Background Accounting scandals are business scandals which occur when the financier] statements are being manipulated intentionally hv executives of a camper\". with false and misleading information. The financial I'l'llSI'Epl'EE-ii'llatigp includes such activities as overstating profit, understating expenses or underreporting the existence of liabilities. It involves an employee, an account or a corporation that provides the misleading financial information to investors and shareholders. These accounting scandals occur because at the poor corporate governance structure and svstem in such companies. This case concerns the accounting scandal in a multinational grocery store. known as Aroma PLC, that is based in the UK. The accounting scandal happened due to poor corporate governance and the issue of aggressive accounting for commercial income. The poor corporate governance is because of the board of directors' lack of competencies. The board at directors is a group of individuals selected as representatives of the company who establish a policy of management to make a decision on major issues. The board of directors, which is responsible for the effectiveness of the organization's internal control system, has failed to monitor the business operations of Aroma due to a lack of business knowledge and skills to govern the company. This case highlights the issues revolving around pom corporate governance practices. as well as the inefficient role of board of directors and related parties to support business activities in Aroma. Issues highlighted Main concerns of this case study: I The coll-porate governance in the Empanp z The re e of the regulators and . scandal problem stakeholders in curbing the accounting 3 The relationship between retailer and suppliers 4 The accounting for commercial income in the retail industry.' Abstract The basis [if \"115 C359 Studv is to show the causes of the weaknesses of corporate governance in a company that could encourage unethical actions taken by the management. in the interest of the company or for individual interest. The issues are only being investigated after one of the staff in the company.t became a whistle-blower to bring forward an accounting scandal which Occurred after the new management was structured. Strong corporate governance is needed in order to ensure the high performance and the integrity 0f the CmPar, and to improve stakeholder perception of the company. Synopsis Aroma is a transnational grocery and merchandise retailer in Great Britain res to everv corner of the world. that is aggressive on expanding its retail sto The company progressed well until September of 2015 when Aroma had admitted that the company had manipulated HF? million of profits by using aggressive accounting in profit recognition. After the company appointed hrough information a new CEO, Derrick, this accounting scandal emerged t received from an internal whistle-blower. After further investigations were made by the auditors. thev found that there was a profit misstatement to 233 million and revealed the past vears' manipulations of commercial income which is a subjective area of accounting in the retail industry. According to Derrick, Aroma's board of directors had failed in their duties to oversee the business operations of Aroma. About Aroma PLC Aroma PLC was founded by Jimmy Low in 1917 as a group of market stalls and the first Aroma store opened in 1927 in the UK. Aroma is a transnational grocery and merchandise retailer in Great Britain and placed as a top-five retailer in the world. Aroma had undertaken the strategy of being a geographical and low-cost provider in order to gain market position 128 Integrated Case Studies for Accounting and compete with other competitors. Aroma sold a wide range of low- cost products such as toys, stationery, electronic appliances, furniture, and telecommunications and internet services. Furthermore, Aroma's retail stores covered ten countries across the Europe and Asia. It was a top-four market leader of groceries in the UK with a market share of around 29.7%. The main competitors of Aroma in this retail industry were Asda, Sainsbury and Morrison. They are Britain's 'big four' supermarkets which included Aroma. Due to the aggressive competition in this industry, Aroma had opened a number of new stores in order to compete with the three supermarkets which had undertaken an aggressive expansion strategy. Aroma found that it was hard to maintain its profit margin in this declining grocery industry due to the growing number of new competitors, aggressive price wars, the growth of online convenience stores and changing of consumers' lifestyle preferences.The board structure Aro ma had twelve directors on the board which consist of ten an-Execuuve directors and two executive directors in 2015. The two executive directors were Chief Executive Officer (CEO) Elliot. who held several positions in Aroma's store management before joining the board and Chief Finance Officer [CFO] Nicholas Ng. who worked before at the Coca-Cola Company and as a Distribution Director in Aroma before joining the board. They were the only two directors on the board who had knowledge and experienceinthe retail industry. The remaining ten board members included the Chairman, John Chong. who worked at TSB Bank before with no experience in retail and Kelly Tan and Michael Wong who had a backgron in audit. Out of the remaining members. three had a background in the nance industry. two in the telecommunications industry. one in the banking industry and another one who worked with goventment before. The lack of retail experts in the board's composition caused concerns about the knowledge and competency of the board when it came to the retail industry. Warnings on profitability In 2015. a few prot warnings were~issued by Aroma regarding its protability. The first warning issued was on ? January 2015 due to the reduction in Christmas sales and the unexpectedly low projected profit. Elliot was the only remaining executive director on the board who possessed retail knowledge and experience since the resignation of Nicholas N3 in April 2015. But Nicholas Ng signed a mutual agreement with Aroma that he would still remain with the company mm the unusual title of 'CFU emeritus' and was not allowed to spread his resignation news to the public before Aroma found a suitable person to replace him. So upon the mutual agreement, Nicholas Ng could receive around $977,700 in October, which included a bonus for the six-month period since he left Aroma. KPMG had heen engaged as an auditor for Aroma for around 30 years, starting from 1987. But in May 2015, KPMG had raised its concerns about the accounting for commercial income in Aroma due to the difficulty in interpreting the uncertainty on how Aroma achieved the sales target and the timeliness of hookings where cash was received earlier before sales were made. But in the end, KPMG was persuaded by the audit committee. The conversation between KPMG and the audit committee on this issue was as follows. KPMG: How did Aroma recognize its commercial income received from suppliers? We have to make a judgement on it because this may contain a risk of overstated profit in Aroma. Audit committee: Recognition of commercial income is not an important area to make a disclosure of in the audit report as long as our management is operated in a controlled wo. environment that can lower the risk in this area. In addition, this non-disclosure would not bring impact to your unqualified opinion on the audit report, so we don't think that it is compulsory to make a disclosure in the report. Subsequently, on July 2015, Aroma issued a second profit warning due to the same reason, where it did not achieve sales and targeted profits as expected, which caused dissatisfaction among shareholders. James, chairman of nominating committee in Aroma, was forced to expel Elliot from Aroma based on the failures to improve Aroma's financial performance in order to resolve the pressure from shareholders. Derrick was appointed as a new CEO in Aroma and at the same time share price rose by 2.7% to 297.70p.The relationship between Aroma and suppliers Normally, the suppliers would supply products to Aroma first and then received payments from Aroma according to the suppliers' term. But the suppliers found that Aroma always deferred the payment to them. According to one of the suppliers: 'I had experienced that Aroma took around three years to pay me back the sum of the owed money.' Aroma also charged a higher slotting fee to the suppliers for their products to be displayed in Aroma's retail stores and to be placed at strategic positions in Aroma shops' shelves. Furthermore, the suppliers would pay promotional costs, discounts or rebates as a reward to Aroma if Aroma helped the suppliers boost the sales target of the products by running promotional offers. In addition, Aroma had provided 27 types of 130 Integrated Case Studies for Accounting rebates for its suppliers. All these kind of payments from suppliers are called commercial income and normally these payments are made a year in advance where the cash will be received earlier than actual sales made. At that time, Aroma was in a bad financial position and the sales were reducing unexpectedly. These reduced its share price in the share market. So it came up with an idea to record the 'bookings' or accrual profit earlier and delay the record of expense or cost accrual in order to make things look healthier than they actually were. It meant that Aroma overstated its profit for the period. Furthermore, Aroma had booked the promotional rebates based on historical volume to avoid missing the targets on volume- driven rebates. Aroma also increased thousands of lines of new products from suppliers to its range in order to increase the income.Internal whistle-blower triggers Aroma's alarm bells According to The Times. an cmelwes wh was 3\" accumam in i\"Gnu. Augustine. blew the whistle on a rear million accounting scandal bill it was ignored in July ants. According to the WhiSHE-hIDWEf. Augustine: Aroma. on this accounting error but I failed to get his attention. Aitenvards. i had prepared a report to notify the CED. Elliot. who still held the position at that moment but in the end1 my mum went missing and i got nowhere. So at the start of September 2015, I knew that the arrival of our new CEO. Derrick. was my last chance to reveal this accounting error. Thus. I approached Derrick and made a presentation to him with a full and complete report about this accounting problem. Fortunately. my presentation raised the concerns of Aroma's general counsel and triggered an investigation.' Augustine continued to express his opinion: 'As an employee of Aroma. I love Aroma yery much so I can't ignore this serious problem and let it be. 1 hope my revelation can benet Aroma. It you gave me a second chance. I sll would blow the whistle even if I lost my job. i believe that we should hold on to our integrity and responsibility and continue to be an ethical person.' After the revelation of the accounting error by Augustine. Derrick made an official announcement on the Monday of the following week: 'Aroma found a serious issue with the overstated prots of 51?? million and we had responded accordingly. As Aroma's CEO. I had called an emergency meeting on the spot and convened a group of senior managers to gure out the consequences of this problem' Dnce the announcement was made. the public lost confidence towards Juent-la and the share prices dropped sharply around Hik- to MIKE? in the EAT]? Mn'ilt trading. Liter. Aroma's Chairman. John Chong. came out to comment: 'I do not know how long this practice had been going on in Aroma but I knew the CFD position in Aroma had been empty for six months. and this accounting scandal may have happened since the resignation of the last CFC}. Nicholas Hg. in April 2-315. As the Chairman of Aroma. I am responsible for this prot misreporting problem so I will respect the shareholders\" decision on whether I should stay on or leaye Aroma. In my opinion. I wish to stay and help Aroma to weather through this key moment but I will always listen to the shareholders' yoice.' After the discovery of the prot misstatement. the CEO. Derrick. had made an internal announcement in Aroma: \"Sadly. I'm making this announcement to inform that three of the executives in Aroma have been suspended for this accounting scandal. They are the managing director. Louis. who has worked in Aroma for 33 years. the finance director. Robert. and the commercial director. Jonathan. Starting from now. they are removed from their current positions and are called on to assist in the investigation. For any further changes. you will be informed in the neat announcement.' The investigation into the accounting scandal After the announcement of the accounting error, Derrick had appointed one of the 'big four' accountancy firms, Ernst & Young (EY), and a famous law firm, FunFire, to launch an internal inquiry at Aroma. According to Derrick: 'Now we are running a bottom-up check for the whole accounting misstatement issue and I hope all of you can give us some time and be patient for our findings. I promise to all of Aroma's shareholders that once we have fully investigated this issue, I will share the information directly with you. At the moment, our business will run as usual and we promise that we will continue to provide the best service to our customers around the world. I have to mention here that this investigation will not have any impact on Aroma's turnover. We have hired a new finance director, Alex, who came from Fortnum & Mason. He will be fully in charge to provide assistance to the group of external investigators for a thorough investigation on the inflated profits and accounting misstatement.'On 7 October 2015, the Financial Conduct Authority (FCA) held a full investigation of Aroma to determine whether Aroma had broken the financial disclosure rules and released false and misleading statements to the Stock Exchange. The FCA has the power to file a legal action against a company that intentionally or carelessly provides false and misleading statements to the Stock Exchange. However, the FCA was forced to stop the investigation halfway due to the interruption from UK's Serious Fraud Office (SFO). The SFO had taken over the matter out of the hands of the FCA to continue the criminal investigation into the accounting irregularities at Aroma. On 27 October 2015, EY issued a report on Aroma's accounting misstatement after the investigation. The CEO, Derrick, described the report as follows: 'There is an astonishing overstatement of f188 million in the first six months of the current financial year, 2015, and $100 million related to the previous year, 2014.' At the same time, John Chong made a public announcement in response to EY's report: 'I am guilty in this accounting issue as I failed to oversee the operations in Aroma in order to safeguard the interests of Aroma. So, I will resign once the new CEO, Derrick, and his new team are fully operational.' In December 2015, the Financial Reporting Council (FRC), an independent disciplinary body, had entered the ongoing investigation to probe Aroma's accounts for years 2013, 2014 and 2015. The scope of the FRC's investigation comprised the conduct of Aroma's auditor, KPMG, and the preparation of Aroma's accounts. On 7 February 2016, the Groceries Code Adjudicator (GCA) became one of the investigators in the Aroma accounting scandal. According to Christine Tacon, who led the GCA in the UK: 'I had a suspicion that Aroma had broken the Groceries Supply Code of Practice. But unfortunately, GCA can't apply its right to impose penalty on Aroma of up to 1% of its total annual turnover. This is because this power is only applicable to those large supermarkets that breached the code after 5 April 2016.'Moving forward According to the news reported by The Times, Aroma appointed three more new non-executive directors with a background in the retail industry to join Aroma's board. Aroma's board had a major restructuring after the executive directors left one by one from their positions. The new directors were Darren, who worked as the CFO at Ocado before; Benson, who worked as a COO before in Iceland; and Mathew, who was the previous CEO of Ikea; starting from 1 November 2015.Jason Chew, the new chairman, commented: It is with great pleasure I welcome our three new non-executive directors to the board and I have high confidence that they can rebuild Aroma's image. They have full professional skills and experience in the retail industry that can be counted as assets to the company in the coming years. I hope the effectiveness of the board will be better after the accounting scandal has been resolved.' After three months, two female non-executive directors decided to resign from the board, leaving Aroma with only one female director. The accounting scandal had damaged Aroma's image, so the new board of directors started to move forward with their plan to get back Aroma's place in the market and they were trying to improve their performance to boost the profit of Aroma. Derrick, in response to these developments, alerted the board members on the following issues: 1 Corporate governance Poor corporate governance could lead to unnecessary accounting scandals and cause the share price to drop sharply. Only two of the twelve board members had vast experience in the retail industry, causing the board to have insufficient experts to effectively navigate the retail industry. This could be observed in the poor Christmas sales and several profit warnings in 2015. This was further compounded by the issues revolving around the independence of the auditor (i.e. KPMG), given the fact that it had audited Aroma for over 30 years. Consequently, Aroma had to strengthen the importance of corporate governance by, for example, establishing the proper tone for the top management and developing good organizational culture. 2 The role of board and regulators in dealing with the accounting scandal There is a need to address the issue concerning how board members had neglected their monitoring role to govern the company which had then caused the accounting scandal to happen. The board members should review and approve Aroma's financial statements and financial reporting but they failed to do so, as Aroma's profit was overstated by $277 million. The board members also had the responsibility to oversee the company's management to avoid the CFO position being vacant to up to six months, which may have affected the operation of the company. Next, regulators played an important role in this accounting scandal. For example, the Financial Conduct Authority, the City regulator, the Serious Fraud Office and the Groceries Code Adjudicator are involved in this Aroma case to protect the interests of stakeholders like the consumers and the investors, and to ensure the efficiency and integrity of the market.3 The pressure from the public One of the reasons that Aroma manipulated the accounting books was due to the pressure from the public. As a retail giant, Aroma wanted to maintain its market share and profits in the industry to compete with others in the declining supermarket industry. So Aroma used the aggressive accounting method to overstate its profit in order to maintain its reputation and ranking in the market as well as its share price.1 Comment on the weaknesses of corporate governance in Aroma's business operations. Discuss any recommendations or actions which can be taken to solve the problem.3 Comment on the relationships between the suppliers and Aroma. Discuss the practice of accounting for commercial income in Aroma. Illustrate it with some examples.5 If you are engaged as a consultant and asked to recommend the solutions to help Aroma rebuild its reputation in the market after the accounting scandal, what kind of suggestions would you give