Companies require a solid internal control structure in order to achieve their objectives, improve the efficiency of their operations, obtain adequate financial information, safeguard their assets and make sure they are complying with laws and regulations.
This structure must be continually challenged and assessed to verify it is properly working. When operations change within a company, the structure must be adapted to those changes. As you can infer, this is no easy task for companies’ management. But it is even more difficult when management is far from the entity to be controlled, as when having a foreign subsidiary.
Internal control in foreign subsidiaries must consider situations that may differ from the control structures in your local company. To mention a few:
- Monitoring is not as intensive. Physical distance from your processes will naturally imply less intensive and frequent monitoring. Additional mechanisms must be put in place to ensure the control is effective. For example, more people and authorizations are required when managing cash outflows or authorizing expenses and purchases. The operations become naturally more bureaucratic.
- Cultural differences. Employees in your subsidiary in Mexico might not observe the internal control with the same importance as the holding company. Management may even find ways to override controls thinking it is ok as long as the operations don’t stop, or the financial objectives are met. Timely controls can be delayed, believing they can be implemented later on when operations slow down. Examples of these situations are not doing bank reconciliations or inventory counts.
- A lack or weak control is an invitation to abuse. In any fraud, one of the elements to be found is the opportunity for the individual committing the abuse. Internal controls can be weak, not existent or not monitored. Regardless, the result is the same: the individual will see an opportunity in not having to worry about internal controls. Some examples we have observed during our practice: local management in the subsidiary starts exceeding their authorized expenses, since corporate is not monitoring and amounts in local and foreign currency have different overall impact. Or, upper management share the benefits of their crime with lower management, threatening their good jobs.
- Corruption. Corruption practices vary across countries. While definitely undesirable, this must be acknowledged. Many companies with international operations and subsidiaries have worldwide policies in which corruption will not be tolerated. However, making sure this does not happen requires a stronger effort when a foreign subsidiary is involved. Foreign employees must understand that the company they work for performs differently from what they are used to. They must also learn the worldwide consequences of participating in corrupt practices. But more important, controls should be in place in order to stop illegal payments, bribes or any other legal misconduct.
These are just examples. Furthermore, one thing is to design and implement adequate controls and another to monitor that they are working and being observed. A foreign holding company must increase its monitoring efforts to reduce the impact from geographical distance. A natural tool to increase this monitoring is to search support from an external auditor. The internal control assessment is part of any audit. The scope of the audit can be increased to include more internal control testing. And just from the employees in the Mexican subsidiary knowing that the external auditor, who reports to corporate abroad, will be coming soon, the level of performance and compliance naturally increases.
We have experience auditing Mexican entities of foreign companies and reporting directly to corporate management. Let us know how we can help you increase the internal control on your Mexican subsidiary.