Auditing and Accounting Issues Leading to the Collapse of Dick Smith Electronics Ltd

This report discusses the auditing and accounting issues that led to the collapse of Dick Smith Electronics Ltd, including breach of accounting standards and lack of adequate practices.

ACCT6006 Auditing
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Introduction
This report is developed for developing an understanding of the auditing and accounting
issues that lead to the collapse of an ASX listed entity, that is, Dick Smith Electronics Ltd. The
company has recently gone into liquidation largely due to adoption of unethical accounting
standards and fraudulent financial reporting practices. In this context, this report intends to depict
the reasons responsible for the company collapse such as breach of Australian Accounting
Standards and lack of adequate accounting practices. The analysis of the annual report of the
company for the year 2014-2015 is also undertaken for identifying the issues related to its going
concern, reasons for auditors giving unmodified audit opinion for the financial year and the legal
liability of the auditors in the overall case of the company.
1. Brief History of Dick Smith Electronics Ltd and the Explanation of Reasons Causing
Company Collapse
Dick Smith Electronics Ltd was an Australian chain of retail stores listed on ASX that is
involved in selling of consumer electronics good. The company was established in the year 1968
and conducts successfully its retail chain stores in the Australia and in New Zealand. It is known
to provide employment to about 3300 employees and Dick Smith is known to be the founder of
the company. The company gets collapsed in the year 2016 and the main reasons that are
responsible for its failure is use of unethical accounting practices and processes. The major
reason that is responsible for the failure of the company that were identified were use of massive
inventory purchasing failures and its costly expansion plans. The management remains highly
focused on increasing revenue and creating profits at the expense of fostering the sustainable
growth of the business for promoting its long-term growth and development. The expansion
plans of the company declines its excessive earnings potential and also lead to accumulation of
high level of debt. The change in the customer preferences in the retail sector decrease its market
share and responsible for placing it into the receivership with debt of more than $440 million by
the banks (The Dick Smith Group, 2016).
It was identified by the administrator that the company was carrying out its operations
under a loss during the year 2015-2016 of about $116.7 million due to failure of its expansion
plans. The company failed to maintain its market performance with the changing preferences of
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the customers and thus the excessive inventory purchase in the year 2015 was not able to be
converted into sales and also was overvalued. The company cash receipts were not able to meet
its commitments due to lack of adequate cash resources. The loss incurred by the company
during the period 2015-2016 was largely due to poorer expected sales and margins, write down
of inventory, lease provisions and asset impairments. Thus, it can be said that improper financial
management practices of the firms was highly responsible for causing its liquidation (Parker,
2016).
2. Breaching of Australian Accounting Standards by the Directors of the Company
Dick Smith requires the development and presentation of its financial reports as per the
AASB accounting standards that underline the presentation of the financial statements to the
end-users. The AASB standards requires the development and presentation of financial
statements as per the AASB framework that requires improving reliability and relevancy in the
financial reporting process to protects the interests of the end-users. The director’s of the
company are alleged to adopt the manipulated accounting practices regarding valuation of
inventory and as breached the AASB 102 standards that require inventory to be valued at the
lower of cost and the net realizable value. Also, the directors are alleged to breach the Australian
accounting standard of using bank rebates from suppliers for boosting its earning potential. It has
allegedly used the rebates for inflating the profits and thus depicting higher earnings in its
financial statements. Rebates relate to the cost of gods sold and are required to be captured under
the AASB 102 inventories. The company has adopted the use of rebates that is realizing money
from the suppliers for using their goods rather than purchasing the products that are required by
the customers. These rebates obtained from the suppliers were booked as profits in the
company’s financial statements and this resulted in inflating their earnings potential (The
Conversation, 2016).
In addition to this, the directors have not complied with the fundamental qualitative
characteristics of the AASB conceptual framework of relevance and faithful presentation. The
company as per these characteristics failed to depict relevant and accurate financial information
to the end-users and thus is not able to protect the interests of its investors. The directors as per
the AASB conceptual framework are required to verify the financial statements for ensuring that
they are materially correct and depicts error-free information to the end-users. The directors also
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failed to comply with the AASB code of ethics that requires faithfully presenting the financial
reports to the users. The financial information as per the ethical code should be error-free and
complete in all aspects which the directors of the company have failed to comply (Robertson,
2016).
3. Auditor’s Sign for Providing Evidence Related to the Going Concerns Issues
The auditor’s as per the SAS 59 (Statement on Auditing Standards) requires the auditor’s
for making an assessment of the ability of a company to ensure that it is able to continue itself on
the basis of going concern. It is required that the auditor should continue itself on the going
concern basis for a reasonable period of time. The regular auditing procedures require identifying
conditions and events within the annual report of a company that can indicate the issues related
to going concern. The going concern principles in the field of accounting help in predicting the
ability of a business to continue its operations in the future context. Thus, an auditor conducting
examination of the accounting records and policies of a company are required to ensure that
there does not exists any issue related to its ability to continue its operations in the future period
of time. The opinion regarding the going concern ability of a company must be reported within
the financial statements under the auditor declaration. However, there no specific criteria that an
auditor is required to follow for evaluating the going concern potential of an entity. An auditor
evaluates the potential of a company on a going concern basis on the basis of information
derived from the audit procedures that are implemented for verifying the authenticity of the
financial reports by an auditor (Brunelli, 2018). The major indicators that are helpful in
identifying the issue of going concern within an entity can be stated as follows:
 Negative trends: Reduction in the sales, increase in costs, operating losses, negative
financial ratios outcomes and declining financial performance
 Employee Issues: High turnover rate of employees and labor issues such as lower
productivity, lack of skilled employees or occurrence of problems such as strikes
 Fraudulent Accounting Practices: The identification of any accounting procedure or
policies that leads in reporting of inaccurate financial information to the end-users
 Legal: Any legal violation made by the company in relation to the environmental or
community protection
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 Intellectual Property Issues: Any problems that is present within the company on account
of IP related activities or procedures
 Financing: There is presence of any financial risk within the company on account of not
able to meet its financial obligations such as default on loan or unable to seek new
investments (AICPA, 2017)
The assurance regarding the going concern and identifying nay issues that can negatively
impact the going concern ability of a company must be stated properly by an auditor. This is
because such matters are of great concern to the present and future investors of a company such
as lenders, creditors and borrowers. They make significant investment within a company and
therefore it is necessary for them to gain an assurance whether the company would be able to
meet their interests and obligations in the future context (Cumming & Johan, 2018).
4. Brief Analysis of the 2014-2015 Annual Report of the Company Indicating the Issues
Regarding the Going Concern Problem
The analysis of the annual report of the company for the financial period 2014-2015 has
reflected that inaccurate inventory valuation is a potential issue that questions its ability for the
going concern. The company has reported an inventory write down of $60 million within its
financial statements for the year 2015. Inventory management is regarded to be very important
for ensuring the growth and development of a retail business by controlling the cost of goods
sold. Thus, improper inventory management should reflect as key risk area for the auditors to
identify the going concern issue within the company. The inventory problem within the financial
statements of the company was not able to be accurately identified by its auditors which reflect a
going concern issue (Business Desk, 2016).
Also, the company reported a higher value of its shares soon after listing on the ASX and
has reported a higher NPAT of $37.9 million in comparison to the previous year of the financial
year 2014. This reflects the aggressive growth strategies of the director of the company to put
pressure on management and this reflects a potential issue for auditor to verify the accounting
practices of the firm that whether it is able to create such high profits despite of declining sales of
its New Zealand stores. The profitability of the New Zealand stores of the company has declined
from $3.7 million to $1.4 million for the year 2015 with the reduction in the sales from $199
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million to $179 million. The annual report of the company has stated that the decline in the
profitability segment of its New Zealand stores were largely due to competitive pressures. Thus,
it reflects that the aggressive expansion strategy of the company was not able to create profits for
it and thus reflects an issue of concern for its excessive inventory presence and high debt that
could lead to the occurrence of not able to meet to its financial obligations in the future period of
time. The overvaluation of inventory represents the higher asset position in the balance sheet of
the company which was not adequate in meeting its current liabilities. This represents a
significant financial risk for the company to survive in the future due to possibility of default on
its high debt liabilities and thus represents a significant going concern issue (Dick Smith
Holdings Limited :Annual Report, 2015).
5. Unmodified Audit Opinion for the Company during Financial Year 2015
The auditor of Dick Smith, that is, Deloitte has been questioned on account of the use of
manipulated accounting practices for rebates obtained from suppliers and its associated inventory
controls. The accounting issues regarding the inventory management problem identified by the
administrators has raised red flags on the reliability of the auditor opinion that has been
presented for the company during the year 2014-2015. Deloitte has presented unmodified audit
opinion for the financial statements of the company for the financial year 2014-2015 which
means that its financial reports are materially corrects and depicts its actual financial position.
The major reason that can be regarded as the possibility of providing unmodified audit opinion
by Deloitte is its reliability on the information provided by the management and the financial
statements developed by the company.
Deloitte has long-term relationships with Dick Smith and this raised red flags about it
providing unmodified audit opinion and not raising any concerns regarding its inventory and
financing problems. It has been stated by the AFR report that Deloitte earned about $338,000 for
carrying out audit of the company and an additional income of $103,927 for providing other type
of services. Thus, it can be said that the long-term relationship with the company and higher
compensation realized by the auditor can be regarded as a potential reason responsible for not
providing any indication regarding its financial difficulty. This represents the failure of Deloitte
to comply with the Auditing Standards as it is not able to protect the interests of the investors of
the company (Chung, 2016).
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6. Deloitte, having a case to answer for providing an unmodified audit opinion for the
Company during the financial year ended 30 June 2015
Deloitte has failed to comply with the Auditing Standards in relation to the recognition of
rebates for the financial year 2014-2015. It has failed to exercise reasonable skills and car in
carrying out its duties and responsibilities as per the code of ethics established for the auditor.
The code of ethics established for the auditor has required the auditors to carry out its
responsibilities as per the fundamental principles of integrity, objectivity, professional
competence, confidentiality and professional behavior. Deloitte is unable to meet the stated
auditing code of ethics and therefore have a case to provide answer regarding violation of their
professional duties and obligation as stated by the auditing standards (Spencer, 2017).
It is not able to comply with the FY15 audit rebate procedure as it has not identified any
issue regarding the material deficiency in the financial reporting and systems processes in respect
for recording, calculating and recognition of rebates. The failure of Deloitte for obtaining
reasonable assurance regarding the financial report of the company to be free from any type of
material misstatement and ensuring that it is free from any type of fraudulent activities has lead
to developing a legal case relating to the auditor’s. The allegations against Deloitte has lead to
the auditing firm to come under the case of legal violation of its roles and responsibilities and
playing an important role in leading to the demise of the electronics’ retailer. The failure of
Deloitte to obtain an adequate understanding of the application of accounting policies in relation
to the rebates and evaluating the financial position of the company as per the adequate auditing
standards represents a major legal case against the auditor of Dick Smith Electronics Ltd (The
Conversation, 2016).
The reliability of the auditor’s report was questioned by the administrator after the
liquidation of the company due to its failure to identify any issue relating to material
misstatement. The auditor long-term relationships with the company and receiving higher
compensation by the director’s have also raised issues regarding the reliability and integrity of
the auditor’s. It can be said that the auditor’s are unable to act as per their professional
competence ad due care and thus there is presents an adequate legal case against them as they
have failed to comply with the relevant auditing standards and legislations (Richards, 2016).
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Conclusion
The overall case analysis of Dick Smith have identified that the adoption of manipulated
and fraudulent financial reporting practices can lead to the subsequent collapse of a company in
the long-term. Dick Smith Electronics Ltd have failed to comply with the accounting standards
of inaccurate inventory valuation and improper use of suppliers rebates that lead to
overstatement of its financial position during the financial year 2014-2015. The auditor of the
company has also failed to identify the financial risks present within the company and thus have
a legal case to answer for the unmodified audit opinion provided by them.
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References
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USA: John Wiley & Sons.
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The Conversation. (2016). The ugly story of Dick Smith, from float to failure. Retrieved 28
April, 2019, from https://theconversation.com/the-ugly-story-of-dick-smith-from-float-to-failure-
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