Role of Auditor in Large Accounting Scandals - Dick Smith Case

This report deals with the two commonly recognised corporate accounting scandals where auditors also had a significant role in the occurrence of those scandals. The case of Dick Smith is a case that occurred in the recent times in 2016 where the accounting frauds were not reported by the auditing firm of the company, i.e. Deloitte Australia.

Running Head: Corporate Accounting Frauds
ROLE OF AUDITOR IN LARGE
ACCOUNTING SCANDALS

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Executive Summary:
This report deals with the two commonly recognised corporate accounting scandals where
auditors also had a significant role in the occurrence of those scandals. The case of Dick
Smith is a case that occurred in the recent times in 2016 where the accounting frauds were
not reported by the auditing firm of the company, i.e. Deloitte Australia. The company
manipulated its inventory records and purchased inventory in massive quantity to take the
benefits of discount but such inventory stock could not be converted into sales and it had
become obsolete. The company did not write down the value of its inventory with the motive
of not affecting the profitability state.

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Introduction:
Dick Smith’s Case
Dick Smith Holdings Limited was an Australian entity that was dealing in the retail business
of consumer electronic goods. The company was collapsed in year 2016 due to massive
failure of its inventory management practices coupled with heavy expansion plans involving
opening of more than 30 more stores in the country. The demand patterns of the consumers of
this industry are quite dynamic. To grow and expand, DSG has invested huge sums of money
in its expansions to increase its sales volume so as to increase its overall profitability (Van &
Alexander, 2002). It purchased inventories in bulk for its expansion and to obtain rebates
from the suppliers for the bulk purchases. The required funds were financed through various
bank borrowings and other by undertaking other financial commitments and by way of
utilising its surplus earnings. But due to change in consumer preferences, the demand of
company’s products significantly decline and DSG started losing its market share. This had
ultimately led the heavy losses and it became difficult for the company to pay off its debt
obligations. The company adopted using dubious accounting approaches to manipulate its
sales figures as well as inventory records to achieve desired profitability. The investors were
highly attracted towards the expansion prospects of the business and hence they had invested
huge sums in the company. The other factor that contributed to the demise of the group was
the purchase of business of the group by another private equity group i.e. Anchorage Capital.
After purchasing the DSG’s business, it was made float on Australian stock exchange that
resulted in its high cash flows. The IPO of the company was highly overvalued because of
turnaround plans. These incorrect valuations made the company face its collapse in the
Australian market. The collapse of the company had not only made the company suffer from
the losses but also the stakeholders of the company had to face heavy losses due its inability
to repay the borrowed funds to the credit and investing parties (Pash, 2016).

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Auditors of the Dick Smith Group at the time of accounting scandal:
Deloitte, which is one of the leading auditing firms across the world, was a long time auditor
of Dick Smith and it was also holding the said position of company’s statutory auditor at the
time when the corporate scandal on part of the Dick Smith Group was reported by the
investigating authorities.
Contribution of Audit Procedures in the Collapse
The audit quality was reported as the key problem of both the scandals that occurred in Dick
Smith. Despite of severe manipulations in the financial statements, Deloitte being the
statutory auditing firm of Dick Smith had approved the annual report of the company for the
year 2014-2015. Auditors of DSG had provided a clean report in respect of company’s true
and fair presentation of financial affairs of the company for the financial year 2015. The
auditing firm opined that the financial statements of the group are free from any sort of
material misstatements. However, this was not the case in reality as the firm had been
manipulating its sales and inventories records and was following other false activities for the
purpose of misleading its stakeholders (Fickling, 2016). It has been found that the inventory
value of the company required a write down of around $ 60 million in the month of
November, 2015 because such inventory has become obsolete. However, there was no
evidence to prove the writing off of inventories values which could abide by the company’s
accounting policies as per Australian accounting standard board. The auditors of DSG must
have identified and investigated the reasons for such reduction as a part of their audit
procedures. This shows the negligence on the part of auditing firm of DSG towards their
professional obligations. The auditors of the company should have identified the weaknesses
in the internal control system of the company which had allowed them to carry out such
manipulations of inventory records. Inventory constitutes a significant component of

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financial statements and if any risk of misstatements is identified the auditor in such areas
then they must enhance the scope of audit procedures at least in such areas. The auditors of
the company shall have identified the correct amount of inventory of the company (Carret,
2015) by applying various inventory audit procedures.
The auditor independence and professional and ethical behaviour in the given case:
In the case of Dick Smith, the internal auditor of the company was itself engaged in the
manipulation of the company’s inventory records which is totally unjustified as the
professional and ethical auditing practice. The negligence towards such material
misstatements in financial statements of the company was made due to the collusion between
the managers of the company and the auditors due to which they did not bother about
reporting the weak internal control system in respect of inventories of the company. The
external auditors of the company authorised the earnings management practices because of
the view that its benefits will be quite higher than the penalties of breach of the professional
duties (The National Business Review, 2016).
Improvements in the auditing standards and principles after the accounting scandal:
As auditing profession builds trust and confidence of the stakeholders in the company, this
profession must have high standards of professional and ethical standards. The auditors must
act in the total interest of public. To ensure this code of ethics have been introduced principle
based supports for the auditing professionals in respect of decisions involving revenue or
inventory treatment not only to comply with the provisions of law but also to comply with
law’s spirit (Cohen, et. al., 2012).
Recommendations:

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The auditors of the company must be given requisite knowledge and training on how to
perform the audit procedures in respect of the areas where there are possibilities of material
misstatement and various guidelines must be issued by the regulators of auditing profession
to deal with key audit engagement matters in the most neutral and independent manner so as
to protect the interest of general public. Further, the technologies continue to advance in the
recent era and due to this it are highly recommended that auditing professionals must also
make use of the advanced technologies by way of using auditing software while conducting
the audit so as to have detailed but efficient coverage of audit procedures (ICAEW, 2018).
Conclusion:
In conclusion, it can be said that the auditors must apply their professional judgement as well
as professional scepticism as per the demands of the situations so as to adequately perform
their responsibilities related to auditing profession. They must not be influenced with the
management’s directions while providing the opinion on the financial statements.

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References:
Carret, J., 2015. Some answers, more questions over Dick Smith failure. Available at:
https://theconversation.com/some-answers-more-questions-over-dick-smith-failure-62485
Accessed on: 10.09.2018.
Cohen, J., Ding, Y., Lesage, C. and Stolowy, H., 2012. Corporate fraud and managers’
behavior: Evidence from the press. In Entrepreneurship, governance and ethics (pp. 271-315).
Springer, Dordrecht.
Fickling, D., 2016. Who Killed Dick Smith? Available at:
https://www.bloomberg.com/gadfly/articles/2016-01-05/don-t-blame-private-equity-for-dick-
smith-s-collapse Accessed on: 10.09.2018.
ICAEW, 2018. The Future of Audit: Technology. Available at:
https://www.icaew.com/technical/audit-and-assurance/faculty/the-future-of-audit/the-future-
of-audit-technology Accessed on: 10.09.2018
Malley, A., 2016. Dick Smith collapse raises more questions for accounting profession.
Available at: https://www.smh.com.au/business/companies/dick-smith-collapse-raises-more-
questions-for-accounting-profession-20160721-gqagz5.html Accessed on: 10.09.2018.
Pash, C., 2016. The 8 causes of Dick Smith's collapse. Available at:
https://www.businessinsider.com.au/dick-smiths-administrators-have-outlined-the-8-
underlying-causes-of-the-companys-collapse-2016-7 Accessed on: 10.09.2018.
The national business review, 2016. Analysis: Five serious questions about Dick Smith
collapse. Available at: https://www.nbr.co.nz/opinion/five-serious-questions-about-dick-
smith-collapse Accessed on: 11.09.2018.

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Yallapragada, R.R., Roe, C.W. and Toma, A.G., 2012. Accounting fraud, and white-collar
crimes in the United States. Journal of Business Case Studies (Online), 8(2), p.187.