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Dick Smith - Over stated stock

Dick Smith allegedly bought too much stock at over-inflated prices.  For example, the administrators found Dick Smith had bought 25 years’ worth of batteries; it would take 25 years to sell them.

The allegation is that Dick Smith was buying stock not based on what customers wanted but based on supplier rebates. A supplier would offer products to Dick Smith at above market price.  Dick Smith would then receive a rebate back towards marketing costs.

But the products hadn’t yet been sold.  They were sitting in stock at over inflated price.  The administrators had to offer significant discounts to customers or the stock couldn’t be sold.

“In its report into the company’s failure, not presented to court, liquidator McGrathNicol found that as sales fell, Dick Smith increasingly made purchasing decisions based on rebates the company could earn rather than what customers actually wanted to buy.

This all sounds very familiar to the aggressive accounting Tesco adopted in relation to supplier receipts.

In the case of Tesco, supplier contributions, that were dependent on hitting retails sales targets, were booked even when those targets were unlikely to be achieved. Thus overstating sales. This aggressive accounting can be hidden to a degree providing sales keep growing, but as soon as sales begin to decline, as they inevitably did, there is nowhere to hide.

In the case of Dick Smith, it appears that supplier rebates were booked as a reduction in marketing expense, rather than a reduction in the value of stock. Thus inflating profit and stock. The problem is the stock proved to be difficult to sell without significant price reductions.

What is a rebate and what do you do with it?

“A rebate is an amount paid by way of reduction, return, or refund on what has already been paid or contributed.”

Unlike a discount it it comes back to customers after the purchase. In terms of treatment:

“Rebates typically relate to cost of goods sold and are therefore captured under AASB 102 Inventories. These should then be recognised as a reduction in cost of sales when the inventory is sold rather than recorded as income upfront.”, PWC

However, it is not that straight forward, as PWC point out

“In reality, rebates are often complex arrangements reflecting the different elements of the goods and services exchanged between suppliers and retailers. These include not only the purchase of the inventory from the supplier, but also the marketing and promotion services retailers may coordinate and provide to suppliers. The accounting should follow the substance of these arrangements.”

The problem with this early recognition, as with all shenanigans, is it wasn’t creating any cash.  If the allegations were correct, Dick Smith was simply moving numbers around.  Creating the illusion it was making money, but it wasn’t, it wasn’t generating cash.