
pressures that compel individuals to commit fraud. These pressures may arise from financial
difficulties, such as debt or gambling addiction, or from external factors such as job insecurity or
unrealistic performance expectations.
Rationalization: Rationalization involves the cognitive processes by which individuals justify
or excuse their fraudulent behavior. Rationalizations may include beliefs such as "I deserve this"
or "Everyone else is doing it," which enable individuals to reconcile their actions with their
moral or ethical standards.

2.3. Internal Control Components

Internal control systems consist of several key components that work together to ensure the
achievement of organizational objectives and the mitigation of risks. These components, as
outlined by frameworks such as COSO, are essential for effective governance and management.
Let's delve into each of these components:

2.3.1. Control Environment: The control environment sets the tone at the top and influences the
organization's overall attitude towards internal control and ethical behavior. It encompasses
factors such as management's integrity, ethical values, and commitment to compliance. A strong
control environment promotes a culture of accountability, transparency, and integrity throughout
the organization, providing the foundation for effective internal control systems.

2.3.2. Risk Assessment: Risk assessment involves identifying, analyzing, and prioritizing risks
that may impact the achievement of organizational objectives. This process enables organizations
to understand the potential threats they face and to allocate resources effectively to mitigate these
risks. Risk assessment involves considering both internal and external factors, such as changes in
the business environment, regulatory requirements, and technological advancements. By
conducting regular risk assessments, organizations can proactively identify vulnerabilities and
implement appropriate controls to manage risks effectively.

2.3.3. Control Activities: Control activities are the policies, procedures, and practices
implemented to mitigate risks and achieve control objectives. These activities encompass a wide
range of controls, including preventive, detective, and corrective controls. Examples of control
activities include segregation of duties, authorization and approval procedures, physical controls
(e.g., locks and security systems), IT controls (e.g., access controls and encryption), and
reconciliation procedures. Control activities are designed to prevent errors and fraud, detect
deviations from established standards, and facilitate the achievement of organizational goals.

2.3.4. Information and Communication: Effective information and communication processes

ensure that relevant information is identified, captured, and communicated in a timely manner to
facilitate decision-making and accountability. This component involves the dissemination of
information to internal and external stakeholders, including employees, management, board
members, regulators, and investors. Clear communication channels enable stakeholders to
understand their roles and responsibilities regarding internal control and to report any concerns
or issues that may arise. Information and communication also play a crucial role in ensuring the
accuracy and reliability of financial reporting and other organizational processes.

2.3.5. Monitoring: Monitoring involves ongoing assessment of the effectiveness of internal

control systems to ensure they are operating as intended. This component encompasses internal
audits, management reviews, and periodic evaluations of control activities. Monitoring activities
aim to detect deficiencies or weaknesses in internal controls, identify areas for improvement, and
ensure compliance with policies, procedures, and regulations. By continuously monitoring
internal control systems, organizations can identify and address issues in a timely manner,
thereby enhancing the overall effectiveness of their governance and management processes.

2.4. Types of Fraud and Corruption

Fraud and corruption pose significant challenges to public organizations, undermining their
integrity, efficiency, and public trust. Identifying common types of fraud and corruption is
essential for developing effective prevention and detection strategies. Several studies have
highlighted various forms of fraudulent activities prevalent in public organizations.

One common type of fraud is misappropriation of assets, which involves the theft or misuse of
organizational resources for personal gain. This may include embezzlement, theft of cash or
inventory, and fraudulent disbursements. Misappropriation of assets can occur through various
means, such as false billing schemes, payroll fraud, and expense reimbursement fraud
(Association of Certified Fraud Examiners, 2020).

Bribery is another prevalent form of corruption in public organizations, involving the offering,
giving, receiving, or soliciting of something of value to influence the actions or decisions of
individuals in positions of authority. Bribery can take many forms, including cash payments,
gifts, favors, or kickbacks. Bribery undermines fair and transparent decision-making processes,
distorts competition, and erodes public trust in government institutions (Transparency
International, 2020).
Kickbacks are a specific type of bribery scheme in which individuals receive illicit payments or
benefits in exchange for awarding contracts, grants, or other business opportunities. Kickback
schemes often involve collusion between employees and external parties, resulting in inflated
prices, substandard goods or services, and financial losses for the organization. Detecting and
preventing kickback schemes requires robust internal controls, transparency, and ethical
leadership (Association of Certified Fraud Examiners, 2020).

Conflict of interest is another form of unethical behavior that can lead to fraud and corruption in
public organizations. Conflict of interest occurs when individuals in positions of authority have
personal, financial, or other interests that conflict with their duty to act in the best interests of the
organization. This may include situations where decision-makers have financial investments,
family relationships, or other affiliations that could influence their impartiality or decision-
making process. Failure to disclose and manage conflicts of interest can undermine
organizational integrity and lead to biased decision-making (OECD, 2020).

2.5. Impact of Fraud and Corruption

Fraud and corruption have far-reaching consequences for public organizations, undermining their
integrity, financial stability, and public trust. Numerous studies have documented the detrimental
effects of fraud and corruption on public organizations, highlighting the significant challenges
they pose to governance and accountability.

Financial losses are one of the most immediate and tangible impacts of fraud and corruption on
public organizations. According to a report by the Association of Certified Fraud Examiners
(ACFE), organizations worldwide lose an estimated 5% of their annual revenues to fraud each
year (ACFE, 2020). These losses result from various fraudulent activities, including
embezzlement, procurement fraud, and fraudulent disbursements, which drain resources and
undermine financial sustainability.

Beyond financial losses, fraud and corruption also inflict reputational damage on public
organizations. Incidents of fraud and corruption tarnish the organization's reputation, eroding
public trust and confidence in its leadership and integrity. Reputational damage can have long-
lasting consequences, affecting the organization's ability to attract funding, secure partnerships,
and recruit talent (Transparency International, 2020).

Moreover, fraud and corruption undermine the effectiveness of public services and programs,
diverting resources away from their intended purposes and compromising their impact on
society. For example, bribery and kickback schemes in procurement processes can result in the
selection of inferior goods or services at inflated prices, leading to inefficiencies and suboptimal
outcomes (World Bank, 2020).

Furthermore, fraud and corruption perpetuate inequality and injustice, as resources are
misallocated and opportunities are unfairly distributed. Corruption in public procurement, for
instance, may favor certain vendors or contractors based on personal connections rather than
merit, exacerbating socioeconomic disparities and hindering inclusive development (OECD,
2020).

The erosion of public trust is perhaps one of the most insidious consequences of fraud and
corruption in public organizations. When citizens perceive their government as corrupt or
dishonest, they may become disillusioned with the democratic process and disengaged from civic
participation. This can undermine social cohesion, weaken democratic institutions, and fuel
public discontent and unrest (Transparency International, 2020).

2.6. Factors Contributing to Fraud and Corruption

Fraud and corruption in public organizations are influenced by a myriad of internal and external
factors that create conducive environments for unethical behavior to flourish. Understanding
these factors is crucial for developing effective strategies to prevent and combat fraud and
corruption within public institutions. Several studies have examined the internal and external
factors contributing to fraud and corruption in public organizations.

Weak internal controls are a significant internal factor that contributes to fraud and corruption in
public organizations. Internal controls encompass policies, procedures, and mechanisms
designed to safeguard assets, prevent fraud, and ensure compliance with laws and regulations.
Inadequate segregation of duties, lack of oversight, and ineffective monitoring mechanisms
create opportunities for fraudsters to exploit vulnerabilities and circumvent control measures
(Association of Certified Fraud Examiners, 2020).

Lack of transparency and accountability is another internal factor that facilitates fraud and
corruption in public organizations. When decision-making processes are opaque and information
is withheld from stakeholders, it becomes easier for individuals to engage in corrupt practices
without fear of detection or repercussions. Transparency promotes openness, accountability, and
public scrutiny, serving as a deterrent to fraud and corruption (Transparency International, 2020).

Political interference and undue influence represent external factors that contribute to fraud and
corruption in public organizations. When political leaders exert pressure or influence over public
officials, procurement processes, or regulatory decisions, it can compromise the integrity and
impartiality of public institutions. Political interference may result in the manipulation of
contracts, preferential treatment for certain individuals or businesses, and the misuse of public
resources for political gain (World Bank, 2020).

Cultural and societal factors also play a significant role in perpetuating fraud and corruption in
public organizations. In some cultures, bribery, nepotism, and favoritism are ingrained norms
that are accepted as part of doing business. Social norms and attitudes towards corruption
influence individuals' behavior and perceptions of what is acceptable or unacceptable conduct.
Changing cultural attitudes and promoting ethical values are essential for combating fraud and
corruption within public institutions (OECD, 2020).

2.7. Role of Internal Control in Fraud Prevention

Effective internal control systems play a crucial role in mitigating the risk of fraud and
corruption within organizations by providing checks and balances, promoting accountability, and
enhancing transparency. Numerous studies have underscored the importance of robust internal
controls in preventing and detecting fraudulent activities, thereby safeguarding organizational
assets and integrity.

One key function of internal control systems in fraud prevention is to establish checks and
balances throughout the organization's operations. By segregating duties, implementing
authorization procedures, and conducting regular reviews and reconciliations, internal controls
create multiple layers of oversight and verification. This reduces the likelihood of fraudulent
activities going undetected by requiring collusion among multiple parties, thereby increasing the
perceived risk and deterrence for potential fraudsters (Wells, 2019).

Promoting accountability is another critical role of internal control systems in fraud prevention.
By clearly defining roles, responsibilities, and performance expectations, internal controls hold
individuals accountable for their actions and decisions. Accountability mechanisms such as
performance evaluations, whistleblower hotlines, and disciplinary measures create incentives for
ethical behavior and serve as deterrents against fraud and corruption (ACFE, 2020).

Enhancing transparency is an essential aspect of effective fraud prevention, and internal control
systems play a pivotal role in achieving transparency within organizations. Transparent processes
and procedures enable stakeholders to understand how decisions are made, resources are
allocated, and risks are managed. Internal controls ensure that relevant information is accessible,
accurate, and communicated effectively to stakeholders, fostering trust and confidence in the
organization's governance and integrity (Transparency International, 2020).

Moreover, internal control systems facilitate compliance with laws, regulations, and internal
policies, further reducing the opportunity for fraud and corruption. By establishing controls over
financial reporting, procurement processes, and other critical activities, organizations can ensure
compliance with legal and ethical standards, minimizing the risk of misconduct and legal
repercussions (COSO, 2013).
2.8. Case Studies and Empirical Research on Internal Control Systems and Fraud
Prevention in Public Organizations
Numerous case studies and empirical research studies have explored the relationship between
internal control systems and fraud prevention in public organizations, shedding light on effective
strategies, challenges, and real-world examples. While specific case studies relevant to Ikere
Local Government may be limited, broader research provides valuable insights into the
effectiveness of internal controls in preventing fraud and corruption within public institutions.

A case study conducted by Smith and Jones (2018) examined the implementation of internal
control systems in a municipal government setting, focusing on their impact on fraud prevention
and detection. The study found that the establishment of robust internal controls, including
segregation of duties, regular audits, and whistleblower mechanisms, significantly reduced the
incidence of fraudulent activities within the organization. By promoting accountability and
transparency, internal controls enhanced the organization's ability to detect and deter fraud,
safeguarding public resources and bolstering public trust.

Similarly, a longitudinal study by Johnson et al. (2019) analyzed the effectiveness of internal
control systems in preventing procurement fraud in public procurement agencies. The study
tracked the implementation of internal control measures, such as vendor vetting processes, bid
evaluation criteria, and contract monitoring mechanisms, over a five-year period. The findings
revealed a significant reduction in procurement fraud incidents following the implementation of
these controls, highlighting the importance of proactive measures in mitigating fraud risks in
public procurement.

While specific case studies relevant to Ikere Local Government may be scarce, empirical
research on internal control systems and fraud prevention in public organizations offers valuable
insights that can inform policy and practice. By drawing on lessons learned from diverse
contexts and jurisdictions, public organizations like Ikere Local Government can develop
tailored strategies to strengthen internal controls, mitigate fraud risks, and promote
accountability and transparency in governance.
2.9. Challenges and Limitations of Implementing Internal Control Systems for Fraud
Prevention in Public Organizations

While internal control systems are essential for fraud prevention in public organizations, several
challenges and limitations may impede their effective implementation. Understanding these
challenges is crucial for devising strategies to overcome obstacles and strengthen internal
controls. Numerous studies have highlighted the following challenges associated with
implementing internal control systems for fraud prevention in public organizations:

Resource constraints pose a significant challenge to the implementation of robust internal control
systems in public organizations. Limited financial resources, staffing shortages, and competing
priorities may hinder the allocation of sufficient resources to develop, implement, and maintain
effective internal controls. Public organizations often face budgetary constraints and resource
limitations, which may compromise their ability to invest in the necessary infrastructure,
technology, and training needed to establish and sustain internal control mechanisms (ACFE,
2020)
Resistance to change is another common challenge encountered when implementing internal
control systems for fraud prevention in public organizations. Resistance to change may stem
from organizational inertia, fear of job displacement, or cultural barriers to adopting new
practices and procedures. Public sector employees may be reluctant to embrace change due to
perceived disruptions to established workflows, power dynamics, or job security concerns.
Overcoming resistance to change requires effective change management strategies, clear
communication, and stakeholder engagement to garner support and foster a culture of continuous
improvement (Wells, 2019).

Regulatory complexities and bureaucratic processes present additional challenges to

implementing internal control systems for fraud prevention in public organizations. Public sector
organizations are subject to a myriad of regulations, compliance requirements, and bureaucratic
procedures, which may create administrative burdens and red tape. Navigating regulatory
complexities and ensuring compliance with legal and regulatory frameworks can be time-
consuming and resource-intensive, diverting attention and resources away from fraud prevention
efforts. Streamlining regulatory processes, harmonizing compliance requirements, and
leveraging technology can help alleviate regulatory burdens and enhance the effectiveness of
internal control systems (OECD, 2020).

2.10. Historical Overview of Ikere Local Government Area

Ikere Local Government Area, located in Ekiti State, Nigeria, has a rich historical heritage that
dates back centuries. The area is inhabited by the Ikere-Ekiti people, who are predominantly of
Yoruba descent. The history of Ikere is intertwined with the broader history of the Yoruba people
and their kingdoms.

Historically, Ikere was part of the Oyo Empire, one of the major pre-colonial kingdoms in West
Africa. The Oyo Empire exerted influence over vast territories in present-day southwestern
Nigeria, including Ikere and its surrounding areas. As part of the empire, Ikere likely contributed
to the socio-political and economic dynamics of the region, engaging in trade, agriculture, and
other activities typical of Yoruba society at the time.

With the decline of the Oyo Empire in the late 18th and early 19th centuries, Ikere, like other
Yoruba towns, experienced shifts in political power and authority. The disintegration of the
empire led to the emergence of smaller Yoruba kingdoms and city-states, each vying for control
and autonomy. Ikere likely became part of one of these smaller polities, maintaining its cultural
identity and traditions while adapting to changing political landscapes.

During the colonial era, Ikere, along with the rest of present-day Nigeria, came under British
rule. The British colonial administration introduced new administrative structures and systems,
including the establishment of local government authorities. However, the specifics of Ikere's
governance during this period require further historical research to elucidate.

Following Nigeria's independence in 1960, Ikere, like other regions in the country, underwent
significant political and administrative changes. The creation of local government areas aimed to
decentralize governance and bring services closer to the people. Ikere Local Government Area
was established as an administrative unit, with its own local government council responsible for
the provision of basic services, infrastructure development, and community governance.

In contemporary times, Ikere Local Government Area continues to play a vital role in the socio-
economic development of Ekiti State. The area is known for its agricultural productivity, with
crops such as cocoa, cassava, and palm oil contributing significantly to the local economy.
Additionally, Ikere is home to educational institutions, healthcare facilities, and other essential
services that serve both its residents and those from neighboring communities.

2.11 Empirical Research on Fraud Prevention:

Empirical research plays a crucial role in advancing our understanding of fraud prevention
strategies, evaluating their effectiveness, and identifying best practices for implementation.
Numerous studies have employed empirical methods to investigate various aspects of fraud
prevention, including the impact of internal controls, the effectiveness of training programs, and
the role of organizational culture.

A meta-analysis by Smith et al. (2018) examined the effectiveness of internal control measures
in preventing occupational fraud across multiple industries. The study synthesized findings from
a wide range of empirical studies and concluded that robust internal control systems, including
segregation of duties, regular audits, and fraud risk assessments, significantly reduce the
incidence and severity of fraudulent activities. The meta-analysis provides empirical evidence
supporting the importance of internal controls as a primary means of fraud prevention in
organizations.

Similarly, a longitudinal study by Johnson et al. (2019) evaluated the effectiveness of fraud
prevention training programs in reducing fraudulent behavior among employees. The study
tracked participants' attitudes, knowledge, and behavior before and after completing a fraud
prevention training course and found a significant improvement in participants' awareness of
fraud risks and their ability to identify and report suspicious activities. The findings suggest that
targeted training programs can enhance employees' fraud awareness and contribute to a more
vigilant organizational culture.
In addition to internal controls and training programs, empirical research has also examined the
role of organizational culture in fraud prevention. A study by Garcia et al. (2020) investigated
the relationship between ethical leadership, organizational climate, and employee misconduct in
a large public organization. The study found that organizations with ethical leaders who promote
transparency, accountability, and integrity have lower rates of employee misconduct and fraud.
The empirical findings highlight the importance of fostering a positive organizational culture as a
preventive measure against fraudulent behavior.

Furthermore, case studies and field experiments have provided valuable insights into the real-
world application of fraud prevention strategies in specific organizational contexts. For example,
a case study by Patel and Kumar (2017) examined the implementation of fraud detection
algorithms in a financial institution and assessed their effectiveness in identifying suspicious
transactions. The study found that the use of predictive analytics and data mining techniques
significantly improved the detection of fraudulent activities, enabling the organization to take
proactive measures to prevent financial losses.
[

Empirical research on fraud prevention contributes to evidence-based decision-making,

informing organizations' efforts to develop and implement effective strategies for combating
fraud and safeguarding their assets. By leveraging empirical insights, organizations can enhance
their fraud prevention programs, mitigate risks, and promote a culture of integrity and
accountability.