Store Smith's top brass have been accused of deliberately buying too much stock to inflate earnings by booking supplier rebates as profits while using commercial sales to cover up weak in-store performance.

Lawyers for Store Smith's receivers and bankers have sent letters to the defunct retailer's former directors and managers alleging a series of "wrongful acts" that contributed to its collapse

January, according to The Australian Financial Review. The letter accuses Store Smith management of buying excess stock and booking the supplier rebates, which are for marketing or customer discounts, as an increase in profit or reduction in marketing expenses, the AFR reports.

The receivers also claimed that the banks, National Australia Bank and HSBC, were duped into lending to Store Smith, foreshadowing claims against executive directors for misleading and deceptive conduct, and claimed that directors and officers breached their duties by failing to have proper reporting, among other things.

According to the AFR, the letter from Norton Rose Fulbright claims that the corporation was buying stock based on the rebates it could book rather than client demand.

The alleged behavior began in July 2014 and was motivated by a "concern and emphasis" on meeting or exceeding Store Smith's prospectus performance goals.

According to the AFR, Store Smith is also accused of having private label suppliers retract invoices that were given without rebates and reissue them with rebates and an equivalent rise in stock cost.

The receivers are also said to be concerned that Store Smith may have utilised advertising sales to mask low like-for-like store sales growth.

According to the AFR, Store Smith made no or very little money from commercial sales, although they did assist raise sales.

According to the letter, Store Smith's usage of rebates was questioned by Deloitte in September 2015, and experts identified around $180 million of "problem inventory" that needed to be written down by $60 million by October.

A month later, Store Smith revealed the $60 million write-downs, prompting a 70% drop in the company's stock price.

When the renowned retail firm collapsed in January, just two years after its $520 million flotation's, it owed creditors more than $400 million, including around $140 million to National Australia Bank and HSBC.

From September, ten former Store Smith directors and managers will face receiver Ferrier Hodgson in the NSW Supreme Court to be interrogated about the company's demise.

 

In July 2016, the AFR published two articles of Sarah Mitchell about Store Smith’s usage of supplier rebates to boost earnings and allegations against certain directors and executives of the company adopting a means of accounting that was inconsistent with Australian accounting standards. Study and use the articles for the purpose of the questions below. You are encouraged to conduct your own enquiry to refresh, deepen and/or broaden your understanding of supplier rebates and accounting treatment of this item.

i. Store Smith’s EBIT surged from $10.9 million in 2013 to $59 million in 2014, even though sales went backwards. How did Store Smith utilize supplier rebates to help achieve the (seemingly spectacular) results?

ii. What defense did Smith put up against the suggestion that their treatment of supplier rebates was wrong?

iii. Imagine that you are on the other side who disagree with Store Smith’s treatment of supplier rebates. How would you recognize supplier rebates? Would Store Smith’s EBIT be as spectacular had they followed your approach? What is the fundamental difference between the two treatments that explain the very different outcomes in the context of EBIT?