INTERNAL CONTROL IN SWEDISH SMALL AND MEDIUM SIZE ENTERPRISES

INTERNAL CONTROL IN SWEDISH SMALL AND MEDIUM SIZE ENTERPRISES

 

ABSTRACT

Small and medium size enterprises are currently the major part of economic activities through out the world. Nowadays, they represent about 99% of all types of enterprises in Sweden, with providing high job opportunities to its labour force as these enterprises need focus in their development; the internal control mechanism is a means and a way of directing, monitoring and measuring the SMEs resources. It plays an important role in preventing and detecting fraud and protecting the physical and intangible resources as well as leading to high efficiency of the business operation. Therefore, focusing on this business area is a timely issue and a rewarding one since it contributes a lot for the majority of business enterprise involved in SMEs. This study examines and describes the effectiveness of internal control systems in Swedish small and medium size enterprises. The study focuses on the main five components of internal control and their impact on achieving the company’s objectives. In so doing, the study creates a better understanding of effective internal control that may be applicable to the context of SMEs and establish theoretically the features of an effective internal control for sampled SMEs. To achieve this objective we formulate one research question: To what extent does the internal control system of SMEs comply with the principles of effective internal control? This is intended to look into how closely SMEs follow the virtues of effective internal control in their business operation. Applying an inductive approach in qualitative interview, the study found out that, contrary to what is generally suggested, SMEs are aware of the importance of having a good internal control system. The findings of the research enabled the emergence of a theory grounded in the collected data. Indeed, the major features of an effective internal control system applicable for SMEs are found to be sound control environment, sound risk assessment process, sound operational control activities, effective information and communication system, effective monitoring and evaluation system. Therefore, the major findings of the research fit into the theoretical framework.

Key words: SMEs, internal control, control environment, risk management, control activities, information and communication, monitoring and evaluation

ACKNOWLEDGEMENTS

We are grateful to our supervisor, Professor Kifle Hamde, whose close follow-up and constructive comments enriched this study. His availability and encouragement meant a lot to us throughout this thesis. We also would like to appreciate all those who were willing to give us their time and rich perspective in a genuine interview on a delicate issue such as internal control. We would like thank Professor Hans Nilsson and everyone involved in providing network for selecting our sample enterprises. Moreover, we would like to extend our deepest gratitude to Margareta Paulsson for her understanding and guidance in revising this study. Finally, we would like to thank our family and friends specially Eleni Misganaw for their encouragement and support throughout this study.

 

TABLE OF CONTENTS

Page

Abstract—————————————————————————- ii

Acknowledgements————————————————————— iii

Table of Contents————————————————————— iv

List of Tables & Figures——————————————————– vii

CHAPTER 1. GENERAL INTRODUCTION

• Background information————————————————– 1
• Research objective——————————————————— 1
• Research question———————————————————- 2
• Definitions of main concepts——————————————– 2
• Internal control—————————————————- 2
• Internal auditor—————————————————- 2
• SMEs—————————————————————- 3
• Enterprise———————————————————– 3
• Significance of the study————————————————– 3
• Why SMEs? Why Sweden?————————————- 3
• Why the study is important————————————- 3
• Delimitation of the study————————————————- 4
• Organization of the study————————————————- 4

CHAPTER 2. RESEARCH METHODOLOGY

• Introduction—————————————————————– 6
• Research Philosophy—————————————————— 6
• Positivism———————————————————- 6
• Interpretivism—————————————————— 6
• Realism————————————————————– 7
• Philosophy of this research————————————– 8
• Research strategy———————————————————– 8
• Research types————————————————————– 8

CHAPTER 3. THEORETICAL FRAMEWORK

• Introduction—————————————————————– 10
• Definition——————————————————————- 10
• Defining internal control—————————————- 10
• Defining small and medium size enterprises—————- 12
• Effective internal—————————————— control in SMEs— 14
• What we mean by Effective Internal Control————— 14
• The choice of COSO framework—————————— 15
• Objectives of effective internal control system————– 16
• Components of Effective Internal Control—————— 17

3.3.5  Principles of Effective Internal Control———————- 21

• Roles and Responsibilities in Internal control——————————————– 24
• Internal Control in the Swedish Code of Corporate Governance———————————— 25
• Studies on SMEs     26
• Studies on internal control in SMEs————————– 26
• Finance-related studies——————————————- 28
• Internationalization of SMEs———————————– 29

CHAPTER 4. RESEARCH DESIGN

• Introduction   32
• Research Assumption—————————————————————————————- 32
• Research Approach  32
• Ethical Considerations—————————————————————————————- 33
• Empirical Observation—————————————————————————————- 33
• Methods of data collection————————————– 33
• Methods of Data Analysis————————————– 35
• Research Criteria      40
• Introduction   40
• Reliability———————————————————- 40
• Validity 41

CHAPTER 5. EMPIRICAL FINDINGS AND DATA ANALYSIS

General highlights on the empirical study————————

Major findings———————————————————-

• Awareness on internal control
• Use of computer system
• Levels of authority and responsibilities———————————————————-
• Risk mitigation
• HR Policies and codes of conduct—————————————————————————-
• Communication
• Evaluations

Analysis——————————————————————

• Awareness of SMEs on internal control——————————————————————-
• Control environment
• Control activities
• Risk management
• Information and Communication—————————————————————————-
• Monitoring and Evaluations

CHAPTER 6. CONCLUSION

Introduction————————————————————-

Summary of main findings——————————————

Limitations of the study———————————————-

Possible future research directions———————————

 

LIST OF TABLES

Page

Table 1  Theory, Research Design and Methods—————— 7

Table 2  SME thresholds————————————————- 13

Table 3  Imbalances between risks and controls———————- 19

Table 4  Principles of Effective Internal Control—————- 23-24

Table 5  Internet Search results………………………………………….. 27

Table 6  Influencing factors of competitiveness in SMEs………..   29

Table 7  Four Stages of Analysis in the Adapted Grounded Theory   37

Table 8  Examples of codes and concepts from the data  in case of small

enterprises——————————————————- 38

Table 9  Characteristics of Sample SMEs —————————-  42

LIST OF FIGURES

Figure 1 Diagrammatical emergence of the category “Information

Technology as a mechanism for effective internal control”   35

Figure 2 Control Environment—————————————— 44

Figure 3 Control Activities———————————————– 45

Figure 4 Risk Management———————————————- 45

Figure 5 Information and Communication————————— 46

 

1. GENERAL INTRODUCTION

This introductory chapter provides a general background to the research. It also presents the general objectives of the study and the research questions are also formulated under this chapter with the view to make the research focused on specific relevant issues. In what follows, definitions are given for major concepts frequently used in the study. The significance and delimitation of the research is also discussed and finally, a highlight on the organization of the research paper is provided.

• Background information

Small enterprises and medium-sized enterprises are defined by their size, turnover or balance sheet total. In the European Union, small enterprises have between 10 and 49 employees and an annual turnover not exceeding EUR 7 million or an annual balance-sheet total not exceeding EUR 5 million. Medium-sized enterprises have fewer than 250 employees. Their annual turnover does not exceed EUR 40 million or their annual balance- sheet total should be less than EUR 27 million. In the case of Sweden, all enterprises with fewer than 250 employees are categorized as medium size enterprises and those with fewer than 50 employees are categorized as small (European Commission, 2003, p. 1).

SMEs constitute currently the major part of economic activities in the Sweden. Nowadays, they represent about 99% of all types of enterprises in Sweden and provide high job opportunities to its labour force (Nutek, 2004, p. 15). This business structure is not different from the EU business structure.

Internal control is a means by which resources of these SMEs are directed, monitored, and measured. It plays an important role in preventing and detecting fraud and protecting the physical and intangible resources; moreover it leads to high efficiency of the business operation. Therefore unless they have strong internal control system to monitor and run their businesses, the prospect of bankruptcy threatens each and every Swedish SME (Sampson, 1999, p. 4).

The focus of this research is to examine the effectiveness of internal control systems in small and medium size enterprises in Sweden. Therefore, focusing on this business area is a timely issue and a rewarding one since it contributes a lot for the majority of business enterprises involved in SMEs.

• Research objective

The general objective of this research is to examine the effectiveness of internal control systems in small and medium size enterprises in Sweden. In so doing, the research create a better understanding of effective internal control that may be applicable to the context of SMEs and establish empirically the features of effective internal control for SMEs in Sweden .

• Research question

Since our research objective is set to study the effectiveness of internal control in Swedish SMEs, the main problem that this research paper intends to address can be formulated in the form of the following research question: To what extent does the internal control system of SMEs comply with the principles of effective internal control?

This question is believed to be central to the research as it guides all the way forward to the conclusion. Indeed, for a system of internal control to be effective, it needs to abide by certain standards of effective internal control. The research question intends to look into how closely SMEs follow the virtues of effective internal control in their business operations.

• Definitions of main concepts

In what follows, a general definition of some main terms is given in order to restrict their respective meaning to the sense they are employed in this research on SMEs so that the research question is addressed adequately. A detailed discussion of these concepts is to be found in the review of literature in Chapter Three.

• Internal control

Internal control means a system and a process established and operated within a small and medium sized enterprise for it to carry out its operation in a proper and efficient manner. Major examples of its objectives are ensuring compliance (abiding by laws and regulations), ensuring trust in financial reporting and increasing operational efficiency (COSO, 1992, p.2).

• Internal auditor

By contrast to the external auditor, the internal auditor is an employee of the SME with the major task of advising management on whether its major operations have sound systems of risk management and internal controls (Putra, 2008, p. 1).

Internal audit’s role in evaluating internal controls is wide ranging because ‘everyone from the mailroom to the boardroom is involved in internal control’ (Institute of Internal Audit, 2008). The internal auditor’s work includes assessing the tone and risk management culture of the organization at one level through to evaluating and reporting on the effectiveness of the implementation of management policies at other SMEs (Institute of Internal Audit, 2005, p. 1).

• SMEs

Small and medium sized enterprises are commercial business entities that are generally distinguished from large companies by their size and turn-over. Medium-sized enterprises have fewer than 250 employees and annual turnover not exceeding EUR 40 million. Small enterprises have fewer than 50 employees and an annual turnover not exceeding EUR 7 million (European Commission, 2003, p. 1).

• Enterprise

Enterprise refers to a unit of economic organization or activity, especially a business organization (Merriam-Webster, 1977, p. 380)

• Significance of the study
  • Why SMEs? Why Sweden?

One of the major driving factors in the choice of SMEs for this study is that the effectiveness of internal control tends to be more problematic for such type of businesses (Wai, 2008, p.1). Large enterprises and corporate companies have legal requirements to maintain an effective internal control and the nature and wider scale of their business operation generally drive them to acknowledge the need for an effective internal control. However, as literature on the issue points out, this tends not to be the case for SMEs. Therefore, the study chooses SMEs as major problem areas in this regard.

The choice to deal with Swedish SMEs is justified primarily by their relative physical accessibility to the researchers, given the fact that the study intends to collect primary data on which to base its analysis. In addition, as noted in the background information, Swedish national economy benefits a lot from business activities of SMEs which represent about 99% of all types of enterprises in Sweden and provide high job opportunities to its labour force. Therefore, the research question of this paper is of direct relevance to the context of Swedish business structure.

• Why the study is important

Although the importance of an internal control system is widely acknowledged among large companies, an efficient system of internal control is typically said to be absent or not strong enough in most of SMEs in general (Wai, 2008, p.1).

This study highlights the importance of having a sound standardized internal control system in SMEs and its major roles. The research emphasizes on the fact that lack of proper understanding of the value of effective internal control in SMEs usually leads to inefficient system of internal control in SMEs. Therefore, by underlining to what extent a good system of internal control is vital for sound operations of SMEs and by examining application of effective internal control principles, this study is believed to contribute to the effort of implementing effective internal control systems in Swedish SMEs.

• Delimitation of the study

This study primarily focuses on internal control practices of Swedish SMEs. Thus, its conclusions are not necessarily relevant for all countries of the European Union.

In addition, the research does not include the study of micro enterprises. The European Commission defines micro enterprises as employing fewer that 10 employees and an annual turn over not exceeding 2 million (European Commission, 2003, p. 1). The study is interested in small enterprises and medium enterprises only because these two types of business enterprises are the ones that play greater role in terms of their business activities.

Moreover, although small and medium enterprises have a number of interesting features to be studied, this research focuses on only one aspect: their system of internal control.

• Organization of the study

The research is organized in such a way that the first chapter deals with the general introduction which presents a general background to the study, together with the research’s objectives and questions. It also defines major terms, presents the significance of the study, and delimits the boundaries of the research as well.

The second chapter deals with methodological issues whereby the philosophy, the strategy and the type of the research are presented.

The theoretical background to the study is rooted in the discussion of the third chapter with respect to issues such as a detailed definition, importance, components and principles of effective internal control, as well as a note on the roles and responsibilities involved in internal control.

The research design is discussed in the fourth chapter of the research paper including a discussion of the underlying research assumption and the approaches of the research. A description of the study’s units of analysis and sample characteristics is given together with a note on ethical considerations that are taken into account in the research process. The methods of data collection and the way these data are analyzed are discussed in the chapter, and the final section deals with the research criteria of reliability and validity.

Under chapter five, the major empirical findings are discussed and analyses of the findings are provided. The final part concludes the research paper and forwards some suggestions for further research on the subject.

Thus, in this general introductory chapter, efforts were so far made to provide an overall view of internal control of SMEs in Sweden. As it is noted, providing a definition for SMEs comes to categorizing these enterprises in terms of size, turnover or balance sheet total. SMEs are shown to play a dynamic role in the Swedish economic activities in terms

 

of their number and the employment opportunity they create. In addition, the issue of internal control in SMEs is briefly shown to be vital for the survival of SMEs to remain in the business. This chapter also put precisely what the general objectives of the study are and it forwarded research questions that guide the various activities through out this research. The reason why this research is worth doing is also presented in relation to the fact that due understanding of the importance and the role of internal control in SMEs is vital for the smooth operations of these enterprises. As pointed out in this chapter, the focus of the research is clearly delimited from other tangent issues.

Having set this general introduction

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