Nick Scali Case Study

1. Accounting Analysis

1.1 Identify principle accounting policies

Inventory management is important in retail industry . Nick Scali has complied with AASB 102 by measuring their inventories at the lower of cost and net realizable value . In order to measure cost of inventories, management has used weighted average cost consistently from the year 2009-2012. However, there has been no disclosure in regards to the amount of any write-down of inventories (e.g. due to stock obsolescence or damages), which is uncommon in the retail industry.

Accounting policy for sale of goods is another important factor in retail industry. Nick Scali recognized revenue when the significant risks and rewards of ownership of the goods have passed to the buyers and the costs incurred or to be incurred in respect of the transaction can be measured reliably . Risks and rewards are considered passed to the buyer at the time of delivery of the goods to the customer. Revenue recognized equals the fair value of the consideration received or receivable. This accounting method is in compliance with AASB 118 and similar to other companies in the industry such as Harvey Norman and Fantastic Furniture.

According to Statement of significant accounting policies, trade receivables are recognized and carried at original invoice amount less an allowance for any uncollectable amount. An allowance for doubtful debts is made when there is objective evidence that the Company will not be able to collect the debts. In particular, all amounts past due in excess of 30 days are individually assessed and provided for as doubtful if reasonable doubt to collectability exists . Since receivables are monitored on an ongoing basis, bad debt expense is not significant and credit risk is minimized.

Accounting policy for derivation financial instruments is particularly important for Nick Scali as the company constantly deals with suppliers from overseas and therefore is largely affected by exchange rate fluctuations. In general, foreign currency risk is relatively well-managed by using fair value hedges or cash flow hedges consistently in the past 5 years. Hedge accounting implemented by Nick Scali complies with AASB 9 and AASB 139 and is considered as effective .

1.2 Assess accounting flexibility

The degree of flexibility varies among different accounting policies. For example, there is a medium level of flexibility in estimating net realizable value of inventories as managers have some freedom in deciding the selling prices of the furniture when it's damaged/obsolete and in choosing cost method to measure inventory (Nick Scali has been using weighted average cost consistently). This flexibility more or less affects the amount of inventories at year end. Similarly, there is medium to high level of flexibility in estimating allowance for doubtful debts which is based on professional opinions of managers.

Managers also have freedom to choose different methods (Matched Terms approach or Hypothetical Derivative) to measure derivatives at fair values, which result in a high flexibility in measuring the effectiveness of hedging instruments . There is also a medium to high level of flexibility in depreciating method for Plant, Property and Equipment. Nick Scali has been consistently using straight line basis for depreciation, however managers have freedom to choose the useful life of assets which can affect depreciation expense.

1.3 Evaluate accounting strategy

Overall, Nick Scali's use of accounting policy has complied with accounting standards and generally similar to its competitors. For example, the company uses straight line method to depreciate buildings over 20-40 years, lease hold improvements are depreciated at the shorter of the depreciation period or the term of the lease. Recently Nick Scali started to acquire a great amount of land and buildings in 2011 which consequently increased its depreciation and amortization expense significantly in 2012. This increased the operating cost resulting in a lower profit in 2012 even when sale have increased by 9.37%. The purchase of new Plant, Property and Equipment could be in line with the company's growth strategy. However, if sales do not increase in the following years despite the expansion in new buildings and showrooms, the depreciation expense then would be questionable.

In regards to provision/allowance for bad debts, there is no disclosure on the specific amount for this account which seems questionable as it is different from most of Nick Scali's competitors. At the same time, there has been no bad debt expense over the period of 2009-2012, which is also uncommon in retail industry. Managers have either managed receivables successfully as claimed or they have used accounting discretion to achieve a better profit at year end.

1.4 Potential Red Flags

Although Nick Scali's financial statements are audited, there are still risk areas that are prone to manipulation and restriction in the accounting system that could impact the valuation of their company.

Firstly, revenue recognition is one of the potential red flags in most companies as managers could exercise their discretion to record a future income on the current period in order to boost the company's profits at the period. Therefore, tighter control in revenue recognition such as proper paperwork that specifies the date of ownership change of the goods from Nick Scali to the customer must be applied in order to measure revenues correctly.

Secondly, depreciation is also one of the risk areas as managers could exercise their discretion and increase the effective life of a certain asset in order to avoid writing off a certain asset, which will hinder efficiency as it would slow down investment in newer and better technology, plants and equipment required for the business to create more value for their customers and shareholders.

1.5 Quality of Disclosure

Nick Scali's financial statements provides investors with insight on Nick Scali's principal activities, regulations, remunerations and fees relating to each directors and their short and long term incentives in their Director's Report. Other than that, notes attributed to each part of the Financial Statements that explains in detail the items that is contained in the balance sheet and the income statement are a great help for investors to know the company better.

Nick Scali's financial statements are prepared based on the accounting standards such as the International Financial Reporting Standards (IFRS), the Australian Accounting