Question

A technological failure occurred at KIBO Company last year. A new computer system which was designed to control KIBO’s complicated operational facility broke down shortly after it was installed. This meant that the company was unable to carry out production processes normally for several days.

The cause of the failure was later found to have been a system specification error made by John Dew, the operation director and a professional engineer. He had seriously miscalculated the capacity needed for the new system and had ordered a computer system which was unfit for purpose. Not only had this resulted in the loss of several days of production and a loss of loyalty and goodwill from customers and others, it also cost a large amount to repair and upgrade the system to be able to cope with the actual demands placed upon it.

John acknowledged that he had over-ridden normal procurement procedures in purchasing the system. But he was thought by his colleagues to be such a competent engineer, it was not felt necessary for anybody else in the company to discuss the purchase with the suppliers. His fellow directors believed that John would exercise the judgement needed to purchase and implement the new system. Because the system was needed urgently, there was no time to run it in ‘pilot mode’ or to test it on site before it was fully installed. When he was asked about the failure, John said that he decided to buy the system in question because an old friend had recommended it and that he saw no need to take further advice beyond that.

The non-executive directors met after the incident and collectively decided that John, who had nine months remaining on his renewable three-year contract, had lost the confidence of the board and should leave the company at the earliest opportunity. It was decided to move him to a non-critical role until such time as it was possible to remove him as cheaply as possible.

Identify and analyse the key challenges and issues of internal control failure that the nonexecutive directors should look into. Also, suggest the course of action that should be taken. Relevant examples or illustrations should be given.

Answer 1

In the above case, the cause of the failure was found to have been a system specification error made by John Dew who is the operation director and a professional engineer. The incident resulted in the loss of production, loyalty, goodwill, large amount to repair and upgradation of the system.

Management at all levels of an organisation is responsible for ensuring that internal controls are set up, followed and reviewed regularly. These internal control standards are

1. Implementing ethical standards

2. Enterprise risk management.

3. Policies and procedures to run operations and prevent fraud.

4. Establishment of information and communication systems to track oprrations.

5. Quality control.

Reviewing the effectiveness of internal control is a crucial element of the non executive directors or board's responsibilities whereas management must be responsible for developing, monitoring and operating the internal control system. A board should regularly receive and review reports from management on internal control. A board should be responsible for:

1. Assessing how the risk has been identified, evaluated and managed.

2. Determination of any failing and weaknesses that have been reported.

3. Seeking remedy and proper action for such failings and weaknesses.

4. Assesing all aspects of internal control.

5. Monitoring of risk and internal control system.