Reference no: EM132604995

Question - A few months ago MegaMart, a major national retailer, uncovered a serious issue within its financial accounts. In accordance with local stock market regulation, MegaMart issued a profits warning statement detailing that its pre-tax profits for the last six months had been overstated by $250 million. As a result of this error, profits for the first half of the financial year were around 25% lower than forecast, and already well below initial expectations. When stock market trading opened, MegaMart's share price immediately fell by 12%, and it has not yet recovered.

The audit committee of MegaMart decided to engage a firm of accountants to investigate the reason for this massive discrepancy, and in doing so delayed the publication of its interim results by a month. Their preliminary findings stated that the MegaMart profit overstatement was due to the accelerated recognition of commercial income and the delayed accrual of costs. Further detailed investigations indicated internal financial reporting systems and associated internal controls were wholly inadequate, allowing significant errors to go unchecked.

Before MegaMart announced the results of investigations, they were leaked to the media. The alleged serious errors and the need for further external assurance were widely reported due to the scale of the irregularity and the importance of MegaMart to the national economy.

The board as a whole was heavily criticised, and at an extraordinary general meeting convened at the express wish of its major institutional shareholders, the chairman, the chief executive officer and the finance director were all asked to tender their resignations and the new board to establish a risk committee to ensure such problems would never arise in the future.

Required -

(a) Explain the responsibilities of the board of MegaMart for ensuring effective financial reporting and internal control systems, and explain how the work of a risk committee can help the board fulfil its responsibilities.

(b) Describe the objectives of internal control systems, and explain how meeting these could help prevent further misreporting or error at MegaMart.

(c) Explain the general principles of disclosure and communication which the board of MegaMart should follow when it briefs its shareholders.