Its time for risk consultants to be players with the team on the line. Learn how to achieve innovative advantage using the case studies.
Sunday, August 26, 2007
Audit Committee on Stove
Is audit committee adding any value or is just for statutory compliance? asked the furious chairman, who had been advised recently about the abnormal functioning of some of the non-financial performance measures. He said I know you all are really independent but, are you performing your oversight function as expected? Although the firm has been certified by the external auditors for effectiveness of its financial accounting controls during the past years, these controls have inherent limitations when looked at in silos. It is high time for the audit committee to look at non-financial performance measures as well.
He further said that the stakeholder expectations are very high nowadays. Not just the financial accounting controls but the entire gamut of management accounting controls needs to be looked at. Those who design and implement controls can also override or bypass these controls. The audit committee members began to wonder how they could have met the expectations better. Audit Committee members while justifying for their current way of functioning emphasized on having, a written code of conduct and its communication at all the levels of management to prevent overriding and bypassing of controls and a hotline programme. Though the chairman considered the importance of these steps, he wanted the audit committee to become more smart and business like. He wanted the audit committee to add value.
The board room conflict was in the open. Surely the members of the board and committee had failed to understand each other's expectations. Another problem was that expectations were not shared and reviewed periodically. The expectation from the audit committee had been changed over time. With their expanded responsibilities, the audit committee members were struggling to fully understand and embrace the scope of their duties, including oversight of risk management and internal controls.
To avoid surprises, the audit committees should understand the importance of defining and agreeing with the board of directors on the scope of their oversight of risk management and internal controls. This scope should be revisited on a periodic basis.
Audit committee members can meet increased expectation by demonstrating the appropriate level of skepticism, asking probing questions, having open discussions with the management and the auditors keeping business perspective in the mind. Audit committee should also target non-financial measures and various key success factors for monitoring. These key success factors for monitoring should be determined with extensive top management involvement.
The conventional financial accounting reports, both internal and external, are much like a scoreboard at a cricket game. The scoreboard tells players whether they are winning or loosing the game, but does not tell one about what is right or wrong about his batting, bowling or fielding. One must watch the ball in order to get a hit rather than just study the scoreboard. Conduct of the management cannot be monitored effectively just looking at the financials alone; one should see the non-financial performance measures too.
Internal Audit partner and his client, the CEO had arranged pow-wow among their teams to encourage an open discussion on the bitter auditor-auditee relationship. At the pow-wow, the marketing manager made a remark that although one should never minimize findings or neglect ones obligation to report accurately, too many internal auditors needlessly drive a wedge between themselves and their auditees by presenting findings in a way that belittles the auditee instead of treating findings, analysis, presentation as an opportunity to address problems and to facilitate improvements. The purchase manager added that internal auditors always act as policemen and come with backing of authority.
To this, one audit manager answered that the business managers will have to begin to look internal audit as an objective consulting group and not just an independent assurance group. Answering to the concerns of the marketing manager, he said that part of the problem is that internal audit also has a stereotype like business managers and an education process is needed for both, the auditor and the auditee. He also said that our source of authority is our ability and independence whereas business managers think that we are in the organization to appraise them for their performance and thus our reports with suggestions are treated as report with coercion by them.
The CEO said that Internal Auditor should keep management informed of the progress of their work along the way. Letting management know what they are finding allows them to take action and fix problems while the audit is still in progress. We need 'No Surprises'. Also, internal auditors don't leave considerable time open in the audit schedule so that we can make special requests.
The IA partner replied that our terms of reference and scope should be clearly interpreted as the management inevitably try to prevent audit encroachment onto the 'management patch' and thus try to restrict us to the policeman's role, whereas we view our role as that of the independent reviewer covering all areas and levels of operations, decision making and governance. We agree that Internal Auditors should employ a just-in-time approach in setting up their audit plans for adjusting special requests of its clients, but at the same time, they expect from auditees to co-operate and respect their time.
The CFO said that both auditor and auditee have their own perception regarding one another's needs. Also, they have an expectation as to the nature of their relationship. I have closely seen both the sides in my life. This bitter relationship soon motivates young internal auditors to seek career elsewhere. This is also one of the reasons; the audit industry is seeing a huge turnover of young professionals. Internal auditing's success in the next millennium will depend on providing its audit clients with unique and exceptional services. We need to listen to each other innovatively. Such pow-wow is definitely a step in this direction. The pow-wow continues...
Like every year, this year too, the ERM meeting by Chief Risk Officer was not very interactive. The external consultants who were present at this year's meeting with their vibrant presentation even could not engage the senior managers present to contribute to 'to be' Enterprise wide Risk Management System (ERMS). The senior managers at the meeting didn't ask searching questions and they didn't debate but were just sitting passively watching the nicely made power point presentation. The meeting soon got over before the lunch hour and the managers left with no commitments whatsoever.
Two weeks later, when annual budget and operating plan for the next year was on the table of CEO; inherent conflicts of interests were visible. All the line managers had strongly presented their cases for granting excess budgets for their activities. They had confirming information for their decisions which they had already committed of making. All had justified their future action plans without any sort of critical evaluation in light of any disconfirming information.
The Production Head wanted to have full capacity utilization with stable production schedules for bringing major cost saving for the assembly unit whereas Sales Head was pressing for having wide range of products with different sizes so as to increase chances of making a sale. Unlike others, CFO had envisaged lower economic growth ahead and was worried about inventory built-up and additional cash outflow on account of discounts and promotional activities. Many managers have tendency to be over optimistic or unnecessarily pessimistic when their incentives are linked to their specific functional achievements and thus they tend to discount the information that might lead to conclude that their plans were biased and not in synchronization with other functions.
Something was definitely missing. A moaning Risk Management System which critically validates assumptions. If you want to reduce risk in your business, you have to seek both confirming and non-confirming information before you take action. This helps the firm to make intelligent trade-offs based on reality. But most of the time the problem is lack of platform that encourages open debating of the assumptions made by the managers and their by challenging of each assumption by cross functional leaders at granular level with penetrating questions.
Is Chief Risk Officer responsible for seeking disconfirming information or decision makers themselves are to seek such information compulsorily while making any decisions as a process? Who will conduct a meeting for challenging their own assumptions openly? Who will make correct trade-offs? Who will see the entire Elephant of Enterprise wide Risks? Audit Committee!!! I don't think so. Debating in group will only construct and share a comprehensive picture of enterprise wide risks. Only open and guided discussions will encourage commitment to execute with accountability and develop respect for each other.
Yes. Respect and unity within a business team are the missing elements. No one can claim, not even any sort of Committee, of having a vision of the entire Elephant of Enterprise wide Risks. Yes. ERMS too needs integration with the entire body/soul of knowledge system, the biggest of elephant ever known to business kinds.
Mr. Rao, the Chief Internal Auditor of a five star hotel chain was stunned to hear Anil, a young audit executive, who wanted to expose various incorrect practices that were being carried out by the chef-in-charge of one of the hotel properties of the chain. The Chief Internal Auditor and General Manager of the property told him to shun the findings as the chef had been selected as best chef of the year for achieving record favorable food cost percentage. The chef-in-charge's performance was evaluated based on food cost percentage, a relative measure of Food & Beverage (F&B) cost and F&B revenue
Disappointed Anil from the co-sourcing IA firm finally decided to make a note of these findings in the permanent audit file for future reference when he found out that there was no way he could blow a whistle.
The inventory system of the chain provided for outlet-wise ordering and food costing. The chef-in-charge ordered for the high food cost items in name of the outlet, where sales margins were higher. In such cases no accounting had been done for inter outlet transfers and thus benefit of incorrect indenting were transferred to inefficient outlet so as to meet the targeted outlet-wise food cost percentage.
Many times chef-in-charge had been issued with high value raw materials on basis of post dated requisition by the storekeeper to be charged in subsequent periods to avoid reporting of adverse food cost percentage during current appraisal period.
Calculation of food cost was being done after adjusting cost of hospitality checks i.e. check raised for free food served. Thus, food cost percentage was calculated incorrectly, measuring efficiency of the operations of the outlet. Evidences were found of incorrect adjustment of wastage, spoilage and leakage in food cost through hospitality checks. This was done to keep these costs out of the books to achieve a better food cost percentage.
Thus, a non deserving chef had been selected for the award based on the KPI which was manipulated and miscalculated.
Many hospitality players nowadays are implementing latest POS and material management system but they lack proper management accounting practices. With increased empowerment they have achieved innovation but gaps exist in understanding of evolution of control system. It is not enough that the management just sees, touches, smells, tastes and hears the relationship between input and output or oversees the behavior of various personnel. A structured monitoring, end-to-end analysis of completeness, activity based management is a must to add value.
