Can investors trust retailers after Dick Smith?

The collapse of Dick Smith into administration has raised a number of issues particularly around rebates for retailers.

The administrators report into Dick Smith’s collapse highlighted how dependent the consumer electronics retailer was on supplier rebates to pump up its revenues and earnings. Investors will now rightly be concerned about other retailers – and how much supplier rebates affect each companies’ revenues and earnings.

Suppliers can pay retailers a rebate if, for example, they order a certain amount of product. Those rebates are usually included in the balance sheet as part of inventory, but Dick Smith and previously Target were reportedly found to have booked those rebates as revenues through the profit and loss statement. Wesfarmers Ltd (ASX: WES) – the owner of Target – found around 10 staff had manipulated supplier agreements to pump up revenues.

In Dick Smith’s case, management became hooked on supplier rebates to boost earnings after sales sagged. Decisions on what stock to buy and retail were then made on which supplier was offering the best or largest rebates – whether or not the retailer could sell the stock.

But those decisions eventually caught up to Dick Smith and the company was forced to heavily discount the rebated stock to move it. In some cases, the stock was cheaply made, poor quality and couldn’t be sold – as Gerry Harvey, chairman of Harvey Norman Holdings Limited (ASX: HVN) has previously pointed out – labelling it “crook stock”.

But the opaqueness around rebates and how they are treated under accounting standards could see many retailers forced to reveal more details on rebates they have received when they report their half-year or full year results. Analysts are certainly going to question them about it.

New revenue standards are expected to come into effect from January 2018 – which may help to clarify the treatment of rebates. But until then, investors might need to pay closer attention to retailers.

One retailer that might attract plenty of attention is Harvey Norman competitor the Good Guys, which is hoping for a $1 billion listing on the ASX before the end of this year. Treatment of rebates is likely to be a key question from IPO investors.

Foolish takeaway

Clarity over rebates is essential to prevent another Dick Smith from happening and investors losing their dough. The new accounting standards can’t come quick enough.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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