Unrealized opportunities for business growth

Category: Corporate management

Autor: Rustam Tairov

          Business Life Magazine № 3-4 (69-70) April 2013

Issues concerning creation of the structure of the internal control system (ICS) has recently attracted the growing interest among managers and owners of companies. Changes in the competitive environment, the need to improve the transparency of the business for owners of companies, the crisis and the threat to the economy contribute to increase of interest to ICS as to a tool to improve business performance. Rustam Tairov, gives answers on some questions concerning creation of ICS in companies.

“Understanding what is happening in your business - a very profitable habit” John Reese

- What is the essence of ICS? What purpose is primarily achieved by its implementation?

- ICS is a set of measures (policies, business processes, rules, norms of behavior, and so on) that help improve business efficiency and timely response to risks as well as to timely identify, correct and prevent material errors and misrepresentation for the purposes of financial and management reporting.

ICS covers all the activities of the company, and in a very general form serves to achieve the following objectives:

• Ensuring the reliability of financial reporting;
• Ensuring the reliability of management reporting and any other information necessary for decision-making by the management;
• Ensuring effective use of resources (financial, human, material);
• Ensure compliance with laws and internal rules of the company;
• Ensuring the safety of the company’s assets.

- Which companies, in the first place, may be interested in ICS?

• In my opinion, ICS is a necessity for any business entity. For small businesses, it may be enough to issue some orders that will govern all aspects of the business. The situation is much more complicated in the regions of medium and large businesses. It can be presented by:
• A company with a complex structure of the business (for example, such companies may include various divisions, geographically distant from the place of business administration);
• Companies belonging to the sectors that clearly dictate the high demands of ICS, in view of existence of risks inherent to those sectors (for example, mining companies).
• Holdings and companies with complex organizational structure. ICS is vital for such business entities.

- What are the legal requirements of Kazakhstan with respect to ICS?

- There are not legal requirements governing the ICS in the Republic of Kazakhstan (the RoK), although there are special requirements for individual market entities that form the elements of ICS. For example, the Law of the Republic of Kazakhstan on joint stock companies (JSC) states that JSC can form an internal audit service directly subordinated to the to the Board of Directors of JSC. The Decision of the Board of the Agency for Regulation and Supervision of Financial Market and Financial Organizations approved the Regulations on requirements to the procedure of internal auditing in the insurance (reinsurance) organization. But it should be noted, as is often happens in practice, the existence of the relevant provisions, such as for example, the provisions on the internal audit, corporate codes of ethics and other provisions, does not form ICS and in no way contributes to the efficiency of the business. Unfortunately, we have to make sure that, very often, the adoption of such documents is a mere formality.

Also, we had to deal with some misconception of CEOs, who believe that the passage of the external audit compensates for the lack of ICS, as the audit procedures of ICS are provided for by the audit standards. In fact, International Standards on Auditing (ISA) cover a wide range of issues, including testing of ICS. As required by ISA, the external auditor must inform the management team of the shortcomings in the ICS, but is not responsible for the development and performance of tests of controls that are beyond the ISA. The auditor considers the ICS in order to design audit procedures, but not for the purpose of expressing an opinion on the effectiveness of ICS.

- What are the principles of ICS? How can this be expressed in practice?

- This issue is extensional. Of course, it is the principles of professionalism and honesty. Also, it is the principle of the division of responsibilities, authority and responsibility, the principle of balance control functions and controls, the separation of the functions of performance and control, and others.

In practice, for example, the situation of non-compliance with the principle of separation of functions of performance and monitoring is as follows:

A company orders an inventory of independent specialized company. Attracted consultants present the results of the inventory, expressed by surpluses and shortages. The company’s management instructs the incharge of warehouse to analyze the discrepancies revealed based on the inventory results. The incharge of warehouse, in turn, instructs the work to storekeepers. Storekeepers submit their information and may invalidate the results of an independent inventory. Thus, the assessment of the inventory was assigned to persons with respect to whom the test procedure has been assigned. That is, there is a significant risk that the effect of the control procedures was not reached, and the company used considerable resources to attract independent company.

- What advice could you give to managers of companies who take the decision on the ICS structure?

- The process of ICS structure is divided into the following basic stages: testing - production - implementation - monitoring - improvement.

Of course, the managers of companies who decided to implement ICS, especially for subjects of medium and large businesses must fully assess the scope of the work. In practice, the implementation of all stages can take the time from several months to a year or more, depending on the scope and specifics of the business. One of the common errors made by the management of companies is instruction of development of ICS elements to subdivisions for which the ICS is intended. Most likely, the heads of these subdivisions would try to create the most comfortable conditions of functioning for them, which are not burdened with additional work, in the form of obligations to disclose any further information or additional liability. At the same time, in the case of involvement of independent consultants, employees of such entities, as persons interested in reducing their labor costs, can provide useful information for optimizing procedures.

Also, the introduction of ICS is not a one-time event. ICS is a flexible system that must evolve with the business.

Certainly in ICS structuring, one should be aware of the principle of cost-benefit ratio. The effect resulting from the introduction of a procedure must exceed the cost of implementation and maintenance. The introduction of ICS should not become a goal in itself. The end result is to improve business efficiency, and increase the company’s value.

Of course, first of all, the managers of companies that initiate the implementation of ICS must be ready to work in a new environment, in terms of business transparency, separation of powers and responsibilities, and so on. In practice, sometimes we can observe a situation where managers, verbally standing up for ICS and ready to spend considerable resources for the implementation, are not psychologically prepared to accept these new rules because this is “not royal case”. Accordingly, painstakingly building ICS bottom, they simultaneously destroy it from the top. The higher the degree of readiness of the company’s management to demonstrate meeting the standards and ethics not by words, but by deeds is, the higher the effect of the introduction of ICS will be.

In general, based on our experience, we can say that the issues of ICS in Kazakhstan are very acute, and in many cases remain undervalued by managers and owners of companies, regardless of their form of ownership, organizational and legal forms of business and its scope.