Early Years and Expansion
Dick Smith Electronics was the Australian chain of retail stores that sold electronic goods for consumer use which namely comprised of electronic components and electronic project kits. The company successfully expanded to New Zealand and unsuccessfully in other several other nations. The company was founded during 1968 in Sydney by Dick Smith and was by him and his wife before selling 60% of the shares to Woolsworth Ltd in 1980 (AnnualReports.com, 2018). The operation of company ceased in 2016 after several years of the Dick Smith’s Electronics acquisition by Anchorage Capital Partners.
In the early years, the operations of company included installation and servicing of car radios. Following the year, the business attained success and open more number of shops. Beside the car radio business, the company opened a wholesale and created a playground for electronic hobbyist. The company sold number of electronic components to the professionals and brand soon gained greater market popularity.
During the year 1980 the company had gained the popularity as Dick Smith grew to 20 stores and sold 60% of the working share of the company to Woolworths Ltd. within the span of two years the remaining 40% of the shares were sold to Woolsworth that took the complete ownership of the company (Al Bhadily & Bowyer, 2018). By the year 2016, Kogan acquired the shares of Dick Smith and commenced the takeover operations. Presently, Dick Smith continuous to remain the household name that has greater value and customer can purchase the best products at the incredible price across Australia.
The collapse of Dick Smith Electronic is largely attributable to the series of huge inventory purchase failure in combination with the ill-thought out and expensive expansion. The expansion plans of Dick Smith Electronic plagued its surplus revenues and required the company to borrow huge amount of money (Knapp & Tronnes, 2017). As the customer preference began changing and the retailer started losing its market. The plans of expansion went unchecked and major purchase decision resulted Dick Smith to carry huge amount of stock which was no saleable and was overestimated. The cash receipts of the company were not sufficient to meet the commitments. The company collapsed as it did not have any enough amount of cash resources that was available to meet its present and future commitments.
The value of the shares of the Dick Smith fell by more than 80% as they were listed on the ASX since December 2013 with a halt in share trading was requested. The accounts of Dick Smith represented considerable amount of loss in a span of six months as in December 2016 the company reported a loss of $116.7 million.
Dick Smith Sells Majority Shares to Woolsworth
The directors allegedly breached their duties due to failure in association with the rebate driven buying policy. The receivers have bought a claim against the former directors which alleged that the directors have breached their duties by following the strategy which was driven by the rebates instead of customer demand (Lau, 2016). This led them in being failure to place any sufficient process or systms of monitoring the purchase and impairment of inventory. The directors were failure in making sure that the finanical statements were correctly accounted for inventory and rebates in agreement with the Australian accounting standard.
As a consequence of such failure, Dick Smith purchased and accumulated around $189 million as the bad stock. The directors also published the financial results that lacked proper basis and paid dividends in 2015 that should not have been paid or should have been significantly lower. In wider terms it is claimed that non-executive directors breached their dutyr of care towards company as they failed to put in place the sufficient system in respect to rebates and inventory management (Nelson et al., 2016). There was also a breach in duty of directors as they were instances of violation of voluntary administration of the firm. The directors breached the accounting standards as they were engaged in insolvent trading. It was revelaed that the directors allegedly went beyond their way of securing borrowing as it would enabled them to pay dividends to themselves.
Furthermore, claims from the receivers states that the directors were engaged in the activities of uplifting the invoices and uncommercial transactions. This involved cancelling the earlier invoices of stocks which was issued without the rebate and asked the suppliers to issue new invoices that showed the rebates with equal increase in the cost of goods.
From the July month of 2014 there were certain forms of rebates that included over and beyond. These rebates were recorded in the account books immediately following negotiation with the suppliers (Schmidt et al., 2016). Prior to receiving the rebates and the stocks are paid or sold which were in breach of accounting standard and aimed at increasing the earnings. The accounting standards were also breached when the directors engaged in the unreasonable director related transactions. In spite of the unfolding disaster the directors passed the resolution of paying interim dividend to the sharehoders. Therefore, to pay the dividends of $16.6 million the company extended the overdraft facility.
The Collapse of Dick Smith Electronics
The auditors were failure in recognizing that the directors of Dick Smith were engaged in manipulating the figures of sales and stock inventories that led the company purchasing excess amount of inventory to meet their rapid expansion of stores as well as bank rebates from the suppliers. The auditors failed to identify that the divergent in financial diclosure and untimely information related to investment decision (Clarke et al., 2016). The directors linked the floating of shares in order to pursue aggressive growth strategies and increasing the floor stock as well as the warehouse. The auditors failed to identify the signs of divergence from the standard operational behaviour that involved structuring the transactions which will change the financial results to probably deceive the users of financial statements.
There were instances of reduction in expenses of research and development, events of selling fixed assets, discount in price to meet the short term earnings target and overproduction that results in excess amount of inventory to reduce the cost of goods sold have been ignored by the auditors (Louwers et al., 2015). There were signs of rebated sales which was overlooked by the auditors and the same was never sufficient to supplement the instances of retail cash flow.
The instances of obsolete stock was ignored by the auditors which make Dick Smith even more probable of breaching their debt covenants with the banks. This eventually led the company to pay heavily for the inventory that subsequently led to shortage in cash flow and resulted the company to be insolvent (Knechel & Salterio, 2016). This ultimately raised questions for the auditors. Despite realising that inventory was over-valued the auditors justified the decision to value Dick Smith as the going concern.
The long standing auditor of Dick Smith, Delloite overlooked the weak-balance sheet where the company had run out of funds and signed off the accounts without any warning nor raising any fresh issues which ultimately questioned the Going concern ability of the company. The auditors should have looked into the voidable transactions which was entered into for defeating or delaying rights of creditors (Zhou et al., 2016). This is because those transactions may have occurred when the company was insolvent or the company may become insolvent as a result of those transactions. Signs such as incorrect inventory valuation and outdated stock should have been noticed by the auditor to question the ability of Dick Smith as the “Going Concern”.
Breach of Duty by Directors
As per the financial statement of Dick Smith Electronics, the financial statement of the company is prepared by the business following all relevant accounting standards and regulations which is required by Australian Accounting Standard Board. The total sales revenue of the business has increased slightly which can be considered to be a positive sign. The overall expenses of the business are shown to have increased significantly which is a negative sign for the business and overall level of operational inefficiency can be assumed from the rise in the costs of the business (Dick Smith Holdings Ltd – AnnualReports.com. 2018).
The annual report also shows that even though sales has increased from previous year but there is a constant fall in sales which can be traced from 2012 which is not a positive indicator for the business. In addition to this, the cash flow statement which is shown by the business reveals negative cash from operating activities which further confirms the operational inefficiency of the business. Moreover, the overall debts of the business are also seen to have increased which is seen in the annual reports of the business. The increased amount of debt in the capital structure mix of the business increases the overall risks of the business. This is not a favorable sign for the business and it shows that with expansion plan which is in place in the business, the requirement of funds has increased for the business. As shown in the annual reports of the business, the management of the company has opted for debt capital which has increased during the current year whereas the equity capital of the business remains the same as shown in the income statement during the year.
The evidences which are shown in the analysis of the financial statements of the business indicates towards negative indicators for a business and there is certainly a sign that the business is not performing well in terms of other factors. The financial reports of the business further show that the business has legal considerations as well which is related to onerous contracts and warranties which are related to the products which are offered by the business. The following signs which are portrayed in the financial statements of the business can be taken as factors affecting going concern principle (Banimahd, Noorifard & Davoudabadi, 2013). Thus, the profit and loss statement and the EBITDA might not give clear indications and might seem favorable but the same is not the case and there are certain hints available in the annual reports itself and also can be obtained from externals sources which can suggest that the going concern of the business might be in threat.
Audit Failure and Financial Concerns
As per the case of Dick Smith Electronic, the audit for the business was conducted by Deloitte which is considered to be one of the Big four auditing firms (Andrés Suárez et al., 2013). As per the opinion of the firm, the financial statements of Dick Smith Electronics are prepared in accordance with the Corporation Act of 2001 which provides the general framework for the businesses for preparing financial statements of a business. In addition to this, the financial statements are prepared by following all relevant standards of accounting which is followed in Australia and applicable to the company. On the basis of the conditions which are satisfied above, the auditor has given the opinion that the financial statements which is prepared by the management of Dick Smith Electronics are showing true and fair view (Cox, 2013).
The auditor of the company has provided the business with an unmodified report because the financial statements are prepared following all the regulations of Corporation Act 2001 and also all the relevant standards of accounting which is applicable to the business. In addition to this, the financial statements contain appropriate disclosure requirements and the same is portrayed in the notes to accounts section of annual reports (Battle, 2018). The auditor of the company is engaged in continuous audit for the same company and therefore is aware of the internal processes of the business and also with other measures of the business as well.
Judging from its past experiences and also with the fairness with which the financial statements are prepared, the auditor has issued an unmodified report. However, the financial statements of the company might seem favorable but the trend shows decline in the business where inventory management is concerned. The auditor should have considered the going concern principle which can be indicated from the private float which was offered by the company and purchased by a private business Anchorage (Geiger, Raghunandan & Riccardi, 2013). The above discussion shows that the auditor has not considered factors which can affect going concern principle and has only provided an unmodified report based on the true and fair view of the financial statement of the business.
As per the case of Dick Smith Electronics, the company was liquidated in 2015. The auditor of the company which was Deloitte was under the fire. The auditing firm suffered a legal suit for not applying diligence in performing audit procedure of the business. The annual reports of the company which was prepared for the year 2015 showed that the business has cooked up and overvalued its stocks in order to provide support to the expansion plan which was set by the management of the company (Dumay & Guthrie, 2017). The expansion plan improved the sales of the business and also the net profit of the business which showed recovery of the business, however the case was not the same.
The ineffective inventory management strategies of the business and the overvalued obsolete stocks which was carried by the business from 2014 started to have impacts on the business and the same resulted in dissolution of the business. The major problems for the business started in 2014 when the company was no longer a subsidiary of Woolsworth company and became listed in Australian stock exchange (Sundgren & Svanström, 2014). Ineffective inventory management of the business is one of the reason due to which the business faced liquidation of the business.
The auditors of the business are at fault becomes overvaluation of stocks was not recognized by the auditor which was material enough to affect the report of the auditor and also the opinion of the auditor (Hapsoro & Suryanto, 2017). In addition to this, the auditor should have recognized the going concern principle of the business was being affected and should have included an emphasis on matter paragraph in the auditor’s report which was issued by Deloitte (Blay & Geiger, 2013). The case of Dick Smith Electronics showed that if the auditor had applied due skills and diligence in conducting the audit process of the business, the factors affecting going concern principle of the business and the overvaluation of the stock could had been identified.
The auditor might be failing legal liabilities which are outlined in the auditing provisions which are established. The auditor will be held responsible for any untrue balance or misstatement which affect the balance sheet of the business and therefore is capable of affecting the opinion of the auditor about the presentation of the financial statements and whether the same is shown is showing true and fair view of the business or not. In addition to this, the auditor Deloitte has also faced legal suits regarding the case. If the same is established than the auditors will facing civil liability for negligence.
Reference
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