Effectiveness of Internal Control Measures on the Detection and

Prevention of Misstatements caused by Error or Fraud in

Selected Small Clothing Businesses in Cavite
 Chapter I

Problem and Its Background

Introduction

Effective internal control system conquers a significant part on every

organization towards achieving its objective. Internal controls pertain to the

procedures outlined by the organization that can be lead to a reasonable

assurance towards efficient and effective operations, reliable financial information

and compliance with rules and regulations. It could really serve as an aid on

mitigating risk and safeguarding of assets. Different entity can implement diverse

internal controls depending on the nature and size of the organization.

There are two primary types of control activities: preventive controls and

detective controls. Preventive controls are activities planned to identify and

address problem before its occurrence. Proper implementation of this control

could prevent losses and other negative outcomes. Some of the common

preventive controls of an organization are separation of duties, proper

authorization, adequate documentation and physical control over assets.

On the other hand, detective controls are designed to find errors or fraud

in transactions after its occurrence. It plays a critical role on assessing that

preventive controls are functioning properly. The organization usually takes into

consideration the physical inventory checks, reviews of different reports and

reconciliation and assessment of current controls.

There are lots of factors that could affect the effectiveness of internal

control including the environment, management risk assessment, accounting and

information system, control activities and monitoring. All controls require

adequate trainings, communication and oversight to ensure appropriate and

consistent implementation. The management should consider conceptualization

and alignment of internal control with the overall objective of the entity.

Nowadays, many companies and organizations strictly implement internal

control activities to prevent loss and obtain an efficient day-to-day operation.

They should cope up with the increasing digitalization and relates internal control

system towards these changes. They should be up to date with their internal

control processes since internal and external regulations are growing rapidly.

Some companies spend lots of resources to obtain efficient and effective internal

control system.

However, small businesses may face difficulties in creating effective

internal control due of different factors. It may include lack of resources and cost-

benefit consideration. There has been also an alarming rate of occurrence of

error and fraud in small businesses and some relate this to the ineffectiveness of

internal control system.

This study entitled, “Effectiveness of Internal Control Measures on the

Detection and Prevention of Misstatements caused by Error or Fraud in Selected

Small Clothing Businesses in Cavite” awakened the curiosity of student

researchers enable to assess whether internal control system really helps in the

detection and prevention of fraud on certain entity. It also aims to identify the

internal control measures being implemented and the usual fraud and error

arises on small clothing businesses in Cavite.

Statement of the Problem

This study aims to determine the level of effectiveness of internal control

measures on the detection and prevention of misstatements caused by error or

fraud in selected small clothing business in Cavite.

Specifically, it is sought to answer the following questions:

1. What are the internal controls measures implemented by small clothing

businesses in Cavite?

2. What are the usual error and fraud detected in the small clothing

businesses in Cavite?

3. What is the level of effectiveness level of internal control measures on the

detection and prevention of misstatements caused by error or fraud in

selected small clothing business in Cavite?

4. Based on the findings what recommendation may be proposed?

Conceptual Framework

Internal
Small control
business measures

Use:
Detection and
Prevention of
Misstatement
s

Figure 1. Conceptual Framework

 Figure 1 presents the paradigm of the study. It presents the small

businesses have their own set of internal control measures that is used in

detecting and preventing misstatements caused by error or fraud.

This study’s conceptual framework is based on the ideas suggested by

Iwejor (2017) and Bongani (2013).

Shielding the company from robbery, fraudulent acts, and

misappropriation of assets are some difficulties that retail company managers

are facing. 5% of the retail companies’ annual revenue lose up to 5% to frauds.

Nevertheless, in most cases, minimizing the problem could be done through

management’s understanding, design, and implementation of effective internal

control systems. (Iwejor, 2017)

To minimize losses, a strong internal control involves a control system that

organizations can implement to identify misstatements rapidly. It serves as a

tool that management use in order to achieve control and operational goals that

involves profitability and survivability (Bongani, 2014).

In this study, the effectiveness of internal control measures in detection

and prevention of misstatements caused by error or fraud in selected small

clothing businesses in Cavite will be examined.

Significance of the Study

The current study aims to study the impact of internal control measures

on the detection and prevention of fraud in selected small clothing businesses in

Cavite. In particular, it would prove to be beneficial to the following:

Business Owners

This study could cater information to the business owners on possible

reasons for usual error and fraud and information on minimizing the

misstatements through internal control.

Business Management

This study will enable the management of the business to identify

weaknesses in their internal controls and help them devise new effective internal

controls.

Future Business Owners

This study could provide ideas to future business owners about internal

controls that could possibly help them in minimizing misstatements that result

from fraud and error.

Future Researchers

This study could add to the growing body of information in the field of

business and auditing. The result of the study would serve as a guide of other

researchers who would like to embark on a study of similar nature

Scope and Delimitation

This study focuses in determining the effectiveness of internal control

measures on detecting and preventing misstatements caused by fraud or error to

help improve the presentation of financial statements of small clothing

businesses in Cavite. This research aims to identify and manage which controls

are significant and appropriate for the business to lessen costs and reduce risk of

fraud. This study limits its coverage to the small clothing businesses in Cavite,

wherein the term ‘small clothing businesses’ means any business activity or

enterprise engaged in trading, whether single proprietorship, cooperative,

partnership or corporation whose total assets, inclusive of those arising from

loans but exclusive of the land on which the particular business entity’s office,

plant and equipment are situated, are ranging from more than P3,000,000 to

P15,000,000. The said businesses would be the ones who will benefit the most in

the future improvement of appropriate controls. A total of 60 small businesses

were randomly chosen out of 71 small clothing businesses in Cavite. This study

covers efficacy of preventive and detective controls used for misstatements from

fraud and error.

Definition of Terms

For the clarity of the research study, the following important terminologies

are defined conceptually and operationally.

Detective Control. It refers to a type of internal control considered in

finding problems within an entity's processes and procedures once they have

occurred.

Error. It refers to non-fraudulent, unintentional discrepancy in an

accounting entry or any financial documentation.

Fraud. It is an intentionally deceptive, dishonest and illegal perpetrated by

individuals or companies in order to provide an advantageous financial outcome

to those persons or establishments that encompasses the loss or

misappropriation of assets, or the falsification of reports

Internal Control. These are the rules, procedures and processes

implemented by a company to ensure the integrity of financial and accounting

information, maintain organization's objectives in operational effectiveness and

efficiency, assure compliance with laws, regulations and policies and prevent

fraud.

Preventive Control. It is a type of internal control that is put in place to

stop or avoid a negative event from occurring.

Small Businesses. It refers to any enterprise or business activity

engaged in the major sectors of the economy whether single proprietorship,

cooperative, partnership or corporation whose total assets, inclusive of those

arising from loans but exclusive of the land on which the particular business

entity’s office, plant and equipment are situated, are ranging from more than

P3,000,000 to P15,000,000.
 CHAPTER III

RESEARCH METHOD AND PROCEDURE

This chapter presents the methods use in this study as well as the

gathering instrument and procedures employed to obtain the specific goals of the

study. It also reveals the sampling methods, research environment and the

statistical treatment of data used.

Method of Research to be used

In this study, the student researchers employed the descriptive design of

quantitative research. It is the most appropriate research design since it aims to

describe the level of effectiveness of internal control measures on the detection

and prevention of misstatements caused by error or fraud in selected small

clothing businesses in Cavite. It also attempts to collect quantifiable information

for statistical analysis. Descriptive statistics are used to summarize and give

order to the measurements made in descriptive research.

Population, Sample Size and Sampling Technique

The student researchers employed probability sampling particularly simple

random sampling techniques. This is used to ensure that each entity have an

equal chance to be selected as participants of this study.

Regarding with this, the respondents of the study includes the owner or

manager of selected small clothing businesses. Slovin’s formula is also utilized

enable to determine the sample size needed. The student researchers also

incorporated 5 percent margin of error to assure the reliability of the study. The

total respondents needed based on the formula are 60 out of 71 small clothing

businesses listed in the website of “findglocal”.

Description of the Participants

Sixty (60) selected small clothing businesses in Cavite will be the

participants in study using purposive sampling. These businesses are capable

of participating in the research study since the purpose of the study is to identify

the effectiveness of business’ internal controls. The 60 small businesses are

specifically located at Indang, Trece Martires, General Trias, Dasmariñas,

Tanza and Alfonso, Cavite.

Research Instrument

The survey questionnaire will be the primary data-gathering instrument in

this study. Survey questionnaire is the most appropriate tool to use since this

study involve greater number of respondents. The questionnaire will be

structured in such way to obtain the expected information from the respondents

and will assure that the survey questionnaires will be validated first before

implemented. Questions will be based on the objectives formulated under the

statement of the problem regarding the internal controls of the small clothing

businesses in Cavite and their effectiveness in terms of detecting and

preventing misstatements caused by error or fraud. After validating the

questionnaire, the researchers will finalize the instrument and make changes

and revisions.

Data Gathering Procedures

The researchers first identified the total population of small clothing

businesses in Cavite and sample size are sought after by using the Slovin’s

formula. After that, the researchers started to create survey questionnaires

aligned on its objectives.

After formulating the survey questionnaires, the researcher makes

validation letter for the person who can help to validate the prepared survey

questionnaires. Its aim is to secure that the survey can sustain the needed

information for the study. The researchers act as the facilitator wherein the

researcher introduced themselves first enable to establish rapport. Furthermore,

respondents are informed about the purpose of the study.

On the other hand, the statistical tools to be used are also determined

based on the survey questionnaire. All the answers in the questionnaires are

tabulated interpreted and analyze to achieve the goals of the study.

Statistical Treatment of Data

The questions under this study were treated by using descriptive and

inferential statistics. The following statistical techniques were used to have more

accurate results.
 1. Percentage Method determined the portion of respondents in terms of

business location and how long their business has been operating which

was based from the total respondents of the study.

2. Ranking method is used to rank the statement, which has the highest

weighted mean.

3. Weighted Mean is a statistical tool that was used to interpret the data

which regards to the level of effectiveness of preventive and detective

controls of the businesses. Specifically, this will use to determine the

weight in terms of mean response on the items provided in the

questionnaire proper.

4. Slovin’s formula was also incorporated enable to achieve the goals of this

research study by identifying the exact number of the respondents.

Slovin’s Formula

n= N

1+Ne²

On the other hand, the following ranges are used to interpret the

data collected.

Ranges Verbal Interpretation

3.26-4.00 Very Effective

2.56-3.25 Somewhat Effective

1.76-2.50 Not Very Effective

1-1.75 Not at All

Effectiveness of Internal Control Measures on the Detection and

Prevention of Misstatements caused by Error or Fraud in

Selected Small Clothing Businesses in Cavite

BUSINESS NAME: _________________________________________

ADDRESS: _______________________________________________

Directions: Put a check on the box if the corresponding internal control exists in

your entity.

Preventive Control Activities

□ Proper segregation of duties

□ Duplicate copies of sales invoice

□ Secured cash register

□ Computer passwords and access controls

□ Signature of authorized personnel for release of certain amount of money

□ Separate books for different nature of transactions

□ Pre-approval of actions and transactions

□ Employee screening and training

□ Only authorized personnel have access to cash register

□ Others, please specify: _________________________

Detective Control Activities

□ Random checks of book records

 □ Unannounced performance review

□ Surprise cash counts

□ Reconciliations

□ Periodic inventory count

□ Periodic supplies count

□ Existence of CCTV

□ Others, please specify: _________________________

Directions: Rate each item as to the extent of occurrence and existence using the

following scale:

5 – Always

4 – Often

3 – Sometimes

2 – Rarely

1 – Never

Existence of Fraud 5 4 3 2 1
1. Presence of theft/missing inventories and

supplies.
2. Detection of missing cash due of theft.
3. Usage of company expense account by

employees for personal expenses.

4. Counterfeit checks drawn against your accounts.
5. Skimming of revenue by the cashier through

non-issuance of receipt.
6. Fraudulent invoicing by the cashier through

issuance of fake invoices.

7. Payroll fraud by employees through

compensating them more than the actual hours

 spent on their work.
8. Falsification of timesheets by employees to

inflate hours.
9. Data, intellectual property and identity theft by

employees due of non-restriction to high-level

documents.
10. Return fraud by customer by taking advantage

of the return, refunds or exchange policy.

Existence of Error 5 4 3 2 1
1. Errors occur in financial statement.
2. Recording current year transactions in a prior

period.
3. Incorrect balances in asset, liability, revenue, or

expense account (posting entries to incorrect

accounts, misclassifying accounts, duplicating

adjusting entries).
4. Misclassifying expenses (posting to other

expense accounts).
5. Physical inventories match recorded inventories.
6. Invoices are recorded in numerical sequence.
7. Saving receipts or other source documents.
8. Schedule routing backups.

9. Seeking help with a professional accountant or

bookkeeper for accounting issues.

10. Performing regular training for accounting staff.
References:

https://scholarworks.waldenu.edu/cgi/viewcontent.cgi?

article=5482&context=dissertations

Bongani, N. (2013). Application of internal controls in NGOs: Evidence

from Zimbabwe. Journal of Finance and Accounting, 1(2), 39-47.

doi:10.12691/jfa-1-2-1