ACCT6006: Dick Smith Collapse, Auditing Theory and Practice Analysis

This report provides a comprehensive analysis of the collapse of Dick Smith Electronics, examining the underlying causes and the responsibilities of various parties. It begins with a brief history of the company and then delves into the reasons for its failure, including high operational costs, rapid market changes, and unsustainable expansion. The report analyzes the breaches of Australian Accounting Standards (AAS) by the company's directors, focusing on the manipulation of rebates and the impact on financial reporting. It also highlights the auditor's responsibility in identifying and addressing going concern issues, including a discussion of the signs auditors should have looked for. The report analyzes the 2014/15 annual report, identifying red flags related to increasing costs, high borrowings, and declining cash flow. Finally, it explores the reasons behind the unmodified opinion issued by the auditors, despite the company's impending collapse. The report concludes with a summary of the key findings and their implications for auditing theory and practice.

Running head: AUDITING THEORY AND PRACTICE
Auditing theory and practice
Name of the student
Name of the university
Student ID
Author note

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Table of Contents
Introduction......................................................................................................................................2
Answer 1..........................................................................................................................................2
Answer 2..........................................................................................................................................4
Answer 3..........................................................................................................................................5
Answer 4..........................................................................................................................................7
Answer 5..........................................................................................................................................8
Answer 6..........................................................................................................................................9
Conclusion.....................................................................................................................................11

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Introduction
The aim of the report is to analyse the reason of collapse for Dick Smith during the year
2016. The report will focus on responsibility of the directors in breaching the requirements of
AAS. Further, it will highlight the auditor’s responsibility behind collapse of the entity and the
issues of going concern involved in the financial reports of the entity. The report will further
focus on the opinion expressed by the auditor on the financial statements and the reason of
expressing such opinion (Auasb.gov.au, 2018).
Answer 1
Brief history – Dick Smith
Dick Smith, the retail entity based in Australia and engaged in providing consumer
electronic products. Wide range of products are sold by the entity and they are categorized into 4
groups namely, office, mobility, entertainment and different other services and products. The
entity operates its business from 2 segments namely, Dick Smith Australia and Dick Smith New
Zealand. It has more than 393 stores all over New Zealand and Australia. The company was
formed as a young electronics technician during the year 1968 and was focused to installing and
servicing the car radios in the initial days. However, by 1980 it was able to grown to 20 stores
and the working shares of the entity were sold to Woolworths. Within next few years hundreds
of stores opened by the entity those included David Jones Electronics. However, during May
2016, Kogan.com acquired brand name of the entity and started carrying out the operations of
Dick Smith (Dicksmith Australia, 2018).

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Reasons of company’s collapse
Dick Smith’s collapse was resulted from shortfall to the creditors amounting to more than
$ 260 million. Moreover, as the banks were entitled to get their dues, very little amount was lefy
for unsecured creditors. As stated in the report of McGrathNicol, the administrator of the entity,
main reasons behind the entity’s collapse are as follows –
 High network cost – store network of the entity was considerably bigger as compared to
the competitors. Hence, higher cost base with significant exposure and dependencies
towards market for the computer related products and the fast moving office product
resulted into higher amount of cost involvement (Arens et al., 2013).
 Changes in network – consumer electronic market is highly competitive and changes
taking place frequently as per the consumer’s demand and preference
 Too fast – significant commitment is required for finance and utilization of the total
available cash resources for the expansion plan. Further, it requires significant
commitments from the suppliers and for bank borrowing
 Drop in sales and shrinkage for market share – revenue growth was dependent on the
growth of the stores and commercial sales at low margin (Arens, Elder & Beasley,
2013).
 Sales for the entity did not work – clearance sales of the company were not able to
generate sufficient sales and margin to ease the pressure of the cash.

4AUDITING THEORY AND PRACTICE
 Finance costs were too expensive – the entity was unable to raise the fund with the
favourable credit terms and it gad adverse impact on the stock levels, store presentation,
and product mix.
 Demand for the loan was crushing – cash flow pressure lead the entity to the banking
covenants for the purpose of breaching that was not even repairable.
 Too many on shelves – inventories related decisions taken under existing environment
were irregular in context of the consumer demand. Eventually the entity was left with the
significant quantity of obsolete and inactive stocks those were required to be written
down considerably (SmartCompany, 2016).
Answer 2
Breaching of the AAS (Australian accounting standard) by the directors
It was found in the case of Dich Smith that 8 directors and executives were charged for
breaching a number of duties and damaged thereon claimed for more than $ 10 million. Further,
the allegation was that the profit of the company was significantly inflated during 2015 resulted
from numerous questionable activities associated with the way in which the supplier’s rebate
were manipulated. Further, it was claimed that the company would have reported loss or
considerably lower amount of profit if the directors and executives were performed their duties
responsibly. Main allegation against them was that they misuse the rebates and it was not in
compliance with the AAS. Further, the claim was that the policy used by them facilitated the
reporting of gross profit, depreciation and amortisation, profit before interest and tax and the net
earnings. The management were required to report the same in compliance with the AAS,
specifically AASB 102 on inventories (Aasb.gov.au, 2018). However, the strategies applied by

5AUDITING THEORY AND PRACTICE
the directors led to purchase of the stocks those were actually motivated by the rebates and not
motivated by the demand of the customers. Eventually it led to stockpile of unsalable and bad
products. It also enabled them paying dividends, in actual that was not affordable by the entity
ultimately put additional burden on the entity’s financial status (Barker & Penman, 2016).
Apart from above, the entity failed in writing off the provisions for bad debts those were
held by it and those were expected to be hold till 28th December 2014. Further, it was observed
that to pay 7 cents per share of interim dividend the organisation required extension of overhead
limit. Amount of the damages claimed including the dividend recovery that was paid allegedly
was more than $ 27 million, apart from losses fetched from the bad stock purchase that was
amounted to $ 10 million. Moreover, treatment of rebates violating AASB 102 and cash flow of
the entity became the main strain that led the company to be dependent on the external
borrowing to fund the cash requirement. In broader sense, receivers claimed that the duties of
care were breached by non-executive directors as they did not put in place adequate systems for
management of rebates and inventories (Brochet, Jagolinzer & Riedl, 2013).
Answer 3
Signs those must have been looked by the auditor for going concern related issues
Auditors made the analysis with regard to substantial doubt for the entity’s ability to
continue as the going concerns over the reasonable time period is made based on their
knowledge and experience. The knowledge and experience of the auditors are measured on the
basis of relevant conditions and events taken place or those were in existence before completion
of the field work (Chui & Pike, 2013). Different indications those shall have been looked into by
the auditor for the indications of issues related to going concern are as follows –

6AUDITING THEORY AND PRACTICE
 Review of the subsequent events – different subsequent events, for example, bankruptcy
of any of the major customers signifies unfavourable conditions at the balance sheet
date. Various other events. Various other events those indicated the likelihood risks of
going concern, for example, expropriation of the organisation’s assets, reduction in the
market value for inventory or withdrawal of credit line by bank (Dhaliwal et al., 2013).
 Analytical procedures – the analytical procedure is used as the substantive test and is
used for the purpose of planning and overall review of audit. It is used for indicating –
(i) issues faced in collecting the debts (ii) negative trends (iii) issues associated with
liquidity and solvency and (iv) slow movements of inventories
 Inquiry for legal counsel – response of the entity to inquiries regarding legal counsel
including assessments, claims, and litigation and it may indicate the chances of
significant losses due to copyright or patent infringements, contract violations, illegal
acts and claims for the liability of product.
 Reading of the minutes – meeting the minutes of the shareholders, board of directors
and board committee may indicate – (i) likelihood of the expensive litigation (ii) loss of
major supplier (iii) changes in the business operation that may result into significant
losses and (iv) reduction of credit line from the lender and creditor (Johnstone, Gramling
& Rittenberg, 2013).
 Confirmation regarding financial support – confirmation from 3rd party and the
associated parties with regard to the arrangement details for providing or for maintaining
the financial support that may indicate loss from the 3rd party guarantees or reduction in
line of credit from bank may increase the entity’s indebtedness.

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In addition to the above mentioned indications below mentioned conditions and events
may signal red flags or warnings for risks associated with going concerns –
 External events – external events that may indicate going concerns issues are – (i) loss of
the principle customers or suppliers (ii) loss of the key franchise, patents or license (iii)
legislation or similar matters that may generate issues related to operating liability
(Legoria, Melendrez & Reynolds, 2013).
 Internal matters – different internal events that may indicate going concerns issues are –
(i) loss of key managerial personnel or operational personnel (ii) issues related to labour
or stop of work (iii) inefficient accounting system (iv) requirement of revision for
significant operation (v) high level of dependency on success of any specific project
(Dicksmith Australia, 2018).
 Negative trends – it involves – (i) increase of the costs (ii) negative cash flow from
operational activities (iii) deficiencies in the working capital (iv) increase of borrowings
(v) recurring losses from the operational activities (vi) reduction in sales and profits (vii)
unfavourable financial ratios (Krishnan & Wang, 2014).
Answer 4
Analysis of annual report for the year 2014/15 and issues related to going concern
Indications related to going concern issues found from annual report for the year 2014/15
are as follows –
 Increase of the costs – from income statement of the entity for the year closed on 28th
June 2015 it can be recognised that various expenses significantly increased as compared
to the last year. These costs include – (i) administration costs of the entity went up from $

8AUDITING THEORY AND PRACTICE
45,173 thousands to $ 57,287 thousand (ii) occupancy and rental expenses of the entity
has been increased from $ 79,257 thousand to $ 93,288 thousand (iii) finance costs of the
entity went up from $ 2,854 thousand to $ 4,111 thousands. Negative trends of all these
costs indicated that there were going concern issues with the entity (Linsmeier, 2016).
 Borrowings – higher amount of borrowing put additional burden on the company with the
requirement of interest payment which in turn may lead it to unstable position. Balance
sheet of the entity for the year closed on 28th June 2015 is indicating that the entity raised
additional borrowing amounting to $ 70,500,000. Total borrowings were 13.86% of the
organisations’s total asset which is considerably big. It indicates going concern issues for
the entity (Dicksmith Australia, 2018).
 Inventories – inventories of the entity increased from $ 253,814,000 to $ 293,044,000
over the one year time period. Excessive inventories were purchased with the intention of
store’s rapid expansion while in actual the business was running though loss.
 Cash from operational activities – cash flow statement reported that the cash outflows
from operation was $ 39,40,000, whereas in the previous year it was $ 52,177,000.
Hence, the significant drop in cash flow increased the liquidity risk as the entity had
inadequate current assets to meet the short-term obligations (Dicksmith Australia, 2018).
Answer 5
Reasons behind unmodified opinion provided by the auditors
Unmodified opinion indicates that financial reports of the entity are prepared and
presented as per the requirement of applicable framework for preparing the financial reports.
Deloitte Touche Tohmatsu audited the financial reports of the entity for the year closed on 28th

9AUDITING THEORY AND PRACTICE
June 2015 who is the long term auditor for the entity. It is the auditor’s responsibility to take
reasonable care to ascertain that financial statement of the client company has been prepared and
presented truly and fairly. Moreover, the auditor is liable to take reasonable care to ascertain the
same (Liu, 2015). Apart from that, the auditor as per the requirement of AASB (Auditing and
Assurance Standard Board) shall –
 Gather sufficient and appropriate proof regarding the financial status of the entity for
expressing the audit opinion
 Analyse appropriateness of the accounting policies used and the reasonableness of the
accounting estimates and the related disclosures those are made by the entity.
 Analyse structure, overall presentation and content of the financial report. Further, the
auditor shall look into the disclosures related to financial reports of the entity to find out
whether the financial reports presents underlying transactions and events in true and fair
manner or not (Maroun, 2017).
However, auditors are not bound to exercise more than the reasonable care and skill
while carrying out the enquiries and investigations. The auditors are not insurer and hence, they
are not obliged to provide any assurance regarding correct and true position of the company’s
activities. Further, the auditor is not responsible for suggesting the way in which the business
operation of the entity shall be carried out. Therefore, it is assumed that the auditor’s have
expressed unmodified opinion on the basis of financial statement analysis as it is likely that the
auditor was not able to find any misstatement while analysed the financial statements (Sundgren,
& Svanström, 2014).

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Answer 6
Liability of the auditor’s for expressing unmodified opinion
Different questions can be raised to the auditors as even after recognising that the
inventories of the entity were overvalued they valued it as a going concern. As per the
requirement of conceptual framework issued by the AASB particular concepts shall be followed
for preparing and presenting the financial statement so that it can be presented to the users and
the users can use the same for the purpose of decision making (Apesb.org.au, 2019). The
conceptual framework further assists the users to interpret the information reported in the
financial reports prepared in accordance with the AAS. Hence, if the information were used by
the auditors properly, they could verify the going concern position of the entity. Further, it was
clearly recognised that the entity violated the AASB 102 while treated rebates under the income
statement and the same was unnoticed by auditors. These could have saved the entity from the
collapse as the AAS framework identifies objectives of the financial statement and the
qualitative objectives to determine the information’s usefulness (Apesb.org.au, 2019).
Another key feature of the fundamental qualitative element is the materiality. Materiality
concept is considered as company specific as it depends on the magnitude and nature of the
organisation’s business and the items included under the company’s financial report. Hence, the
Deloitte, the auditors of Dick Smith should have been focussed on the specific element for
finding out material elements (Apesb.org.au, 2019). It could help the auditors in recognising and
understanding the misstated or omitted information regarding the company’s financial statements
and could save the entity from collapse. Apart from that, in accordance with APES 110 – code of
ethics, the auditors should have complied with the ethics to avoid any confusion or error while
carrying out the audit of the entity. Hence, if the auditors were implemented and followed APES

11AUDITING THEORY AND PRACTICE
110, they were being able to find the misstatement in the presentation of the financial statements
(Sultana, Singh & Van der Zahn, 2015).
Conclusion
From above discussion it is identified that auditors of Dick Smith was responsible to a
great extent for the collapse of the entity. Further, the auditors were responsible for overlooking
the red flags regarding the going concern issues of the entity those were visible from the
financial reports of the entity. Moreover, they are answerable for expressing unmodified audit
opinion by ignoring the facts. Major reason of the company’s failure was that it did not follow
the AASB framework and requirements in preparing and presenting the financial statements.

12AUDITING THEORY AND PRACTICE
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