CHAPTER ONE

INTRODUCTION

1.1 Background of the study

Any entity of whichever form or size should put in place its own system of controls in order to achieve its objectives (Mwindi, 2008). A system of effective internal controls is a critical component of company management and a foundation for the safe and sound operation of organizations. However, ineffective internal controls result in ineffective programs and eventually leading to losses (Olumbe, 2012). While writing a report on Capital Markets Regulators Reign in on Rogue Firms for the Standard Media in May 2013, James Anyanzwa stated that the recent incidence of corporate failures and accounting frauds are mostly preceded by failure in companies internal control structures. This research paper is intended to look into the correlation between internal controls and revenue collection in Kenya Revenue Authority (KRA).

KRA was established in 1995 as an Act of Parliament. Initially it was set up as the department of taxes and customs and excise and it was under the control of the Ministry of Finance. KRA was formed mainly to facilitate in widening the tax base by streamlining tax expenditure, minimize revenue leakages and enhance trade by expediting smooth and quick clearance of goods. Cognizance of the fact that viability will be enhanced with efficient internal controls and established accounting systems KRA embark on huge capital outlay in procuring and establishing accounting software like the Simba system, ITMS, ORACLE and implemented the relevant internal controls to ensure continued viability. Although the organization has committed itself to the large capital expenditure on soft ware packages and internal controls there are still widespread claims and perception that there are a lot of leakages through unscrupulous activities within the organization. This raises the fundamental question of whether the whole effort on the investment was in vain. The study therefore will seek to explore the effectiveness of the internal controls in KRA’s revenue collection given the claims and perceptions to the contrary. The paper will try to verify whether the huge capital outlay on accounting software and the internal control systems put in place by KRA has any impact in the revenue collection.

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Due to the important role that effective internal control systems play in the achievement of corporate objectives, the Commissioner continued to say that plans were under way to upgrade the Internal Control (Audit) unit to help achieve the objectives of the Authority.

From the above, it is therefore imperative to say that, internal controls play a significant role in helping managers to achieve their goals hence the need for this study to investigate the effects of internal controls on revenue collection at Kenya Revenue Authority.

1.1.1 Internal Control System

According to Hamed (2009), Internal Control System refers to an organized amalgamation of functions and procedures, within a complete system of controls established by the management and whose purpose is the successful function of the business. Internal Control System is all the methods and procedures followed by the management in order to ensure, to a great extent, as much successful cooperation as possible with the director of the company, the insurance of the capital, the prevention and the detection of fraud, as well as the early preparation of all the useful financial information (Keitany, 2000). Hongming and Yanan (2012), adds that Internal Control System resembles the human nervous system which is spread throughout the business carrying orders and reactions to and from the management. It is directly linked to the organizational structure and the general rules of the business.

Whittington (2001) has defined that a system of internal control extends beyond those matters which relate directly to the functions of accounting and the financial statements. In addition, he notes that internal control is a systematic procedure which will lead to evaluate the degree of correlation between those established criteria and the real results of the business.

Internal Control, as defined from the APC (Auditing Practices Committee, 1980), is an independent examination and certification from an inspector appointed by the business to control the finances according to the legal framework established each time.

From the forgoing therefore, the objective purpose of Internal Control is on the one hand, the allowance of specific and high level of services offered towards the management, and on the other hand, the allowance of assistance towards the members of the organization for the most effective practicing of their duties. Internal Control Systems are being implemented in businesses as tools that add up value to the company. In this way, we can achieve a systematic approach

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towards the most effective operation of the organization, as a unity (Schleifer and Greenwalt, 1996). Finally, as mentioned by the COSO report internal control is defined as a procedure which offers fundamental security to the business concerning the credibility of financial affairs. The report defines internal control and describes a framework for internal control. But the difference of this report is that it also provides criteria for the management to utilize so as to evaluate controls.

1.1.2 Revenue Collection

Awitta (2010) stated that revenue collection is the amount of money that a company receives during a specific period. It is the "top line" or "gross income" figure from which costs are subtracted to determine net income. Revenue collection can be defined as income that a company receives from its normal business activities, usually from the sale of goods and services to customers. Revenue is referred to as turnover. Some companies receive revenue from interest, dividends or royalties paid to them by other companies. Revenue may refer to business income in general, or it may refer to the amount, in a monetary unit, received during a period of time.

The Financial Accounting Standard Board(FASB) Concept Statement 6, Elements of Financial Statements (December 1985) have defines revenue as inflows or other enhancements of assets of an entity or settlements of its liabilities (or combination of both) during a period from delivery or producing goods, rendering service or other activities that constitutes the entity’s ongoing major or central operations. In addition, Hongreen (2002) described revenue as inflows of asset (almost always cash or accounts receivables) received for products or services provided to customers. However, KRA have referred revenue to means taxes, duties, fees, levies, charges, penalties, fines or other monies collected or imposed under the written laws set out in the First Schedule.

1.1.3 Kenya Revenue Authority

Kenya revenue Authority was established by an act of parliament in 1995 as a semi-autonomous government agency responsible for revenue collection. The overall objective was to provide operational autonomy in revenue collection and enable its evolution into a modern, flexible and integrated revenue collection agency i.e. KRA was established for assessment, collection, collection and enforcement of laws relating to revenue. The Act made KRA ―a central body for the assessment and collection of revenue, for the collection and enforcement of laws relating to

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revenue and to provide for connected purposes. The Authority is under the general supervision of the Minister of Finance as an agent for the collection and receipt of revenue. KRA currently collects around 95% of government revenue. (Odundo 2007).

Since the inception of KRA, revenue collection has continued to grow while professionalism in revenue collection has been enhanced. However, a number of processes remain manual and KRA is yet to operate as a fully integrated organization. (Yusuf 2007).

To achieve the above targets, the management of KRA must adopt measures to ensure that available resources are prudently used to obtain valve for money from resources allocated to them. Management in turn should generate operational data with which they evaluate the efficiency and effectiveness of their operation. It is fundament aspect of management stewardship responsibility to provide interested parties with reasonable assurance that their organisation is effectively controlled and that the information they receive are accurate and dependable. Developing a strong system of internal control systems provides this assurance.

1.2 Research Problem

Slanislav (2006) highlighted that the heightened interest in internal controls is, in part, as a result of significant losses incurred by several organizations. He explained that, an analysis of the problems related to losses indicated that they could probably have been avoided had the organizations maintained effective internal control systems. Such systems would have prevented or enabled earlier detection of problems that led to losses in the banking industry, thereby limiting damage to the organization. This same idea is reflected in Kaplan (2007), that, poor standards of corporate governance had led to insufficient controls being in place to prevent wrong doing in the United States in the 1990s, as demonstrated by the collapse of Enron and WorldCom.

The incidence of internal control weaknesses, unsatisfactory and deteriorating service delivery have the undesired effect of not only weakening the company’s ability to e