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International Journal of Commerce and ManagementThe impact of internal control requirements on profitability of Saudi shareholdingcompaniesAli A. Al-Thuneibat, Awad S. Al-Rehaily, Yousef A. Basodan,Article information:To cite this document:Ali A. Al-Thuneibat, Awad S. Al-Rehaily, Yousef A. Basodan, (2015) The impact of internal controlrequirements on profitability of Saudi shareholding companies, International Journal of Commerceand Management, Vol. 25 Issue: 2, pp.196-217, doi: 10.1108/IJCOMA-04-2013-0033Permanent link to this document:/10.1108/IJCOMA-04-2013-0033Downloaded on: 19 April 2017, At: 04:25 (PT)References: this document contains references to 59 other documents.To copy this document: permissionsThe fulltext of this document has been downloaded 1152 times since 2015*Users who downloaded this article also downloaded:(2016),Internal control effectiveness a clustering approach, Managerial Auditing Journal, Vol. 31Iss 1 pp. 5-34 /10.1108/MAJ-08-2013-0910(2005),Internal auditing practices and internal control system, Managerial Auditing Journal, Vol. 20Iss 8 pp. 844-866 /10.1108/02686900510619683Access to this document was granted through an Emerald subscription provided by emerald-srm:536947 For AuthorsIf you would like to write for this, or any other Emerald publication, then please use our Emeraldfor Authors service information about how to choose which publication to write for and submissionguidelines are available for all. Please visit /authors for more information.About Emerald Emerald is a global publisher linking research and practice to the benefit of society. The companymanages a portfolio of more than 290 journals and over 2,350 books and book series volumes, aswell as providing an extensive range of online products and additional customer resources andservices.Emerald is both COUNTER 4 and TRANSFER compliant. The organization is a partner of theCommittee on Publication Ethics (COPE) and also works with Portico and the LOCKSS initiative fordigital archive preservation.*Related content and download information correct at time of download.Downloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)The impact of internal controlrequirements on profitability ofSaudi shareholding companiesAli A. Al-Thuneibat, Awad S. Al-Rehaily and Yousef A. BasodanAccounting Department, Faculty Economics and Administration,King Abdulaziz University, Jeddah, Saudi ArabiaAbstractPurpose This paper aims to investigate the compliance of Saudi shareholding companies with therequirements of internal control as set by the Saudi standard on internal control and its impact on theprofitability of these companies.Design/methodology/approach A questionnaire was used to collect data about the compliancewith internal control requirements, and four measures of profitability including earnings per share(EPS), return on assets (ROA), return on equity (ROE) and profit margin (PM) for profitability werecalculatedusingdatafromthefinancialstatementsofthesecompanies.Then,MultipleRegressionandt-test were used to analyze the data and test the hypotheses.Findings The results of the study revealed that the degree of compliance with all components ofinternal control is very high. It also appears from the analysis that the effect of internal control and itscomponentsonROAandROEissignificantandpositive,whiletheeffectonEPSandPMispositivebutstatistically insignificant.Practical implications Corporatemanagementsshouldreviewtheeffectivenessoftheimplementation of internal control requirements, especially those related to control environment,information and communication and monitoring.Social implications The findings of the study shed light on the relevance of internal controlsystems of the Saudi shareholding companies in improving the financial performance of the thesecompanies,whichisexpectedtohelpinsafeguardingtheinterestsofallinterestgroupsandimprovethesociety s well-being.Originality/value ThepaperprovidesnewevidenceabouttherelationshipbetweeninternalcontrolandprofitabilityintheSaudiArabianenvironment.Thefindingsofthestudyaddgoodcontributiontothe literature because they direct our attention to the expected effect of the environment on therelationship between internal control and performance. The results may suggest that there is a need toexpandthisstudyusingothermethodologiestodelveintothedepthsandunderstandthisphenomenonwithin its context.Keywords Profitability, Monitoring, Risk assessment, Internal control, Control activities,Control environment, Information and communicationPaper type Research paperIntroductionThegrowingconcernwithcorporatecontinuityandthereductioninbusinessrisksthatmaypreventbusinessentitiesfromachievingtheirobjectivesencourageregulatorsandbodies of standard setting to give more attention to control mechanisms and corporategovernance (Corici, 2009; Tseng, 2007). This concern emerges clearly when observingthecontinuousdevelopmentininternalcontrolsystemssincethe1940s.ItisrecognizedThe current issue and full text archive of this journal is available on Emerald Insight at:/1056-9219.htmIJCOMA25,2196Received15April2013Revised22July2013Accepted27July2013International Journal of Commerceand ManagementVol. 25 No. 2, 2015pp. 196-217EmeraldGroupPublishingLimited1056-9219DOI 10.1108/IJCOMA-04-2013-0033Downloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)by the standard setting bodies and regulators all over the world that good internalcontrol systems provide managers with reasonable assurance that the basic objectivesof management will be achieved (Postan, 2010; Mawanda, 2008; O Leary et al., 2006;Conard, 2003; Venables and Impey, 1991). The International Federation of Accountants(IFAC) (2012a) stated that one of the best defenses against business failure and animportantdriverofbusinessperformanceishavinganeffectiveinternalcontrolsystem.Management typically has three broad objectives when designing an effectiveinternal control system (IFAC, 2012b). First, management is responsible for preparingfinancialstatementsforinvestors,creditorsandotherusers.Therefore,thereliabilityoffinancial reporting is the first basic objective of an internal control system. Second,controls are meant to encourage efficiency and effectiveness of operations, that is,effective use of resources to optimize the company s goals. Third, internal controlencourages the compliance with laws and regulations.Therefore, it is generally accepted that a good internal control system will providereasonable assurance that the business is doing well. It is expected that the financialperformanceofbusinessentitiesthathavestronginternalcontrolsystemsisbetterthanthe performance of those entities that have weak systems (Tseng, 2007; Chirwa, 2003;Greenley and Foxall, 1997). Tseng (2007) stated that firms with weak internal controlshave lower market value. The IFAC (2012a) ascertained that successful organizationsknow how to take advantage of opportunities and counter threats, in many instancesthrough effective application of internal controls, and therefore improve theirperformance. This concern with the relationship between internal control systems andfinancial performance creates opportunities for researchers to delve into this area andprovide regulators and the various interest groups evidence of this relationship.Thegrowingconcernwithmanycorporateissues,suchasinternalcontrol,corporategovernance, financial performance, corporate failure and collapse and audit failure allovertheworld,enhancestheneedforinvestigatinganddebatingtheseissues,especiallyin the Middle East countries. In the Kingdom of Saudi Arabia, the standard settersdeveloped an audit standard to manage this issue. Saudi companies are required todesign their control system taking into consideration the requirement of this standard.Accordingly, this study will investigate the compliance of the Saudi shareholdingcompanieswiththerequirementsoftheSaudiinternalcontrolstandard,andtheeffectoftheircomplianceontheirfinancialperformance.Morespecifically,thestudywillanswerthe following questions: To what extent do the Saudi shareholding companies comply with therequirements of the Saudi Standard “Internal Control for Financial StatementsAudit”? (SOCPA, 2010) WhatistheeffectofthecomplianceoftheSaudishareholdingcompanieswiththerequirements of the Saudi internal control standard on their profitability?It is recognized that strong internal control systems and financial performance ofbusinessentitiesareofgreatinteresttoallpartiesinterestedineconomicprosperityandcorporatecontinuity(Kiabel,2012;AigbeandJames,2011;Bejide,2006;HermansonandRittenberg, 2003; Eiseberg, 1998). This study makes several important contributionsrelated to internal control and performance. It makes an important theoreticalcontributiontotheextantliteraturedealingwiththeexpectedimpactofinternalcontrolcomponents on profitability. Additionally, to our knowledge, this study is the first to197Impact ofinternalcontrolrequirementsDownloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)provide empirical evidence of the impact of internal control regulations on manymeasures of profitability in a Middle East country (The Kingdom of Saudi Arabia).Weexpect that our study will help in reducing the research gap about these issues in SaudiArabia, and provide evidence from a different environment. It is expected that ourresearch will be of great interest to all stakeholders, that is, effective corporateperformance and financial transparency are at the top priorities of shareholders andinvestors.Amongstthepartiesthatwillbenefitfromthefindingsofthisstudyarethebodiesincharge of regulating the profession and regulating companies. Solid evidence wouldprove the effectiveness of internal controls in achieving corporate objectives andimprovingtheirprofitability,thussupportingthenotionofthemandatoryapplicationofinternal control requirements, or else, a revision of the standard may be needed.Additionally, it is expected that the results of this study provide decision makers withinformation about the degree of management commitment in designing andimplementing internal control as required by the Saudi standards, and whether theimplementation is effective in promoting performance or not.Theoretical framework and hypotheses developmentThe primary responsibility for the achievement of corporationsobjectives rests withboth those charged with governance of the entity and management. It is theirresponsibility to design, implement and develop a strong internal control system thatincludes all components and procedures that persuade every part of the organization towork in the best interest of the organization as a whole. It can be argued that the toppriority of any corporation is the financial performance (Hussain and Bhatti, 2010;Ramlall, 2009; Chirwa, 2003). Performance, basically, is reflected in liquidity, solvencyand profitability. It is this performance that will result in the financial well-being ofcorporations.The overall financial well-being of corporations may be considered as an importantdeterminantofthesociety swell-being,aswellastheinterestedgroupsandindividualswell-being. The concern with financial well-being, transparency and trust influencedregulator s thinking and decisions since the inception of shareholding companies.Regulatorsconcern with safeguarding the interest of the stakeholders of corporationsall over the world has been a basic factor behind the regulatorsconcern with internalcontrol systems since the early days of the creation of corporations (Eiseberg, 1998).The International Standard on Auditing, ISA 315, has defined internal control as aprocess designed, implemented and maintained by those charged with governance,management and other personnel to provide reasonable assurance about theachievement of an entity s objectives with regard to reliability of financial reporting,effectiveness and efficiency of operations and compliance with applicable laws andregulations (IFAC, 2012b). These objectives of internal control systems arecomprehensive and interrelated, that is, all of them are expected to contribute to thewell-being of any corporation. The financial performance of a corporation can beexpressed in terms of profitability, liquidity and solvency. These measures of financialperformance are the concern of creditors, investors and shareholders. These measuresarealsotheconcernofregulatorsaswellasthoseresponsibleforcorporategovernance.The remaining part of this theoretical framework addresses the theoretical argumentsIJCOMA25,2198Downloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)regarding the relationship between internal control systems and financial performanceof corporations represented by companiesprofitability.Reliability of financial reporting, which is the first objective of internal control,should reflect the actual performance of the entity, that is, the management shouldimplement internal control that provides reasonable assurance about the reliability offinancial statements. The most important internal controls usually preside over thefinancial information of a company. Improperly reporting financial information isconsideredfraudandwillquicklycauseproblems.DeFondandJiambalvo(1991)arguedthat past research finds that financial reporting errors are negatively associated withperformance. This means that good internal control is expected to enhance theperformance of companies.Thesecondbasicobjectiveofinternalcontrolistheachievementoftheefficiencyandeffectiveness of operations. It can be stated that the satisfaction of customer demandsand the achievement of high level of sales and other revenues are the basic sources forincreasing profitability. However, these objectives and the sources to achieve theseobjectivesmustbeaccompaniedwithanefficientmanagementofusingresources.Thatsuggests controlling costs and limiting excessive spending. Internal controls helppromote efficiency and effectiveness for all operations, this means that internal controlshould help in producing high-quality products and services and control all operationsto achieve good control over all types of costs. In other words, this objective of internalcontrol is also concentrated on the achievement of financial well-being of theorganization. Altamuro and Beatty (2007) argued that improvements in real operatingactivitycanleadtohigherpersistenceinearningsbecauseasystemwithbettercontrolsis easier to monitor and is less likely to be subject to operating surprises that induceearnings volatility.The third objective of internal control systems is the achievement of the compliancewith applicable laws and regulation. The Saudi standard on internal control stated thatthe effect of laws and regulations on financial statements varies considerably. Thoselaws and regulations to which an entity is subject constitute the legal and regulatoryframework. The provisions of some laws or regulations have a direct effect on thefinancial statements, in that they determine the reported amounts and disclosures in anentity s financial statements. The compliance with such regulations is expected to forcemanagementtopresenttheactualfinancialperformance.Thisadherencetoregulationsand actual performance is expected to stimulate the improvement of financialperformance of an entity. Rogers (2008) argued that the significant contributors tofinancial performance include openness and reliability. Openness and reliability aremeasuresoftrustwhich,inturn,hasasignificantimpactonfinancialperformance.Thestandardalsostatedthatnon-compliancewithlawsandregulationsmayresultinfines,litigation or other consequences for the entity that may have a material effect on thefinancial statements.The above discussion of internal control objectives shows how these objectives areinterrelated and work as forces to enhance corporate performance. Brown et al. (2008)suggested a positive effect of internal control regulation on earnings quality; forexample, he stated that German firms experienced a frequency of small positiveearnings, consistent with less earnings management. Altamuro and Beatty (2007)investigated the relationship between earnings characteristics and mandated internalcontrol reforms. They investigated the impact of internal control on earnings199Impact ofinternalcontrolrequirementsDownloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)persistence, earningsability to predict future cash flows and the earnings responsecoefficient. They stated that internal control reforms lead to improvements regardingeach of these earnings characteristics for banks affected by the regulation relative tounaffected banks during the same period.Dechow et al. (2011) investigated the characteristics of misstating firms on variousdimensions, including financial and non-financial performance. One of their findings isthat both financial and non-financial measures of performance are deteriorating. Thisconclusion seems to suggest that bad internal control which results in a deterioratingcondition of earnings management will result in deteriorating performance. The fear ofbad financial performance will result in a fear of decreasing stock prices. Dechow et al.(2011)alsofoundthatmanagersofmisstatingfirmsappeartobesensitivetotheirfirm sstock price. Mawanda (2008) investigated the relationship between internal controlsystems and financial performance in an institution of higher learning in Uganda. Heconcluded that there is a significant relationship between internal control systems andfinancial performance in an institution of higher education.However, there is limited empirical evidence on whether internal control regulationleads to systematic improvements in earnings (Jensen, 2011; Ashbaugh-Skaife et al.,2008; Bdard, 2006). Jensen (2011) stated that fundamental technological, political,regulatory and economic forces are radically changing the worldwide competitiveenvironment.However,duringthepasttwodecades,corporateinternalcontrolsystemshavefailedtodealeffectivelywithmanychangesincludingthereducedgrowthratesoflabor income, excess capacity and the requirement for downsizing and exit.Jeffrey et al. (2007) stated that poorly performing firms simply may not be able toadequately invest time and/or money in proper controls. Good internal control requiresboth financial resources and management time, and this may not be a priority for firmsthatareconcernedwithsimplystayinginbusiness.Wijewardenaetal.(2004)statedthatthere is a positive relationship between internal control complexity and performance.Some researchers argued that a quickly growing firm may outgrow any internalcontrolsithasinplace,anditmayrequiretimetoestablishanewprocedure(KinneyandMcdaniel, 1989). New personnel, processes and technology are usually needed to matchthe internal control with the firm s growth. Krishnan (2005) stated that the existence ofalossispositivelyassociatedwithreportinganinternalcontrolprobleminaudit-changefirms. He expected to find fewer internal control weaknesses in firms with strongerfinancial health. The inconclusive results regarding the interaction between internalcontrol and financial performance lead us to draw the following hypothesis:Ha. There is a significant influence of internal control systems on financialperformance (represented by profitability) of Saudi shareholding companies.This is the basic hypothesis of the study. It will be sub-divided into five hypothesesabout the effect of each component of the internal control system on profitability. Forthis purpose, the remaining part of this theoretical framework will discuss the fivecomponents of internal control and their expected impact on performance.Internal control components and financial performanceInternalcontrolisthemostcommontermusedtodescribetheprocessesanorganizationusestoachieveitsobjectives.Itisrecognizedasthecornerstoneofcorporategovernance(Verschoor, 1998). The Saudi standard on internal control (SOCPA, 2010) and theIJCOMA25,2200Downloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)InternationalStandardonAuditing(ISA315)definedinternalcontrolasaprocessdesigned,implemented and maintained by those charged with governance, management and otherpersonnel to provide reasonable assurance about the achievement of an entity s objectiveswithregardtoreliabilityoffinancialreporting,effectivenessandefficiencyofoperationsandcompliance with applicable laws and regulations (IFAC, 2012b). The Saudi standard forinternalcontrolidentifiedfivecomponentsofinternalcontrolsystems,whicharethesameasthose mentioned by the international standard. These components include controlenvironment, control activities, communication and information, risk assessment andmonitoring(SOCPA,2010).Control environmentIntegrity and ethical behavior are products of the entity s ethical and behavioralstandards. The enforcement of integrity and ethical values includes, for example,mitigating conflict of self-interest, that is, the ethical values promote the managementandemployeestoworkinthebestinterestofthecompany(Berroneetal.,2005),andthisis expected to be an important factor in enhancing the profitability of the company.Additionally, ethical values include management actions to eliminate or mitigateincentivesortemptationsthatmightpromptpersonneltoengageindishonest,illegalorunethical acts. Many research papers show that ethical values are very important inprompting performance (ACCA, 2010; Berrone et al., 2005; Stainer et al., 2004).The ACCA (2010) conducted a ground-breaking multinational survey of chieffinancial officers (CFOs) carried out by Association of Chartered Certified Accountants(ACCA)CFOresearchservicesaboutthelinkbetweenethicsandbusinessperformance.Thesurveyshowedthatthosecompanieswhichbuildacultureofethicsaremorelikelyto succeed financially. The survey revealed that there is a strong evidence of acorrelation between ethics and financial performance. It showed that the EuropeanCFOs in those companies that had outperformed the others financially believed theirboards had given more consideration to ethical issues.Staineretal.(2004)exploredtherelationshipbetweenvalues,ethicsandstakeholdersin a performance context. The foundations and importance of core values to everybusinesswerediscussedinrelationtomodesofbehavioranddecision-makingpractices.They are demonstrated as under-pinning the strategic direction, conveying what isexpected by both the organization itself and the major stakeholders.Berroneetal.(2005)empiricallyassessedtheimpactoftheCorporateEthicalIdentity(CEI) on the firm s financial performance. They argued that firms with a strong ethicalidentity achieve greater degree of stakeholder satisfaction, which, in turn, positivelyinfluence the firmsfinancial performance. However, their study indicated that, whilerevealed ethics has informational worth and enhance shareholder value, applied ethicshas a positive impact through the improvement of stakeholder satisfaction.Competence, as an important figure in the control environment, includes theknowledgeandskillsnecessarytoaccomplishtasksthatdefinetheindividual sjob.Itisoneoftheimportantfactorsnecessarytoenableindividualstocarryontheirdutiesandresponsibilities and therefore, to help in achieving the entitiesobjectives.Another determinant of control environment is participation by those charged withgovernance. It plays an important role in the process of reviewing the effectiveness ofthe entity s internal control. This participation builds a solid ground for directing allefforts toward the achievement of the entitiesobjectives and improving performance.201Impact ofinternalcontrolrequirementsDownloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)Summers and Hyman (2005) conducted a study on employee participation andcompany performance. Their study revealed that a combination of financial andwork-related participatory measures can have a positive impact on companyperformance, as all employees do not react to participation initiatives in the samemanner. Some respond well to financial initiatives and others to more work-relatedelements. The researchers concluded that a combination of participation and welfaremeasures (such as equal opportunities and family-friendly policies) are expected toenhance organizational performance and the quality of working life.Control environment also includes the establishment of a relevant organizationalstructure,assignmentofauthorityandresponsibilityandthesettingofhumanresourcepoliciesthatemphasizethemostefficientstandardsforrecruitmentandthereforestresscompetence, integrity and ethical values. These elements of control environment areexpectedtoplayanimportantroleinensuringthatallpersonnelunderstandtheentity sobjectives,knowhowtheirindividualactionsinterrelateandcontributetothoseobjectives(Summers and Hyman, 2005; Meijaard et al., 2005). These theoretical arguments aboutcontrol environment and performance lead to setting the first sub-hypothesis of the basicresearchhypothesis,whichstatesthat:There is a significant influence of the control environment on financial performance(represented by profitability) of Saudi shareholding companies.Entity s risk assessment processThe second component of internal control is the entity s risk assessment process. Itforms the basis for how management determines the risks to be managed. Themanagement should have a reasonable assurance that the risk assessment process isappropriatetothecircumstances,includingthenature,sizeandcomplexityoftheentity.For financial reporting purposes, the entity s risk assessment process includes howmanagementidentifiesbusinessrisksrelevanttothepreparationoffinancialstatementsinaccordancewiththeentity sapplicablefinancialreportingframework,estimatestheirsignificance, assesses the likelihood of their occurrence and decides upon actions torespondtoandmanagesuchrisksandtheirresults.Similarly,riskassessmentincludestheriskoffailuretomeetpriorobjectives,qualityofpersonnel,geographicdispersionofcompany s operations and entrance of new competitors (Elder et al., 2012). Severalstudies explored the relationship between good risk management practices andimproved financial performance (Mackay and Moeller, 2007; Nocco and Stulz, 2006;Schroeck, 2002; Hakim and Neami, 2001; Smith, 1995). These studies propose thatprudent risk management practices reduce the volatility in financial performance,particularlyoperatingincome,earnings,firm smarketvalue,sharereturnandreturnonequity. Mackay and Moeller (2007) argued that risk management can add value whenrevenues and costs are non-linearly related to prices.Schroeck (2002) and Nocco and Stulz (2006) stress the importance of good riskmanagement practices to maximize firm value. In particular, Nocco and Stulz (2006)arguedthateffectiveenterpriseriskmanagementhasalong-runcompetitiveadvantagefor firms compared to those that manage and monitor risks individually. Thesetheoretical arguments addressing risk assessment and performance lead to setting thesecond sub-hypothesis of the basic research hypothesis, which states that:There is a significant influence of risk assessment on financial performance(represented by profitability) of Saudi shareholding companies.IJCOMA25,2202Downloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)Information and communication systemsAn information system consists of infrastructure, software, people, procedures anddata. The quality of system-generated information affects management s ability tomake appropriate decisions in managing and controlling the entity s activities andto prepare reliable financial reports. The IFAC (2012a, 2012b) recommendsmanagements to ensure regular communication regarding the internal controlsystem, as well as the outcomes at all levels within the organization, to make surethat the internal controlprinciplesarefullyunderstoodandcorrectlyapplied.MaloneandCrowston (1994) stated that the first business trend is the use of information andcommunicationtechnology(ICT)todecreasecostsandincreasecapabilities.Thaddeus and Chimezie (2011) explored the effect of ICT adoption and usage onthe performance of commercial banks in Nigeria and found that ICT adoption andsubsequent usage has positively influenced the service quality and financialperformance of commercial banks. The analysis proves that the use of ICT has ahuge impact on the overall branch profit. Weill (1992) stated that there is a positiverelationship between the investment in operational information technology andcorporate performance because of the efficiency in reducing costs, but there is nosignificant relationship between information technology used in informationsystems and financial performance. Corici (2009) investigated the changes thatfacilitate the interaction under the direct impact of information technology andcommunication as a means of influence on organizational performance. He arguedthat the role of knowledge is a distinct factor of production aimed at renewing andapplying information for the maintenance and survival of the organization. Theexpected effect of information and communication systems and performance leadsto setting the third sub-hypothesis of the basic research hypothesis, which statesthat:There is a significant influence of information and communication systems onfinancial performance (represented by profitability) of Saudi shareholding companies.Control activitiesControl activities are the policies and procedures that help ensure that managementdirectives are carried out (COSO, 2001). Control activities include segregation of duties,authorization, documentation, physical controls over assets and records andperformance reviews (IFAC, 2012a, 2012b; COSO, 2011; SOCA, 2010). These controlactivities include: reviews and analyses of actual performance versus budgets, forecasts and priorperiod performance; relating different sets of data operating or financial to one another, togetherwith analyses of the relationships and investigative and corrective actions; comparing internal data with external sources of information; and reviewing functional or activity performance (IFAC, 2012b).These control activities represent very important tools in corporate governance, which,in turn, enhance firm s performance. Brown and Caylor (2006) investigated therelationship between corporate governance and firm performance. They used sixperformance measures allocated to three categories:203Impact ofinternalcontrolrequirementsDownloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)(1)operating performance (return on equity, net profit margin PM, sales growth);(2)valuation (Tobin s Q); and(3)shareholder payout (dividend yield and stock repurchase).The study found that better governed firms were relatively more profitable, morevaluableandpaidoutmorecashtoshareholders,whilepoorlygovernedfirmshadloweroperating performance and paid out less cash to shareholders.Allcontrolactivitiescontributeintheachievementofinternalcontrolobjectives.Forexample, efficient financial control contributes in preventing and eliminatingdysfunctions, improving the organization and the management of the decision-makingprocessandenhancingtheoverallefficiencyoftheeconomicactivity(Postan,2010).Theexpected effect of control activities on performance leads to setting the fourthsub-hypothesis of the basic research hypothesis, which states that:There is a significant influence of control activities on financial performance(represented by profitability) of Saudi shareholding companies.Monitoring of controlsMonitoring of controls is a process to assess the effectiveness of internal controlperformance over time. It involves assessing the effectiveness of controls on a timelybasis and taking necessary remedial actions (IFAC, 2012b; COSO, 2011; SOCPA, 2010).Management s monitoring of controls includes considering whether they are operatingas intended and that they are modified as appropriate for changes in conditions.Previous research discussed many monitoring techniques that provide reasonableassurance regarding the role of monitoring in prompting performance (Kiabel, 2012;Aigbe and James, 2011; Bejide, 2006; Eiseberg, 1998). Monitoring of controls mayinclude internal auditorsevaluation of sales personnel s compliance with the entity spolicies on terms of sales contracts, and the legal department s oversight of compliancewith the entity s ethical and legal requirements (IFAC, 2012a; 2012b; Aigbe and James,2011; Hermanson, and Rittenberg, 2003).AigbeandJames(2011)arguedthatmonitoringisakeytechnologyinthecommerciallending business model, and the theoretical literature in finance suggests thatmonitoring is value enhancing. They added that banks which devote more resources tomonitoring are more profit efficient and the effect is large. Venables and Impey (1991)stated that internal audit is an “invaluable tool of management for improvingperformance”. Bejide (2006) argued that an effective internal audit service in particularcan help reduce overhead, identify ways to improve efficiency and maximize exposuretopossiblelossesfrominadequatelysafeguardedcompanyassets,allofwhichcanhavea significant effect on the bottom line.Kiable (2012) stated that most internal audit professionals argue that an effectiveinternal audit function correlates with improved financial performance. However,Kiable found no strong association between internal auditing practices and financialperformance, and political influences do not significantly impact on this relationship.The weak association between internal auditing practices and financial performance isattributed to these enterprises inadequacy and poor implementation of internalauditing practices. Where internal auditing is de-emphasized, it cannot impactpositively on performance. Greenley and Foxall (1997) note that although studies haveIJCOMA25,2204Downloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)foundanassociationbetweenaccountingcontrolsystemsandperformance,theoryalsopredictsthattheseassociationswillbeinfluencedbyexternalenvironmentalinfluences.These theoretical arguments about monitoring controls and performance lead tosetting the fifth sub-hypothesis of the basic research hypothesis, which states that:There is a significant influence of monitoring controls on financial performance(represented by profitability) of Saudi shareholding companies.Study design and methodologyData and data sources: for the purpose of this study, we used two appropriate datasources, which are generally acceptable to provide a basis for the measurement of ourvariables. The first type of data is the responses of the financial managers and internalauditorsoftheSaudishareholdingcompaniesaboutthecomplianceofthefirmswiththerequirements of internal control related to the five components of internal control. Aquestionnaire was designed to collect the data of the compliance of the Saudishareholding companies with the requirements of the internal control standard. Thequestionnaireincludedquestionscoveringeachcomponentoninternalcontrolassetbythe Saudi standard for internal control. The second source of data is the financialstatements of the firms who responded to the questionnaire. We used the financialstatements to calculate the profitability measures used in the study. The measures ofprofitability included the earnings per share (EPS), return on assets (ROA), return onequity (ROE) and PM.Population and sample: the target population of this study consists of all the Saudishareholding companies listed on the Saudi Bourse for the year 2011. The number oflisted companies is 160 companies. To create a unifying theme between the firms in thestudy sample and eliminate any factors that might create noise, and thus affect thefindings of this study, firms in the sample were selected based on the following criteria: Thefirm ssharesshouldbelistedfortradingontheBourseduring2011,whichisthe period of study. Thefirm sfinancialstatementsmustbeavailablefortheyear2011,toprovideforthe financial data needed to calculate the study s variables. The firm should not have undergone an extraordinary event, such as a merger oracquisition,orothersimilartransactionsthatmightresultinreorganizationofthefirm sbusinesssegmentsand,asaconsequence,affecttheentityanditsfinancialstatements.Basedontheabovecriteria,thenumberoffirmsincludedinthesampleamountedto120.A questionnaire was sent to all these companies. We used many methods ofcommunication with the respondents, by mail, e-mail and in person. However, thenumber of responses was 90 with a response rate of 75 per cent which is reasonablyacceptable.Weusedthesefirmsfinancialstatementstocalculatetheprofitabilityratiosandthentestthehypotheses.Inotherwords,twosourcesofdatawereused,thefirstoneistheresponsesofthefirmstothequestionnaireandtheotheristhefinancialreportsofthose firms which responded to the questionnaire.Limitations: even though a questionnaire represents a structured technique forcollecting primary data, there are some limitations of such research method, that is,respondents to questionnaires may record their own answers. Additionally, care has tobe taken when creating a questionnaire. However, it is a technique in which various205Impact ofinternalcontrolrequirementsDownloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)persons are asked to answer the same set of questions and we think that ourquestionnaire is well designed to motivate the respondents to give accurate andcomplete information to get reliable and relevant data. Furthermore, we discussed thequestionnaire with our colleagues to assure its relevance for measuring the variables ofthe study. To assess whether the different items of the questionnaire form a reliablemeasure of internal control, Cronbach s alpha was computed. The alpha coefficients forthe items measuring control environment, risk assessment, control procedures, controlactivities and monitoring were all close to 0.85, which indicates strong internalconsistency and reliability.Data analysis: the data were analyzed using the appropriate statistical methodsincluding one-sample t-test and multiple regression. The basic model for the study is:Pr ?1CEi,t?2RAi,t?3CAi,t?4ICi,t?5Mi,tt? ?i,t,where, Pr: profitability; CEi,t: control environment; RAi,t: risk assessment; CAi,t: controlactivities; ICi,t: information and communication; and Mi,t: monitoring.Results and discussionThestartingpointforouranalysisistoinvestigatethereliabilityofthedatacollectedbythe questionnaire and investigate the normality of distribution of the data related to allstudy variables.Toassesswhetherthedifferentitemsofthequestionnaireformareliablemeasureofinternal control, Cronbach s alpha was computed. The alpha coefficients for the itemsmeasuring control environment, risk assessment, control procedures, control activitiesand monitoring were all close to 0.85, which means strong internal consistency andreliability.Oneofthebasicassumptionsrequiredtouseregressionanalysisisthatthedatahavea normal distribution. Therefore, a test for the normality must be done for the databefore using regression analysis. For this purpose, we used the one-sampleKolmogorovSimrnov (KS) test. Table I shows the values of significancecorrespondingtotheKSvaluesofthedatarelatedtoallvariables,whicharemorethan0.05, which means that the data have a normal distribution.Descriptive statisticsTo test the research hypotheses, we started by investigating the degree of compliancewith internal control requirements as set by the Saudi standard on internal control. WeTable I.One-sample KS testVariableMeanSDKSSignificanceEarnings per share (ES)2.882.190.7530.622Return on assets (ROA)5.447.441.180.122Return on equity (ROE)10.9210.560.810.52Profit margin (PM)0.410.761.700.06Control environment4.260.600.910.36Risk assessment4.260.670.830.49Control procedures4.450.531.030.24Information and com4.674.871.700.06Monitoring4.340.470.630.80IJCOMA25,2206Downloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)investigated the compliance of Saudi shareholding companies with the basiccomponents of internal control and the detailed requirements of each component.Table II shows some descriptive statistics about the internal control of the firms inour sample. It provides evidence about the compliance of the firms with therequirements of internal control according to the Saudi standards. Also it shows a highlevel of the degree of compliance with all components of internal control.Thereisahighdegreeofcompliancewitheachcomponentofinternalcontrol,thatis,the minimum degree of compliance is 4.26 and the maximum is 4.67 on a five-pointLikert scale. This means that the range of compliance is approximately between 85 and93 per cent, which represents a high degree of compliance. These percentages ofcompliance mean that there is a very good internal control and a high degree ofcompliance with its requirements. The table shows that the t-values ranged from 37.29to 56.6 and all significance values are less than 0.05, which means that the degree ofcompliance with all internal control components is statistically significant.According to the views of the respondents, the degree of compliance with thecontrolenvironmentisapproximately85percent.Thecontrolenvironmentincludesall issues necessary to help in achieving the basic objectives of internal control. Forinstance, the regulations of the Saudi companies seem to give a high degree ofpriority to integrity and moral values and encourage those who are responsible forgovernance and all employees to give attention to such characteristics. Theresponses of all companies to the questionnaire show that they devote their effortsto create a control environment that helps in setting a solid ground for the othercomponents of internal control. Control environments of these companiesconcentrate on competence, training and continuous learning and improvement thatare accompanied by a flexible organizational structure with emphasis onparticipation and human resources development.Table II shows that the Saudi companies are very interested in risk assessment, thatis, there is a wide concern with all types of risks that may reduce the ability of thecompanies to achieve their objectives. The respondents of the companies declared thatthere is a continuous improvement in risk evaluation, including internal and externalrisks that may affect the success or failure of achieving the objectives of the company.There is a continuous development of comprehensive plans to manage risks andcontinuous evaluation of all risks including risks related to the preparation of thefinancial statements.Table II.One-sample t-testVariableMeanSDt-valueSignificanceEPS2.882.197.780.000ROA5.447.444.320.000ROE10.9210.566.110.000PM0.410.763.170.003Control environment4.260.6041.850.000Risk assessment4.260.6737.290.000Control procedures4.450.5349.010.000Information and com4.674.8756.800.000Monitoring4.340.4754.210.000207Impact ofinternalcontrolrequirementsDownloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)The third important component of internal control is represented by the controlprocedures. On average, the respondents of the companies declared that managementsof their companies give major importance to the control procedures mentioned by theSaudi standard. That is, the degree of compliance with all control procedures isapproximately89percent.Segregationofduties,performanceevaluation,safeguardingof assets and authorization represent the basic control procedures used by the Saudishareholding companies.The fourth component of internal control is information and communication. Thedegree of compliance with all requirements of information and communication isapproximately94percent.Therespondentsofthecompaniesstatedthattheaccountingsystemsoftheircompaniesarebasedonclearconceptsandprinciplesandthesesystemsprovidetherequiredinformationintheappropriatetimeandquantity.Theyalsostatedthat the communication systems include effective documentation to control the varioustypes of transactions.The fifth component of internal control is the monitoring process. The mostimportanttoolofthemonitoringsystemistheinternalauditfunction.Therespondentsviews provide evidence that the degree of compliance with the requirements of internalcontrol is 87 per cent. The responses show that the internal audit function iscomprehensiveandincludesalltypesofaudit,i.e.financial,complianceandoperationalaudit.Theresultsshowalsothat,onaverage,mostofthefirmsinoursampleareprofitable.Table II shows that, on average, the EPS is 2.88, the ROA is 5.44, the ROE is 10.92 andthe PM is 0.41. These indicators of profitability suggest that the Saudi shareholdingcompanies are profitable.Hypotheses testing. Before interpreting the results of regression, a test ofmulticollinearitymustbedonetocheckwhetherthevaluesofregressioncoefficientsarenot inflated because of the correlation between the independent variables. The generalrule of thumb is that variance inflation factors (VIFs) exceeding 4 warrant furtherinvestigation, while VIFs exceeding 10 are signs of serious multicollinearity requiringcorrection(Kaplan,1994;Leahy,2000).LookingatTablesIV,VI,VIIIandX,weseethatthe VIF values for all independent variables are ranging between 1.6 and 3.3, whichmeansthatthefactorsareverysmall,andtherefore,theexpectedeffectontheregressionresults is minimal.The effect of internal control on EPS. The model summary in Table III shows somestatistics related to the relationship between internal control and EPS. The table showsthatthecorrelationbetweeninternalcontrolandEPSis0.497,whichmeansthatthereisa positive relationship between them. In other words, the higher the compliance withinternal control, the higher the EPS.The adjusted R2is used to assess the explanatory power of models used for testingour hypotheses. The table shows that the adjusted R2is equal to 11.7 per cent, whichmeansthat11.7percentofthevariationinfinancialperformance(measuredbyearningsTable III.Model summary andANOVA results(Internal control andEPS)RR2Adjusted R2Standard error ofthe estimateFSignificance0.4970.2470.1172.059901.9020.125IJCOMA25,2208Downloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)pershareEPS)isinterpretedbyinternalcontrol.However,theANOVAtestinTableIIIalso provides information about the overall regression because the value of thesignificance is 0.125 which is higher than 0.05; thus, it can be concluded that therelationship between internal control in general and EPS is statistically insignificant ata level below 0.05. In other words, no statistically significant linear dependence of themean of EPS on internal control was detected.Table IV shows the regression coefficients for each component of internal control.Thecorrelationcoefficientforvariablecontrolenvironmentis0.869andthesignificancevalue is 0.294, which is higher than the significance level used in this research (0.05);therefore, the effect of control environment on EPS is insignificant.The correlation coefficient for variable risk assessment is 2.211 and the significancevalue is 0.006; therefore, the effect of risk assessment on EPS is significant. Thecorrelationcoefficientforvariablecontrolproceduresis2.443andthesignificancevalueis0.044;therefore,theeffectofcontrolproceduresonEPSissignificant.Thecorrelationcoefficient for variable information and communication is 2.101 and the significancevalue is 0.122; therefore, the effect of information and communication on EPS isinsignificant. The correlation coefficient for variable monitoring is 0.777 and thesignificance value is 0.418; therefore, the effect of monitoring on EPS is insignificant.The effect of internal control on ROA. The model summary in Table V shows somestatisticsrelatedtotherelationshipbetweeninternalcontrolandROA.Thetableshowsthat the correlation between internal control and ROA is 0.723, which means that thereis a positive relationship between them. In other words, the higher the compliance withinternal control, the higher is the ROA.ThetableshowsthattheadjustedR2isequalto44percent,whichmeansthat44percent of the variation in financial performance (measured by return on assets ROA) isinterpreted by internal control. The ANOVA test in Table V also provides informationabout the overall regression because the value of the significance is 0.000; thus, theconclusion is that the relationship between internal control in general and ROA isTable IV.Regressioncoefficients (Internalcontrol and EPS)VariableUnstandardizedcoefficientsStandardizedcoefficientstSignificanceCollinearitystatistics?Standard error?ToleranceVIFControlenvironment0.8690.8120.2381.0700.2940.5231.912Risk assessment2.2110.7520.6842.9410.0060.4792.086Controlprocedures2.4431.1580.5992.1100.0440.3233.100Information andcommunication2.1011.3190.4671.5920.1220.3023.311Monitoring0.7770.9450.1680.8210.4180.6211.610Table V.Model summary andANOVA results(Internal control andROA)RR2Adjusted R2Standard error ofthe estimateFSignificance0.7230.5230.4405.572546.3520.000209Impact ofinternalcontrolrequirementsDownloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)statistically significant at a level below 0.05. In other words, a statistically significantlinear dependence of the mean of ROA on internal control was detected.Table VI shows the regression coefficients for each component of internal control.Thetableshowsthatthecorrelationcoefficientforvariablecontrolenvironmentis3.427and the significance value is 0.130; therefore, the effect of the control environment onROA is insignificant. The correlation coefficient for variable risk assessment is 9.912and the significance value is 0.000; therefore, the effect of risk assessment on ROA issignificant. The correlation coefficient for variable control procedures is 11.093 andthe significance value is 0.001; therefore, the effect of control procedures on ROA issignificant. The correlation coefficient for variable information and communication is5.607 and the significance value is 0.127; therefore, the effect of information andcommunication on ROA is insignificant. The correlation coefficient for variablemonitoringis2.848andthesignificancevalueis0.275;therefore,theeffectofmonitoringon ROA is insignificant.The effect of internal control on ROE. The model summary in Table VII shows somestatisticsrelatedtotherelationshipbetweeninternalcontrolandROE.Theresultsshowthat the correlation between internal control and ROE is 0.564, which means that thereis a positive relationship between them. In other words, the higher the compliance withinternal control, the higher is the ROE. The table shows that the adjusted R2is equal to20 per cent, which means that 20 per cent of the variation in financial performance(measuredbyreturnonequityROE)isinterpretedbyinternalcontrol.TheANOVAtestinTableVIIalsoprovidesinformationabouttheoverallregression.Becausethevalueofthesignificanceis0.04,itcanbeconcludedthattherelationshipbetweeninternalcontrolin general and ROE is statistically significant at a level below 0.05. In other words, astatistically significant linear dependence of the mean of ROE on internal control wasdetected.Table VIII shows the regression coefficients for each component of internal control.Thetableshowsthatthecorrelationcoefficientforvariablecontrolenvironmentis4.248Table VI.Regressioncoefficients (Internalcontrol and ROA)VariableUnstandardizedcoefficientsStandardizedcoefficientstSignificanceCollinearitystatistics?Standard error?ToleranceVIFControlenvironment3.4272.1970.2771.5600.1300.5231.912Risk assessment9.9122.0340.9034.8740.0000.4792.086Controlprocedures11.0933.1310.8003.5420.0010.3233.100Information andcommunication5.6073.5690.3671.5710.1270.3023.311Monitoring2.8482.5580.1811.1140.2750.6211.610Table VII.Model summary andANOVA results(Internal control andROE)RR2Adjusted R2Standard error ofthe estimateFSignificance0.5640.3180.2019.445892.7090.040IJCOMA25,2210Downloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)and the significance value is 0.263; therefore, the effect of control environment on ROEis insignificant.Thetableshowsthatthecorrelationcoefficientforvariableriskassessmentis10.583and the significance value is 0.005; therefore, the effect of risk assessment on ROE issignificant. The correlation coefficient for variable control procedures is 15.901 andthe significance value is 0.006; therefore, the effect of control procedures on ROE issignificant. The correlation coefficient for variable information and communication is8.642 and the significance value is 0.164; therefore, the effect of information andcommunication on ROE is insignificant. The correlation coefficient for variablemonitoringis0.932andthesignificancevalueis0.831;therefore,theeffectofmonitoringon ROE is insignificant.The effect of internal control on PM. The model summary in Table IX shows somestatistics related to the relationship between internal control and PM. The correlationbetween internal control and PM is 0.284, which means that there is a positiverelationship between them. In other words, the higher the compliance with internalcontrol, the higher is the PM.ThetableshowsthattheadjustedR2isequalto7.8percent,whichmeansthat7.8percent of the variation in financial performance (measured by PM) is interpreted byinternal control. The ANOVA test in Table IX also provides information about theoverallregression.Becausethevalueofthesignificanceis0.768,itcanbeconcludedthatthe relationship between internal control in general and PM is not statisticallysignificant at level below 0.05. In other words, a non-statistically significant lineardependence of the mean of ROE on internal control was detected.TableXshowstheregressioncoefficientsforeachcomponentofinternalcontrol.Thecorrelation coefficient for variable control environment is 0.157 and the significancevalue is 0.619; therefore, the effect of control environment on PM is insignificant. Thecorrelation coefficient for variable risk assessment is 0.294 and the significance value is0.318; therefore, the effect of risk assessment on PM is insignificant. The correlationTable VIII.Regressioncoefficients (Internalcontrol and ROE)VariableUnstandardizedcoefficientsStandardizedcoefficientstSignificanceCollinearitystatistics?Standard error?ToleranceVIFControlenvironment4.2483.7240.2421.1410.2630.5231.912Risk assessment10.5833.4470.6803.0700.0050.4792.086Controlprocedures15.9015.3080.8092.9960.0060.3233.100Information andcommunication8.6426.0500.3991.4290.1640.3023.311Monitoring0.9324.3360.0420.2150.8310.6211.610Table IX.Model summary andANOVA results(Internal control andPM)RR2Adjusted R2Standard error ofthe estimateFSignificance0.2840.0810.0780.792590.5080.768211Impact ofinternalcontrolrequirementsDownloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)coefficient for variable control procedures is 0.334 and the significance value is 0.459;therefore, the effect of control procedures on PM is insignificant. The correlationcoefficient for variable information and communication is 0.217 and the significancevalue is 0.673; therefore, the effect of information and communication on PM isinsignificant. The correlation coefficient for variable monitoring is 0.275 and thesignificance value is 0.456; therefore, the effect of monitoring on PM is insignificant.Conclusions and recommendationsThe above discussion of descriptive statistics and hypothesis testing shows that thedegree of compliance with all components of internal control is at a high level. Theanalysis revealed that all dimensions of internal control including control environment,risk assessment, control procedures, information and communication and monitoringhadpositiverelationshipswithallprofitabilitymeasuresincludingEPS,ROA,ROEandPM. However, hypotheses testing showed that there are some differences in thesignificance of the relationship between internal control and profitability measures andintherelationshipbetweentheinternalcontrolcomponentsandthevariousprofitabilitymeasures.First, the analysis revealed that there is a positive relationship between internalcontrol and ROA. In other words, the higher the compliance with internal control, thehigheristheROA.Additionally,astatisticallysignificantlineardependenceofthemeanof ROA on internal control was detected. Similarly, it is noticed from the analysis thatthere is a positive relationship between internal control and ROE, which means that thehigher the compliance with internal control, the higher is the ROE. Additionally, astatistically significant linear dependence of the mean of ROE on internal control wasdetected. These results of the study seem to be in congruence with those of some ofprevious studies in some instances. That is, as we mentioned in the theoreticalframework, there is a positive relationship between internal control in general andprofitability.Thehighdegreeofcompliancewithinternalcontrolrequirementshelpsinthe achievement of internal control objectives. The achievement of internal controlobjectives provides a solid ground for enhancement of profitability (Postan, 2010;Williams, 2005; Venables and Impey, 1991; Greenley and Foxall, 1997). Manyresearchers suggested that internal control is expected to act as a power that preventsdeviationsfromthepredeterminedobjectivesandpoliciesoforganizations(Bejide,2006;Conard, 2003; Hermanson and Rittenberg, 2003; Okezie, 2004). This part of our resultsTable X.Regressioncoefficients (Internalcontrol and PM)VariableUnstandardizedcoefficientsStandardizedcoefficientstSignificanceCollinearitystatistics?Standard error?ToleranceVIFControlenvironment0.1570.3120.1240.5030.6190.5231.912Risk assessment0.2940.2890.2611.0150.3180.4792.086Controlprocedures0.3340.4450.2350.7500.4590.3233.100Information andcommunication0.2170.5080.1380.4270.6730.3023.311Monitoring0.2750.3640.1710.7560.4560.6211.610IJCOMA25,2212Downloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)suggeststhatinternalcontrol,ifeffectivelyimplemented,canenhancetheorganization s performance in certain issues. Accordingly, we may argue that theimplementation of internal control activities related to assets and to the ownersequity,in general, is effective and therefore the impact of internal control on ROA and ROE isstatistically significant.However, the analysis shows that the effect of internal control components on ROAandROEisnearlythesame.Theanalysisrevealedthattheeffectofriskassessmentandcontrol procedures on ROA and ROE is significant, while the effect of controlenvironment, information and communication and monitoring is insignificant. Thestatistically significant effect of some components of internal control over profitabilityseems to support the idea that there is an effective implementation of some internalcontrol activities, while the insignificant effect supports the idea of ineffectiveimplementation of internal control activities in some instances.Second,theanalysisrevealedthat,ingeneral,thereisapositiverelationshipbetweeninternal control and EPS, that is, the higher the compliance with internal control, thehigher the EPS. However, no statistically significant linear dependence of the mean ofEPS on internal control was detected. The detailed analysis of the effect of internalcontrolonEPSrevealedthattheeffectofriskassessmentandcontrolproceduresonEPSis significant, while the effect of control environment, information and communicationand monitoring on EPS is insignificant.Similarly, the analysis showed that there is a positive relationship between internalcontrol and PM. In other words, the higher the compliance with internal control, thehigheristhePM.However,astatisticallyinsignificantlineardependenceofthemeanofPM on internal control was detected. Additionally, the detailed analysis of the effect ofinternal control components on PM revealed that the effect of control environment, riskassessment,controlprocedures,informationandcommunicationandmonitoringonPMis insignificant. These results seem to agree with some previous research findings(Kiabel, 2012; Mawanda, 2008) that concluded that the effect of internal control onperformance is not statistically significant. However, these results are not incongruentwithmanyofthoseofpreviousstudiesinsomeissues(Aigbe,andJames,2011;KimandYoon, 2007; Wijewardena et al., 2004), that is, these studies suggested a statisticallysignificant relationship between internal control and performance in general. OurresultsshowthattheeffectofinternalcontrolonEPSandPMispositivebutstatisticallyinsignificant, and the effect of internal control components on these measures ofprofitabilityisalsostatisticallyinsignificant.Thisresultmayleadustosuggestthattheimplementation of internal control activities is not reasonably effective at all times andin all directions. We have to remember that regardless of the power of internal controlsystems, there are some limitations for any internal control system that may prevent itfrom achieving a high degree of effectiveness, that is, we receive only reasonableassurance of the achievement of internal control objectives (Elder et al., 2012; IFAC,2012a,2012b;RittenbergandSchwieger,1997).Therefore,evenwhenwefindthatthereis a high degree of compliance with internal control requirements, the limitations mayreduce the effectiveness of internal control in the achievement of the companiesobjectives.Basedontheresultsofthestudy,theresearcherswouldrecommendthemanagersofshareholding companies to concentrate on internal control systems with all theircomponents,tomaximizethewell-beingoftheirentities.Evenwhenwefoundthatthere213Impact ofinternalcontrolrequirementsDownloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)isahighdegreeofcompliancewithallcomponentsofinternalcontrol,wefoundthattherelationshipbetweenprofitabilityandcontrolenvironment,informationandcommunication and monitoring is positive but insignificant. The insignificantrelationshipbetweeninternalcontrolandsomemeasuresofprofitabilitymaydirectourattentiontousbeingcarefuloftheproperimplementationofinternalcontrol.Thatisthecompliancewithinternalcontrolrequirementsmaynotleadtoeffectiveimplementation.We may have a proper designed internal control system but not properly implemented(O Leary et al., 2006). The other idea we need to consider is that there are many otherfactors that may influence the performance and result in reducing or improving thepower of internal control in persuading the objectives of the organization. For exampleWelsh et al. (2013) found that management practices, marketing capability andtechnological capability of microenterprises have a positive impact on performancesales,netprofitandgrowth.Kungetal.(2013)statedthatdifferentiationstrategieshavea significantly positive influence on the performance.Regarding this issue, we suggest that the management of Saudi shareholdingcompanies should review the effectiveness of the implementation of internal controlrequirements, especially those related to control environment, information andcommunication and monitoring. It can be argued that the compliance with internalcontrol requirements and, at the same time, the insignificant relationship with somemeasuresofprofitabilitymeanthatthemanagementofSaudicompanieswereunabletoconcentrate on the effectiveness of the system in all directions and issues and unable toachieve efficiency improvement in operating activities. The IFAC (2012a, 2012b) statedthat: internal controls can only work effectively when they, together with the risks they aresupposed to modify, are clearly understood by those involved. Therefore, controls should notbe documented and communicated in isolation but integrated through formal and informalchannels into the elements of the management system in which they are intended to operate,including the related objectives, activities, processes, systems, risks, and responsibilities.Finally, we can argue that the results of our study would also suggest new evidence ofthe relationship between internal control and profitability in a Middle Easternenvironment, which may suggest that there is a need to expand this study using othermethodologies to delve into the depths and understand this phenomenon within itscontext. That is, the results, which are to some extent contradictory to some previousresearch findings, may point to the fact that there are some contextual factorspreventing internal control from promoting performance in all instances and regardingall issues (Serrasqueiro and Nunes, 2008; Weiner and Mahoney, 1981; Grinyer et al.,1980). The impact of internal control on organizations performance may varydependingonorganizationspecificfactors,includingsizeandthenatureofitsactivitiesbesides the macro factors.ReferencesACCA(2010),“Ethicslinkedtobetterbusinessperformance”,availableat:/allnews/national/zimbabwe/ethicsAigbe, A. and James, E.M. (2011), “Bank monitoring, profit efficiency and the commerciallending business model”, available at: /science/article/pii/S0148619511000531IJCOMA25,2214Downloaded by DALIAN UNIVERSITY At 04:25 19 April 2017 (PT)Ashbaugh-Skaife, H., Collins, D. and Kinney, W. (2008), “The discovery and reporting of internalcontrol deficiencies prior to SOX-mandated audits”, Journal of Accounting and Economics,Vol. 44 Nos 1/2, pp. 166-192.Altamuro, J. and Beatty, A. (2007), “Do internal control reforms improve earnings quality?”,Working Paper, The Ohio State University, Columbus, OH.Bdard, J. (2006), “Sarbanes-Oxley internal control requirements and earnings quality”, WorkingPaper, Bentley College.Bejide,O.(2006),“Internalauditproblemsandpossiblesolutions”,CMDWorkshoponAuditinginPrivate and Public Sector Organizations, Ikeja, pp. 14-18.Berrone, P., Surroca, J. and Tribo, J. (2005), “Corporate ethical identity as determinant of firmperformance:atestofthemediatingroleofstakeholdersatisfaction”,WorkingPaper05-31,Business Economics Series No. 8.Brown, L. and Caylor, M. (2006), “Corporate governance and firm performance”, Journal ofAccounting and Public Policy, Vol. 25, pp. 409-434.Brown,N.C.,Pottb,C.andWmpener,A.(2008),“Theeffectofinternalcontrolregulationonearningsquality:evidencefromGermany”,UniversityofSouthernCalifornia,LosAngeles,CA.Chirwa,E.W.(2003),“DeterminantsofcommercialbanksprofitabilityinMalawi:aco-integrationapproach”, Applied Financial Economics, No. 13, pp. 565-571.Conard,C.(2003),“Stemmingthetide:corporatediscourseandagendadenialinthe2002corporatemeltdown”, Organization, Vol. 10.Corici, M. (2009), “The impact of the information and communication technology as a factor ofinfluence on organizational performance”, Journal of Social Information, Vol. 6 No. 12,pp. 22-42.COSO (2011), “Report of the national commission on fraudulent financial reporting”, available at:/Publications/NCFFR.pdf (accessed 23 March).Dechow, P.M., Weili, G., Larson, C. and Sloan, R.G. (2011), “Predicting material accountingmisstatements”, Contemporary Accounting Research, Vol. 28 No. 1, pp. 17-82.DeFond, M. and Jiambalvo, J. (1991), “Incidence and circumstances of accounting errors”, TheAccounting Review, Vol. 66, pp. 643-655.Eiseberg, M. (1998), “The board of directors and internal control”, Cardozo Law Review, No. 19,pp. 237-264.Elder, R.J., Beasley, M.S. and Arens, A.A. (2012), Auditing and Assurance Services, An IntegratedApproach, Prentice Hall.Greenley,O.E.andFoxall,G.R.(1997),“MultiplestakeholderorientationinUKcompaniesandtheimplications for company performance”, Journal of Managem
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