Accounting Headline 7.12 A situation where a company has been found to have opportunistically overstated its assets and understated its liabilities

The tremors left behind as a retail giant falls from grace COLIN JAMES COLIN JAMES explains how the drama surrounding Harris Scarfe unfolded. Harris Scarfe executive chairman Adam Trescowthick said he was stunned when senior managers approached him after the departure of the firms most senior executive. They outlined allegations of irregularities in the companys financial accounts which had left its 35 stores across the country on the brink of collapse. Mr Trescowthick, a 36-year-old businessman who inherited the Harris Scarfe chairmanship from his father, Sir Donald Trescowthick, immediately called in its external auditors, PricewaterhouseCoopers. An investigation confirmed the worst: the companys assets had been overstated and its liabilities understated for up to six years, leaving it in the 333 precarious position where it was unable to pay its debts. Mr Trescowthick and his board of directorsformer Independent Holdings managing director John Patten, former AFL chief executive Ross Oakley, former Young Rubicam and Mattingley chairman David Mattingley, Melbourne lawyer Roger Curtis and Sir Donalds youngest son, information technology consultant Markreceived the news on Friday, March 29. Six days earlier, they had notified the Australian Stock Exchange of the resignation of Harris Scarfe chief operating officer Dan McLaughlin after 27 years with the company. Then, on March 28, chief financial officer Alan Hodgson had informed them he was taking sick leave.

Later that day, Mr Trescowthick and the other directors resolved to call in accountants from international company KPMG, who told the board to take steps to ensure no further liabilities were incurred. They also advised Harris Scarfe not to pay any debts until the situation could be stabilised. KPMG told Mr Trescowthick he had to immediately notify the companys biggest secured creditor, the ANZ Banking Group. A meeting with the banks Adelaide credit centre was scheduled for the following day, where Mr Trescowthick said that if urgent funds were not made available within 48 hours, Harris Scarfe would have to stop trading and appoint administrators.

A second meeting was held on Sunday, April 1, where KPMG representatives outlined the extent of the financial irregularities within Harris Scarfe. The following day ANZ told the Harris Scarfe board it would not be providing any further funds. ANZ made it clear that if administrators were appointed, it would override the move by appointing a receiver to ensure its interests were protected. Mr Trescowthick and his directors met the bank in a bid to avoid receivership, requesting more time to appoint administrators. The bank granted a temporary reprieve, enabling Harris Scarfe to appoint KPMG accountants Michael Dwyer and Lindsay Maxsted on Tuesday, April 3. Three days later, the banks patience expired. Exposed to potential losses of $67 million, ANZ appointed Adelaide insolvency specialist Bruce Carter as receiver, who, on Wednesday, announced Harris Scarfe would be sold to recover its debts. The sale came as no surprise to Harris Scarfes 1200 unsecured trade creditors, many of whom had been experiencing difficulties for several years with getting payments from Harris Scarfe. Some had been forced to use debt collectors to ensure bills were paid. One credit company, Australian Business Research, had interviewed Mr Hodgson in January as part of a report which it completed for suppliers on March 23, the day Mr McLaughlins resignation was announced to the ASX. The ABR report, obtained by the Advertiser, said Mr Hodgson said Harris Scarfe was experiencing a difficult trading year because of the GST, interest rates, increasing petrol prices and the post-Olympic spending slump. In its assessment of Harris Scarfe, ABR warned creditors to exercise caution when supplying stock to its stores in SA, New South Wales, Queensland, Victoria, Western Australia and Tasmania. According to figures provided by the company, ABR said its assets of $195, 433, 000 were predominantly funded through debts of $118,576,000. Observing this situation indicates a cause for concern. ABR said the company was in a poor short position, meaning short-term debt is not covered by short-term asset position.

This situation was confirmed on Tuesday when Mr Dwyer and Mr Maxsted presented their preliminary report to a creditors meeting at Thebarton Theatre. Mr Dwyer and Mr Maxsted said that after the ANZ and creditors had refused to supply further credit, a more thorough investigation of Harris Scarfes cash flow projections revealed that the liabilities of the company had been understated and the assets overstated . This systematic overstatement of profit has been funded by increased debt both to the (ANZ) bank and to creditors, they said. Mr Dwyer and Mr Maxsted told creditors a more accurate financial position could be reached by reducing assets by $17.2 million and increasing debts by $16.3 million. Investigations were continuing into how these irregularities had occurred, they said. Company records had been seized and copies sent to the Australian Securities and Investments Commission, which had been alerted by Mr Trescowthick following the appointment of Mr Dwyer and Mr Maxsted. The two men are working closely with ASIC investigators in a bid to unravel what happened inside Harris Scarfe and how misleading financial accounts were allegedly maintained for up to six years. Mr Trescowthick, who was on an internal audit committee with Mr Patten and Mr Hodgson charged with ensuring the accuracy of the companys financial records, has said senior management did not inform directors of the problems. This situation will be closely examined as it is the legal responsibility of directors to ensure they fully inform themselves about the financial positions of companies they represent. The ASIC also will investigate statements by the directors that they relied on the accuracy of reports prepared by Harris Scarfes auditors over the past seven years, Ernst and Young, and PricewaterhouseCoopers. Both firms lodged formal declarations with the ASIC and ASX between 1996 and last year saying the accounts had been subjected to full audits conducted in accordance with Australian Auditing Standards. This included statements to the ASX which said our procedures included examination, on a test basis, of evidence supporting the amounts and other disclosures in the financial report, and the evaluation of accounting policies and significant accounting estimates.

Adelaide Advertiser , 14 April 2001

Read Accounting Headline 7.12, which discusses the accounting practices used at the Australian company Harris Scarfe. It has been shown that Harris Scarfe reported results that inappropriately overstated its assets and understated its liabilities. Discuss whether this is consistent with the opportunistic perspective provided by PAT and explain from a contracting perspective why an organisation might want to overstate its assets and understate its liabilities.