Dick Smith's Demise: An Audit Case Study on Financial Mismanagement

This case study investigates the collapse of Dick Smith, a prominent Australian electronics retailer, attributing its downfall to financial manipulations and breaches of Australian Accounting Standards. The report analyzes the company's history, highlighting key factors such as high inventory levels, board tensions, and private equity issues following its acquisition by Anchorage Capital. It examines the role of directors in violating accounting standards through practices like aggressive rebate chasing and misreporting expenses. The analysis of the 2014-15 annual report reveals warning signs, including increased marketing expenses and discrepancies in rental and other expenses. The report also touches upon the liability of auditors. Desklib provides access to similar solved assignments for students.

Running Head: AUDITING THEORY AND PRACTICE
AUDITING THEORY AND PRACTICE
Name of the Student
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1AUDITING THEORY AND PRACTICE
Executive Summary:
Dick Smith was one of the most reputable electronic retail companies coming out
from Australia. During the preliminary phase of the company, it had gained a gigantic fan
following and had it had already become a family name in Australian household. Although
due to long range of financial manipulations and mal practices, the company suffered, which
led to its unfortunate termination. In this report, an investigative and logical approach has
been taken into account for looking into this matter. This report has been divided into various
sections, including a Brief History and Collapse, Breach of Australian Accounting Standards,
including an enquiry into the causes of the unmodified report by the auditors.

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Table of Contents
Introduction:...............................................................................................................................3
Brief History of Dick Smith and collapse:.................................................................................3
Breach of the Accounting standards of Australia:.....................................................................6
Role of the directors in the breach:........................................................................................6
Concise Analysis of the Annual Report:....................................................................................7
Different Signs of the Going Concern problem:........................................................................8
Liability of Auditor towards third parties:...........................................................................10
Conclusion:..............................................................................................................................10
References:...............................................................................................................................11

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Introduction:
A business can fail in a variety of ways. Some of these causes are beyond the control
of the particular business or concern and sometimes, the company has complete control over
its own fate and situation. In the former cases, the concerned organisation collapses due to
various external; threats such as recessions, levy of high taxation by the government, or
failure to comply with the government’s policies. Through this report, a similar case of
collapse of a reputed electronic company has been made, which goes by the name of Dick
Smith. In this case, it is the company to blame for its own collapse. There have been various
kinds of financial manipulations which at various levels of the organisation, which has
brought the company, in its current state of affairs, where it had to suspend its operations on a
permanent basis. This report lends a comprehensive and analytical view into the collapse of
one of the well-known electronic accessories companies of Australia.
Brief History of Dick Smith and collapse:
The company which goes by the name of Dick Smith was one of the most well-known
electronics brand, to have ever come out of the Australian sub-continent. It later came to be
known as the DSHE Holdings Limited (dicksmith.co.nz, 2018). The company primarily
engaged in the sale of electronics goods, electronic components and project kits of various
kinds. This company, had its own share of humble beginnings, with the company being
founded in the year 1968, by Mr Dick Smith, after whom the company has been named,
along with his wife. During its initial years, the company had operated through two different
segments of its electronic business, in the form of catering to the demand of both its
Australian as well as the New Zealand market. Steadily the company was growing through
the 1970s and the 1980s. by that time the company, had expanded its business horizons by
opening a network, which eventually had reach an impressive network of 20 stores. In the

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year 1980, famous retail company of Australia, Woolworths, had acquired a total of 60%
shares of Dick Smith. In the year 1982, Dick Smith had sold their remaining shares to
Woolworths, at a total price of $25 million. Later in the year 2012, Woolworths had
announced complete reshuffling of the basic structure of Dick Smith and sold it to Anchorage
Capital, for a $115 million. After the sale of the company to Anchorage, the company’s
decline had started, which led to the ultimate closure in the year 2016, which eventually
would be discussed later.
This company, which was one of the most sought after Electronics Company back in its
heydays, had filed for its liquidation on the 25th July, in the year 2016. It has only itself to
blame for, for its downfall at such a time, where the business of electronics had been
expanding at a very rapid rate, than before. The major causes of the downfall of the company,
have been explained below:
 Maintenance of high level of inventory: Dick Smith had suffered from the lack of
effectively knowing and analysing the demands and requirements of their customers.
The gap between the demand and the products placed in the stores of the company,
was very huge and it had started growing towards the end of 2014-15. The company
had been very lackadaisical in its maintenance of inventory, which had led to the
moss of funds. This had led to the accumulation of large number of inventories, which
could not be sold, ultimately piling up on the large stock of unsold goods and
inventory. The problems of inventories of the company had started towards the later
part of 2014-15 financial years. The chief executive of the company Mr Nick
Abboud’s private label push had led to the high level of inventory, which had created
a strain on the cash flow of the company. A significant example of this is the fact that
by the month of October, 2015, Dick Smith had accumulated a total of 12 years’
worth of AA private label batteries, which had led to the blockage of cash flow.

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 Tensions within the board of directors of the company: Dick Smith’s directors
have been a huge advocate of rebates from its suppliers. In fact the non-executive
director Mr Bill Wavish had also defended the controversial use of rebates. He was
the former CEO of Woolsworths, who had the reputation of having a flamboyant and
loud personality, who exuded confidence as he spoke, while on the contrary, director
Mr Tomlinson, was a soft spoken personality. Mr Bill used to dominate the
boardroom meetings and practically controlled the systems at Dick Smith, which
never used to go down with the other directors. He was an aggressive promoter of
supplier rebates, once he had boasted that Dick Smith had taken out a leaf from his
book of strategies of using rebates. He compelled Nick Abboud to fly over to Las
Vegas to crack a deal with senior Panasonic executives; he had the plan of deriving
the maximum amount of cash from the suppliers, by using rebates. This caused huge
amount of tension within the board itself (afr.com 2018).
 Private equity problems: When the company was sold off to Anchorage Capital, its
decline was imminent. This was one of the major causes of decline of the company.
There were a series of disagreements on a range of issues, such as there was complete
lack of agreement on the book value of Dick Smith’s inventory at the time of sale to
Anchorage. Anchorage had also floated the company with a valuation of $520
million, which was a significant blow to the good faith exuded by the company, since
its heydays. The aggregate valuation was very high, in accordance with the market
standards, as it was too high, when compared to the original price at which it was sold
by Woolworths, for just $25 million.
Breach of the Accounting standards of Australia:
There has been widespread breach of the various relevant provisions of the accounting
standards of Australia. It has happened on a frequent basis. There has been commitment of

6AUDITING THEORY AND PRACTICE
widespread financial manipulations, which has led the company to the ruins. The role of
increased amounts of frequent rebates, influence on the inventories, purchasing decisions of
the management, hiding of the real; earnings of the company, the acquisition costs and
financial aspects of the company.
Role of the directors in the breach:
The directors of Dick Smith were on the driving seat of the company. It is their
actions and decisions which had led the company since the very beginning, and in the current
debacle, which had led to the untimely collapse of the company, the directors had a major
role to play. Various directors of the company have been caught red handed in the collapse of
the organisation. They have been accused of breaching various provisions of the Australian
Accounting standards. Ex. Directors of the company, such as Bill Wavish, Jamie Tomlinson,
Phil Cave, and CEO of the company Nick Abboud had breached their boundaries of duty,
which has been entrusted by the law for speculation purposes (Efax.com.au 2018). These
directors had failed to adequate number of systems for the rebates provided by the suppliers
and for the management of the inventory. Failing to comply with both these activities is a
blatant violation of accounting standards number AASB 102. Here it is stated that the
concerned organisation must take all the possible steps for the correct treatment of the
inventories and the supply rebates provided by them. Most importantly, another deliberate
violation has been committed by the directors by reporting a huge amount of $27 million as
expenses of depreciation, taxes and amortisation. This deliberate attempt is the breach of the
ASA 240, where the employment of deceitful and deceptive mechanisms had been used
(aasb.gov.au). It had become a regular tactic by the company of using and chasing rebates for
the purpose of inflating the profits of the company. This has led to the violation of the
fiduciary faith which has been entrusted upon the board of directors of the company by the
different faithful stakeholders of the company. It has also been alleged against the directors in

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the Supreme Court, that the directors of the company had pursued a rebate maximising
strategy and plan, which had resulted in the buying of stocks, which were driven by rebates
and not by natural demand of any kind (NewsComAu, 2018). This had resulted in the
accumulation of the products, which had remained unsalable at the end of the period. This
has also led the company to call for dividend, which it was not able pay, leading to a massive
loss for the shareholders of the company. This was a breach of the AASB 108, which states
that changes in accounting estimates and errors must be avoided at all costs.
Concise Analysis of the Annual Report:
The financial statement is one of the most important statements of any business
organisation. It helps in providing vital information about the financial performance of the
company. Whether the concerned organisation has been running on losses or earning gains,
everything becomes clear from the annual report of the company. A brief general overview is
also provided by the annual report, about the general health of the company. The annual
report helps the organisation and its different stakeholders by stating about the current state of
affairs of the company. It also shows the different elements of dangers, currently faced by the
company. Apart from the regular kinds of information regarding the financial state of affairs
about the company, it also helps in assessing the success of the different kinds of strategies
adopted by the concern, and how useful they have been to the concern. This is also true for
Dick Smith too. A certain number of important issues were unearthed as from the annual
report of the company for the year 2014-15. Various kinds of troublesome signs for the
company were visible along with different cases of financial malpractices. A list of the
different kinds of financial mishaps and various other notable mentions has been provided
below:

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 Huge increase in the amount of marketing expenses and sales expenses by a very
large amount of $17,609 million, by the extended use of the rebates from the
suppliers of the concern.
 The company had, on the other hand, had decreased the rental expenses by $14,031,
while strangely, in other cases, the company had increased the other expenses by
$15.899. Here there has been no health connection between the increase and the
decrease. Each one took place to counter the effects of the others.
 There has been manipulation of the total amount of sales and the inventories of stock,
which had led to the rapid amount of accumulation of inventories. This had put huge
amount of pressures on the financial resources of the company.
 Interestingly, the operational inefficacy has been very much visible from the cash
flow statement of the electronic concern. In addition to this, there was complete
absence of the correct amount of balance in the capital structure of the company
between the equity as well as the debt capital. Where it was seen that there was a
massive increase in the debt capital of the company (Wang, Chen and Yu 2013). The
total amount of debt had been increased by a staggering $70,500 million, which was
detrimental for the capital structure of the company.
Different Signs of the Going Concern problem:
It is very important for any business organisation to work in a healthy manner, where
the efficiency is clearly visible from the annual reports and other parameters of the company.
Going concern helps the stakeholders in assuring them that their money, hard work and faith
are living in a healthy manner (Amin, Krishnan and Yang 2014). In the case of Dick Smith,
there were some worrying signs, which had helped in concluding that the company was
suffering from the problems of going concern. Some of them have been provided below:

9AUDITING THEORY AND PRACTICE
 Far-reaching decrease in the earnings per share of the concern from $0.59 to $0.05, in
the year 2014 to 2015.
 There had also been a severe fall in the gross profit of the company, from a staggering
$308,002 in 2014 to $184,397 in the year 2015.
 There had also been a drastic fall in the net profit of the company, from $140,190
million in the year 2014 to a depressing figure of $19,856 in the year 2015. In
addition to this, the fall in the total income of the electronics giant had been the final
nail in the coffin, which had cemented the fall of the great electronics company Dick
Smith. The fall of the comprehensive income has been from $146, 484 to $19,442.
Cause of unmodified report by the auditors:
Deloitte, being one of the big four companies in the world of audit, was under the
obligation of providing a correct and impartial audit report, as the future investments and the
present ones depend on the audit report provided by them. The auditors have been at constant
pressure, because the company’s directors along with Deloitte had played a foul game in this
regard. This is proved. Deloitte provided Dick Smith's 2014-15 finances a clean chit of sound
financial health in August (NZ Herald, 2018). Deloitte had also earned an astounding
$338,000 for conducting the audit, along with this, $103,927 for various other services which
had been rendered. The corrupt nexus between the two is pretty much evident over here.
Liability of Auditor towards third parties:
Deloitte, which had acted as the external auditor of Dick Smith was morally and
professionally responsible for ensuring that the companies receive information in a timely
manner. Deloitte has a moral responsibility towards preparation and presentation of the audit
reports. The complete explanation of the report must be found out and understood. The

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actions, investment of the different stakeholders such as the investors depend on them. In
such scenarios, for some extra amount of income, putting at risk of the future of the
stakeholders and residents can be destroyed (Velte and Freidank 2015). Thus here it can be
seen that the auditors not only have any compulsion to bring out the problems to the finance
commission file. This helps the company taking important financial decisions. The
company’s actions depend on the report of the external auditors. In such case, it is important
to communicate the problems to the driver.
Conclusion:
Truth and transparency are two of the most important support systems upon which the
long term success of any business organisation. In this particular, it was due to the corruption
improper management of the concern’s inventory. Series of malpractices such as inflation of
the sales, financial manipulations of different kinds. In order to stop this association, it is
better to provide the correct information to the different stakeholders, keeping in mind a long
term working life. It is very important on the part of the company to assure the healthy
working of the company, signalling the preference on the long term gains.

11AUDITING THEORY AND PRACTICE
References:
Aasb.gov.au. 2018. [online] Available at:
http://www.aasb.gov.au/admin/file/content105/c9/AASB108_07-04_COMPjan15_07-15.pdf
[Accessed 11 Aug. 2018].
ABC News. 2018. Dick Smith hearings reveal questionable accounting of rebates. [online]
Available at: http://www.abc.net.au/news/2016-09-28/dick-smith-hearings-reveal-
questionable-accounting-of-rebates/7885480 [Accessed 11 Aug. 2018].
Amin, K., Krishnan, J. and Yang, J.S., 2014. Going concern opinion and cost of
equity. Auditing: A Journal of Practice & Theory, 33(4), pp.1-39.
Arnold Sr, D.F., Dorminey, J.W., Neidermeyer, A.A. and Neidermeyer, P.E., 2013. Internal
and external auditor ethical decision-making. Managerial Auditing Journal, 28(4), pp.300-
322.
Belo, F., Lin, X. and Yang, F., 2014. External equity financing shocks, financial flows, and
asset prices (No. w20210). National Bureau of Economic Research.
DSH Class Action. 2018. Dick Smith leaders accused of inflating profits to meet expectations
- DSH Class Action. [online] Available at:
http://dshclassaction.com.au/news/press-releases/dick-smith-leaders-accused-of-inflating-
profits-to-meet-expectations/ [Accessed 11 Aug. 2018].
Efax.com.au. 2018. Online Fax - Send & Receive Faxes by Email or Online with eFax.
[online] Available at: https://www.efax.com.au/blog/the-things-small-businesses-can-learn-
from-the-collapse-of-dick-smith [Accessed 11 Aug. 2018].