ANALYSING THE INFLUENCE OF INTERNAL CONTROL COMPLIANCE AND COMPENSATION SYSTEM

AGAINST UNETHICAL BEHAVIOR AND ACCOUNTING FRAUD TENDENCY (Studies at State University in
East Java)

By: Siti Thoyibatun Universitas Negeri Malang Email: drb 112@yahoo,corrt

Made Sudarma Universitas Brawijaya Malang

Eko Ganis Sukoharsono Universitas Brawijaya Malang

Abstract

This study aimed to test and obtain empirical evidence of the influence of internal control compliance
and compensation system to the unethical behavior and the tendency of accounting fraud. Research
was conducted at universities under the auspices of the Ministry of National Education and Ministry of
Religious Affairs in East Java. Survey was carried out against all the respondents consisting of officials as
budget users, accounting implementer and all parties involved in the preparation of accountability
report. Of the 330 questionnaires distributed there are 146 returned (response rate 44.24%). Of these
only 130 are worth analyzing. The results of the analysis led to the conclusion that internal control
compliance negatively affects the unethical behavior and the tendency of accounting fraud. While,
compensation systems do not affect the unethical behavior, however compensation systems have a
positive impact on accounting fraud tendency.

Keywords: Internal Control compliance, compensation systems, unethical

behavior, accounting fraud tendency

LIntroduction

Accounting Fraud Tendency (AFT) has been received a lot of media attention as an open and widely
occurance dynamic. There is opinon that AFT is interchangeable with corruption tendency in definition
and terminology due to the involvement of several elements that is consist of disclosure of fallacious
facts, violation of rules or entrusted trust, and omition of critical facts (Soepardi. 2007:24). AFT is
indicated from the form of deliberate policies and actions for the purpose of deception or manipulation
to the detriment of other parties. AFT includes various forms, such as the tendency of corruption,
misuse of assets tendencies, and disclosing a deceptive accountability reports tendencies.

AFT cases in Indonesia occurred in the private sector or public sector was virtually the same shape, only
differ in terms of place or object alone. In the public sector, AFT is in the form of budget leak. For
example, the case of Budget Regional (APBD) deviation involving a former deputy chairman of
parliament Sidoarjo for 1999-2004 period and a number of other members, deviation of Parliamentary
budget of Malang Regency for 1999-2004, Regional budget manipulation of Blitar district by the head of
finance and the regent of Blitar, and abuse of general allocation funds (DAU) in 2001 in Sumenep
involving the district secretary, and misuse of credit funds for Farmers (KUT) which involves the head of
Parliament of Sidoarjo for the years 2004-2009 (www.tempo interaktifcom.id March 23, 2005,
www.tempo interaktitcom.id December 30, 2004).

Several government agencies as a public institution do not depart from such condition. The condition is
characterized by the results of TA project reports of 2004 and 2005 showed that the Internal Control
Compliance (SPI) has strived to improve control over the activities but not sufficient to prevent
irregularities and weaknesses in financial management (BPK, 2006). Other forms is discovered from the
results of compliance testing that revealed the existence of non-material items that have an impact on
the fairness accountability report (BPK, 2005 and 2007).

Agency theory describes the organization as a cooperative relationship between principals and agents
(managers) based on the agreed contract (Jensen and Meekling, 1976). Both sides base their
cooperation objectives for the interests of achieving material utility in order to realize its existence as
homo-economicus. These conditions allow the clash of interests between both sides as each wanted to
achieved maximum benefit for themselves. Conflict of interest raises the possibility that managers to
behave unethically and tend to conduct accounting fraud as a step to defend their interests.

Managers as individuals is no different from normal human being in general, which have self-interest to
achieve his own welfare. Therefore, when there is a conflict between managers and principals so that
the manager's behaving away from the agreed contract, the contract can be improved through revision
on compensation system and increase the cost control through re-designing Internal Control System
(Baiman, 1990).

Based on the above assertion, it can be expected that if the compensation and the proposed IC is
considered adequate, the occurrence of unethical behavior and AFT can be suppressed. However, base
on the fact that occurred in public companies and State Owned Enterprises (SOEs) in Indonesia show
differenct case. On those agencies, it is found that even when the compensation is adjusted and is
considered adequate but it is not reduce unethical behavior and AFT (Wilopo, 2006). This is not
consistent with previous findings which say that adequate incentives will be sufficiently surpress AFT
and unethical behavior (Wang, 2002).

Therefore, this study intended to explore the perceptions of accounting implementer, preparer of
accountability reports, and the parties involved in the use of budget to analyze the effects of ICS and
Compensation system against unethical behavior and aft on a different object, that is State Universities.
The difference with previous studies are: (1) the indicator of compensation system from previous
research is based on physical performance as a key factor, whereas in this study is based on physical
performance and ethics, (2) previously internal control effectiveness is measured based on Standard
Professional for Public Accountant or SPAP (IA!, 2001 ), whereas in this research it was added with
checklist of COSO (1998) to measure the effectiveness of the participant for ICS, (3) previous research
used abusive behavior of management in resources use to measure unethical behavior, it is not used
anymore because it overlaps with the indicator of AFT.

As for the research questions are: (1) Does the objectives of Internal Control Compliance negatively
influence unethical behavior? (2) Does the objectives of Internal Control Compliance negatively affect
the AFT? (3) Is compensation system negatively affect unethical behavior? and (4) Is compensation
system negatively affect AFT?

2.Literature Review and Hypothesis Development

Accounting Fraud Tendency (AFT)

The tendency is defined as "more interested in ..."; but not always interested in ... (Daryanto, 1997:138),
who concluded that the behavior has consist a lot of values towards the things that he is interested in.
Thus, AFT has been interpreted as a fraud regardless of its degree since fraud was not raised
continuously. Therefore, the study of previous research in this study was based on various studies that
focus on fraud issues.

IAI (2001) describes accounting fraud as an inaccurate financial reporting and assets. In relation to
financial reporting, the forms of AFT are: (a) manipulation, falsification, or alteration of accounting
records or supporting documents as a source of data for financial statements disclosure, (b) any false
representation in or omission from the financial reports of events, transactions, or other significant
information, and (c) any intentional application wrong accounting principles relating to amount,
classification, presentation. or disclosure. Inaccuracy of assets may be in the form of theft, or misuse or
improper treatment of assets supported with false documentation or misleading and concerning one or
more individuals among management or employees, or any third party.

The explanation shows that the accounting fraud by the management can be done by using a variety of
sources both in the form of counterfeiting fraud or concealment of evidence of the transaction, the
presentation of information and financial reports that are not true, or misstatement due to improper
treatment of the asset (Lin et al., 2003).

Interpretive study based on theories and approaches commonly used in criminology, discuss issues of
accounting fraud as an integrative form influenced by the existence of crime deliberately aimed at the
organization, lack of social institutions and regulation, and the results of observation by person or group
of people on their environment. Empirical evidence shows the existence of AFT in the private sector or
public sector in nearly the same form (Khera, 2001; Wilopo, 2006; CPC, 2005 and 2007; and www.tempo
interaktitcom.id March 23, 2005)

Unethical behavior

Unethical behavior is behavior that deviates from the main task or goal that has been agreed upon (Dijk,
2000: 297). So, unethical behavior should not be morally acceptable in the general community since it is
resulted in danger to others and the environment (Beu and Buckley, 2001). In practice unethical
behavior has a complex pattern. The complexity symptom of unethical behavior depends on the
interaction between personal characteristics with the appearing social phenomena , environmental, and
complex psychological factors (Buckley et al., 1998:284). Therefore, it is sometime difficult to describe
the pattern of unethical behavior.
 In previous studies it is mentioned that the unethical behavior consist of abuse of official position,
organizational resources, power, and passive behaviors with respect to position and power (Tang and
Chiu, 2003). In this study the behavior of misused of organizational resources are not used as an
indicator of unethical behavior because it is part of AFT. Dallas (2002) suggests that unethical behavior
resulted in unhealthy climate in the workplace and encourage the emergence of AFT (Victor et al.,
1993), and interfering performance accountability (Dijk, 2000).

The Impact of Internal Control Compliance on unethical behavior and AFT.

Organizations need to demonstrate the expected behavior in the more clearly forms through the ICS and
instill the understanding to every individual in the organization that their activities will be compared to
the standard (Beu and Buckley, 2001). If internal control is implemented effectively, ethical values will
be integrated with the behavior of members of the organization so that the appearance of unwanted
behavior (not ethical) can be compressed (D'Aquilla, 1998; D'Aquilla, 2001).

Implementer of ICS forms a particular work pattern, which affects the employee's decision style (Sims
and Keon, 1999; Touby, 1994). Internal control is a process that can assure the reliability of financial
reporting because ICS describes a set of rules or principles that guide the action of members of the
organization in order to cultivate the habit of ethical behavior (Schminke, 2001; Boynton et al., 2002).

H.1 : The objectives of Internal Control Compliance is negatively affect unethical behavior.

H.2 : The objectives of Internal Control Compliance is negatively affect AFT.

The Impact of Compensation System on unethical behavior and AFT.

To resolve the conflict in order to control the behavior of managers hence they consider the interests of
principals is by revising the contract through a correction of the compensation management system
(Jensen and Meekling, 1976; Watts and Zimmerman, 1986; Baiman, 1990). If the planning of incentive
structures is improved, it will affect how managers behave in achieving performance (Luthans, 2002).
These influences on certain conditions have a positive direction (Conyon and Peck, 1998) and the other
conditions have negative relationship with the profitability of the organization but has a positive
relationship with growth and size of organization (Abdullah, 2006).

H3: compensation system is negatively affect unethical behavior.

H4: compensation system is negatively affect AFT.

3. RESEARCH METHODOLOGY

3.1. Types of Research

Type of research: the confirmatory survey research (Newman, 1991:128,150). Focus: studying the
behavior of managers and all staff who received the delegation of authority and duty to be involved in
preparing performance accountability report based on the rules applied under their own opinions. Data
collection is using a questionnaire (Appendix 3) in four months (July to October 2008). The models to be
confirmed are:

Yi = a + LOCI+ b2X2+ e

Y2 = a + biX, + b2X2+ e

Where:

Yi = unethical behavior

a = intercept

b1-b2= regression coefficients

Xi = Internal Control Compliance

X2 = Compensation system

3.2. Research Object.

AFT is expressed through the organization of accounting and accountability reports presented by each
accounting entity. Therefore, the unit of analysis in this study was an officer and all parties who received
the delegation of authority and responsibility to engage in the use of budgeted funds, the implementer
of accounting, and preparer of accountability report.

All populations are given the opportunity to fill in the questionnaire to obtain information relating to all
the existing diversity. As for the respondents: chairman, chief financial officer, head of the
administration, official of general affairs and equipment, and official of financial affairs and personnel
that have direct involvement with the use of budgets, implementation of accounting and accountability
report preparation (PP no. 23/2005 Article 32: 22).

Of the 360 questionnaires sent, only 146 returned (response rate = 40.56%). There are 130 responses
worthy of analysis and fully filled. The number of respondents and questionnaire is presented in Annex I.

3.3. Research Variable: Measurement, Operational Definition, and Indicators.

All variables except for performance accountability are measured by Liken scale of 1-5 as a measure of
the response (Hartono, 2004: 66-67). The data for performance accountability as observable variable is
obtained in the form of percentages. Operational definitions of variables are as follows:

I. Unethical behavior is behavior that is not classified as legal and morally acceptable within the
organization concerned.

2. Accounting Fraud Tendency, is the existence of indicator, the direction of behavior, or other signs that
prove the occurrence of deliberate errors in action and policy in presenting the disclosure in financial
report and asset management for the purpose of achieving personal benefit/interest and make the
other person as the aggrieved victim.

3. Performance Accountability, is the percentage of achievement of targets as a form of implementation

of tasks on the authority and responsibility delegated to him.

4. Internal Control Compliance is the compliance level on Internal Control that are developed and
efforts of people involved in supporting the goals of ICS, which is to provides sufficient confidence in
achieving effectiveness, efficiency, compliance to rules and regulations. and reliability financial
statement presentation.

5. Compensation system is the determinant of the number of standard honorarium and other facilities
(other than the welfare as the basic salary) as the right of managers based on their own interpretation.

Indicators of each variable was developed based on previous research after it was determined that the
selected indicators have substantial validity when compared with previous research indicators.
Indicators are presented in Annex 2 (the condition after the pilot-test instrument).

3. RESULT AND DISCUSSION 3

3.1. Validity and Reliability Test of Questionairre

Testing research instruments both in terms of validity and reliability of the 33 respondents pilot study
showed that the instruments used are valid. The correlation value is greater than 0.3 (Masrun in
Sugiono, 2002) and the coefficient of reliability (Cronbach Alpha) is greater than 0.6 (Sekaran, 2003). The
complete validity and reliability tests are presented in Table I. attached.

3.2. Classical Asumption Test

3.2.1. Normality Test

The results from Kolmogorof Smirnov Test (see Table 2) have shown that the normal distribution of the
model has the probability value of 0570 and 0604 (0.570, 0.604> 0.05). Therefore, Multiple Linear Model
Regression can be used.

3.2.2. Serial Correlation Test

Based on the results of DW calculations by using the regression (see Table 3) shows that there is no
serial correlation between residuals, so that the variables are independent (no serial correlation) this is
indicated by du < dw < 4-du (1.760< 1.953, 2.089 <2.240).

3.23. Heteroscedasticity Test

Heteroscedasticity test in this research is done using gleijser test. From Table 4 it can be concluded that
the Internal Control Compliance and compensation system on the absolute residual reveals no
heteroscedasticity base on Limb., smaller than LI*.

3.2.4. Multicolinearity Test

To detect the existence of multicolinearity can be seen from the Variance Inflation Factor (VIF). From
Table 5 it can be concluded that for the variables (Internal Control Compliance and Compensation
System) does not incur multicolinearity since VIF values is less than 10.

3.3. Result and Interpretation

3.3.1. The Impact of Internal Control Compliance on Unethical behavior

The results of data analysis showed the regression coefficient of -0344 with calculated t value of-5816.
This value is smaller than t table (-5816 &It;-1970). so that HI is not rejected. These results indicate that
the Internal Control Compliance has significant negative impact of unethical behavior.

The findings are consistent with the opinion Beu and Buckley (2001) that an environmental impact (as
one component of internal control) on the effort to suppress the appearance of unethical behavior. This
finding is also consistent with the findings of D'Aquila (1998) that the existence of unethical behavior
and corruption in the accountability report is due to the intention or desire to behave incorrectly, and
due to the chance to do right is not being used.

These results are also consistent with the Sims and Keon (1999) and Schminke (2001). Sims and Keon
(1999) examine the impact of organization environmental on the decision of the employee. Research
shows that organizations that provide encouragement to made decisions that is ethical, led the workers
to incline on ethical alternatives as well. Schminke (2001) also reported that the organization that has a
set of rules or principles as guidance for the desired behavior, the organization will have a mechanistic
structure and will have stronger ethical framework for members of the organization.

3.3.2. The Impact of Internal Control Compliance on AFT

The results of analysis showed the regression coefficient of -0382 with calculated t value of -5332. This
value is smaller than t table (-5332 < -1970), so H2 is not rejected. These results indicate that the
Internal Control Compliance has significant negative effect on AFT.

These findings support the findings Touby (1994) and analysis of Boynton (2002) which shows that the
implementation of the ICS is associated with the level of fraud or compliance with the rule-making of
accountability report.

These findings support the analysis in the agency theory and consistent with previous research
conducted by Matsmura and Tucker (1992) and Smith et al. (1997). Matsmura and Tucker (1997)
reported that the quality of ICS affect transaction tests and detailed tests on balance sheet, fraud
detection activities, and events fraud. The more fitting ICS with the goal, the more simple fraud
detection needs to be done. Through a comparative study using comparative statistical analysis, Smith
et al. (1997) also asserted that if the ICS is specifically noted, it will reduce the budgeted audit fees to
audit fraud.

3.3.3. The Impact of Compensation system on Unethical behavior

The results of the analysis showed the regression coefficient of -0087 with calculated t value of -1342.
This value is greater than t table (-1342 <-1970), so H3 is rejected. This result shows that the variable
compensation system does not have a significant effect on unethical behavior.

These findings do not support the analysis and findings of previous research that says that
compensation system negatively affect the unethical behavior (Jensen and Meckling, 1976; Watts and
Zimmerman, 1986; Baiman, 1990). This happened probably due to such salary and wage system in State
Universities is based on fixed standard rules and never base their standards on ethical behavior as a
determinant.

3.3.4. The Impact of Compensation system on An.

The results of the analysis showed the regression coefficient for 0244 with a t value calculated for 3106.
This value is greater than t table (3106 &It;-1970), so H4 is not rejected. This result shows that the
compensation system has a significant positive impact on AFT.

This happened probably due to such compensation system improvements have not applied in
accordance with the wishes of management. These findings differ from previous research. Improved
incentive structure planning will affect the way managers behave in achieving performance (Luthans,
2002). The influence of these on certain conditions have a positive direction (Conyon and Peck, 1998)
and the other conditions have a negative relationship with the profitability of the organization but has a
positive relationship with growth and size of organization (Abdullah, 2006).

5. Conclusion and Recommendations

5.1. Conclusion

This research is intended to re-examine the influence of Internal Control Compliance and compensation
system on unethical behavior and AFT. Research is carried out on officials who have the authority to use
the budget, involved in the implementation of accounting, and making financial reports at State
Universities in East Java. As a conclusion:

I. Internal Control Compliance is negative influence unethical behavior. State Universities as an

institution in this case has developed organizational structure and segregation of duties followed by a
apparent working procedures. This condition is also received support from obliged various parties so
that unethical behavior can be surpressed.
2. Internal Control Compliance is negatively affect AFT. Internal Control Compliance provide the
provisions regarding the procedures to obtain and use the work advances, purchase of equipment and
inventory requisitions, use of facilities owned, and accountability. These provisions apply to the relevant
parties and monitored by authorized officials. Incorrectness of these provisions lead to the subsequent
payment request process in the next month, and periodically it is also evaluate by the BPK. These efforts
is useful in suppressing the AFT.

3. Compensation systems have no effect on unethical behavior. There is a possibility that this happens
because the current compensation system does not fit or do not meet the desire of the officials.
Compensation systems are complex and for Stale University there is fixed state regulation that has a
different method of calculating compensation as compare to the profit-oriented company.

4. Compensation systems have a positive effect on AFT. This is reasonable since the managers in general
tend to be opportunistic. 5.2. Limitations and Recommendations. I. This study only examine the
influence of factors Internal Control Compliance and compensation system. Future research might use
other factors such as moral or spiritual variables that have non-physical dimension.

This research was conducted using survey method. Given the unethical behavior and AFT is a very
sensitive issue and tend to be secretive, it is suggested that this kind of study is equipped with case
studies to obtain complementary information.

REFERENCE:

Abdullah, S.N. 2006. Directors' remuneration, firm's performance and corporate governance in Malaysia
among distressed companies. Corporate Governance. 6:2, 162-174. Baiman, S. 1990. Agency Research in
Managerial Accounting: A Second Look. Accounting, Organizations and Society, 15 (4): 341-371. Beu, D.
and M.R. Buckley. 2001. The Hypothesized Relationship Between Accountability and Ethical Behavior.
Journal of Business Ethics, 34:57-73. Boynton, W.C., R.N. Johnson, and W.G. Kell. 2002. Modern Auditing
2001. John Wiley & Sons Inc. Terjemahan: Rajoe, P.A., G. Gania., dan Budi LS. Erlangga. Jakarta. BPK
RI/Auditama III. 2005. Laporan Auditor Independen (terhadap lapomn keuangan UGM). www.hpk.go.id.
27 Mei 2007. BPK RI. 2006. Hasil Pemeriksaan alas Projek Peningkatan Perguruan Tinggi Agama (UIN
Sunan Kalijaga Yogyakarta). www.hpk.go.id. 27 Mei 2007. BPK-RI. 2007. Hash' Pemeriksaan atas
Pengelolaan dan Pertanggungjawaban Kettangan TA 2005 dan TA 2006 pada Universitas Udayana di Bali.
www.bpk.go.id. 27 Mei 2007. BPK-RI. 2007. Hasil Pemeriksaan alas Pengelolaan don
Perianggunglawaban Keuangan TA 2005 dan TA 2006 pada 1PB di Bogor. mmajabaspaki. 27 Mei 2007.
Buckley, M.R., D.S. Wiese., and M.G. Harvey. 1998. An Investigation into the Dimension of Unethical
Behavior. Journal of Education for Business. 98/5: 284-290. Conyon,M.J., and Peck, S.I. 1998. Broad
Control, remuneration committee, and top management compensation. Academy of management
journal. 41 (2):146-157. COSO. 1998. Does your Control System Pass the COSO Test? Publised by the
Institute of Internal Auditors.