Hsh Audit Committee example essay topic

The facts of the incident. In chronological order the "facts", as reported in the media, are below. This matter is still unfolding and Board members and former staff are to appear before relevant tribunals. Those appearances will add to the public knowledge of the events which culminated in the appointment of receivers.

30 March 2001; - trading in Harris Scarfe Holdings' (HSH) shares was suspended at the request of the firm pending "a significant announcement". The firm had previously announced that interim profit to March 2001 was down 45% on the previous year (BRW Vol 23 No 15). 3 April; - the Board appointed KPMG as voluntary administrators citing "accounting discrepancies" which became apparent after the departure of Dan McLaughlin, the Chief Operating Officer (COO) who had resigned on 27 March after 22 years service. The accounting situation related to an overstatement of stock and an understatement of liabilities. The Board had not placed a value on the discrepancy.

The discrepancies may date back as far as six years (AM 3 April 2001). 4 April; - the Australian Securities and Investment Commission (ASIC) announced a formal investigation "into possible accounting, disclosure and other offences" (ASIC 2001). 5 April; - allegations of "serious financial irregularities and a complete cover up by senior management" (World Today 5 April 2001). 6 April; - ANZ Bank, the largest creditor, owed $65 M, moved to appoint a receiver to the company, corporate recovery firm Ferrier Hodgson. (BRW Vol 24 No 14). HSH's biggest shareholder is the Trescowthick family, with 46%.

In the year leading up to the revelations above, the value of the family's shareholding fell from $33.7 million to $20.8 million. When trading was suspended on March 30, HSH shares were at 74 cents. Adam Trescowthick is the Executive Chairman and his brother, Mark, a Board member (Australian Financial Review 13 July 2001). BRW, Vol 23 No 15 reported; Growing debt levels, gearing at almost 90% in 99/00 and payment times extended to as much as 90 days.

The firm acknowledges in its 99/00 annual report that a $15 M notes issue in April 2000 was to increase working capital "to improve trading terms with suppliers". Net assets reduced from reported $107 M on 28 Feb to $61 M by March 2001. Believed that stock was regularly overvalued, maybe, by holding obsolete stock at full price in lieu of normal practice of the writing it down. Liabilities apparently reduced by ignoring ordered stock in transit on stocktaking days.

12 July; - staff terminated; HSH's expansion in the late 1990's, with the help of hindsight, caused major problems" (Australian Financial Review 12 July). 6 August; - the former Chief Financial Officer (CFO) claimed his superiors had ordered him to manipulate the books to create high profits. He said he authorised accounts to be altered to fit profit targets senior management ordered and had specific instructions from the Chairman to report a particular profit figure. The former COO claimed he'd raised concerns as early as 1996 and said gross profit reported to the Board was different to the daily gross profit reports he received (Australian Associated Press 7 August). 7 August; - the former CEO (ie preceding Adam Trescowthick's appointment as Executive Chairman) denied ordering employees to change financial figures and that he had been worried stock was overstated.

The company overstated the half year end January 1999 profit by $1.62 M to $6 M, including a $605,000 adjustment to gross profit and $1 M adjustment to the general ledger (Australian Associated Press 7 August). 3 October; - the former auditor, Ernst & Young, revealed that in 1995, accounting standards regarding depreciation were breached (Australian Financial Review 3 October). 5 October; - Ernst & Young revealed that profits were overstated in 1997 and assets inflated (Australian Financial Review 5 October). 2 November; - in the Supreme Court Adam Trescowthick denied "he had ordered the books to be manipulated" but admitted that "accounting is not my strongest suit" and he had no retail experience until his involvement with HSH. He asserted he believed that HSH was in a strong financial position until the week prior to the receivers' appointment (Australian Financial Review 2 November). At Appendix 3 is an analysis of HSH by Greg Whittred in the Australian Financial Review of 2 November, which among other things reveals; in the previous two years sales per square metre, a critical measure of performance in department stores, had declined and was below that of comparable organisations profit growth was largely attributable to the securitisation of receivables rather than the department store operation in only one of the previous six years had the department store operation been better than marginally profitable between 1996 and 2000 sales grew by 65% but inventory grew by 146% and inventory turnover declined 4.9 to 3.3 store rental expenses more than doubled from 1995 to 2000, from 4.7% to 6.2% of retail sales (by contrast Wal-Mart operates at 3% and David Jones, at the top end of the market and therefore likely to have more expensive fit out, is at about 4%) The role of management and the role of the Board in this issue.

Board members claimed they were mislead for up to six years about the true state of the firm's financial position and when they became aware of the true position they called in a voluntary administrator promptly. Regardless of the veracity of staff accusations, the Board is ultimately responsible for "financial performance... compliance with the law and with appropriate standards of conduct" (Bosch 1995 p 106) and the validity of reported financial position. In that respect the Board appears to have failed to fulfil its responsibilities. The view of Tim Burfield, Ernst & Young (lecture notes 2001) is that the Board may have be facing a significant (unspecified) problem because it is possible that the financial reporting was misrepresented e.g. stock levels not reported correctly. BRW (Vol 23 No 15) held a similar view and noted "clearly the directors... have failed to provide the auditors with the required Corporations Law information".

Mr Burfield advised that Ernst & Young's contract as HSH's auditors was terminated in the mid 1990's because the Ernst & Young audit partner declined to sign off an audit because of the partner's (undisclosed) concerns. HSH then engaged Price Warehouse Coopers as their auditor. Management's role is unclear as events continue to unfold. Allegations have made by both the former Chief Financial Officer and Chief Operating Officer of impropriety by the Executive Chairman whom they allege ordered "adjustments" to financial results to bring about a desired profit result. The Executive Chairman has denied the allegations. My view is that both the Board and management may well have cases to answer.

While the Board is ultimately responsible for the performance of the organisation, if, as the managers claim, the Executive Chairman prevailed on them to manipulate the financials, they will be shown to also have some complicity in the outcome. The components of good governance which should have applied in this case. "Good corporate governance should provide proper incentives for the board and management to pursue objectives that are in the interests of the company and shareholders and should facilitate effective monitoring thereby encouraging firms to use resources more efficiently" (OECD 1999 p 2). The Corporate Governance Statement from HSH's 2000 annual report is at appendix 4. An analysis of the statement reveals it has many if not all the components which the literature suggests should be included e.g. commitment to increasing shareholder wealth, adherence to the highest ethical behaviour and legislative compliance, majority non-executive directors, appropriate committees such as audit, nomination and remuneration, a Board performance review process and so on.

Jim Psaros, University of Newcastle, noted that HSH "had a very impressive corporate governance policy, but the promise never matched the reality" (Background Briefing 13 May 2001 p 12). Despite the public assertions the enterprise very nearly collapsed and it seems that unsecured creditors will receive very little or nothing of what they are owed. The primary purpose of good governance is to improve the performance of the enterprise (Mercer Cullen Egan Dell 2001). It is patently evident that the Board failed in this respect. Corporate Strategy Halliday (lecture notes 2001) defines good governance's goal as "to prevent significant mistakes in corporate strategy from occurring and being in a position to correct quickly those that do occur". While not yet proven at least one commentator, BRW, noted that the Board's strategy of rapid, substantial expansion was a "significant mistake" which was not corrected.

It seems the Board failed in its collective judgement by engaging in an aggressive growth strategy for the past 5 or so years. During that period the firm's gearing increased to nearly 90%. BRW (Vol 23 No 15) observed that the firm was unable to adequately fund that growth from sales revenues and profitability leading to excessive gearing. Business risk The ASX's list of corporate governance matters (ASX 2000) includes, "the Board's approach to identifying areas of significant business risk and to putting arrangements in place to manage them". It is reasonable to assume that the expansion HSH undertook in the last five or so years was predicated on its ability to generate revenue streams which would both fund the expansion and improve profitability proportionally. In this respect the Board appears to have failed to understand the extent of the business risk facing HSH and in not having adequate mechanisms to mitigate that risk.

Audit A fundamental governance responsibility is the "oversight of the preparation of the entity's financial statements, internal controls and the independence of the entity's auditors" (ASX 2000 p 3). The Board has asserted it had been mislead. While that may be the case it is in respect to the over sighting role referred to above that it appears to have grievously failed in its responsibility. As Keith Reilly, a consultant to the Institute of Chartered Accountants stated in BRW (Vol 23 No 14) "the auditor is not the first and last line of defence... the board really has prime responsibility to make sure the company results actually portray reality". In August 2001, the Chairman of ASIC, David Knott observed "it is logical to assume that a lack of independence may lead to a bad audit". He also noted "One sometimes gains the impression that corporations regard audit as a necessary evil rather than a function that should be making a real contribution to shareholder value and security" (ASIC p 8 2001).

The HSH Audit Committee comprised John Patten, a non-executive director, as Chairman, Adam Trescowthick, an executive Director and Chairman of HSH and Alan Hodgson, the company secretary and Chief Financial Officer. Psaros (Background Briefing May 2001 p 12) asserts that this arrangement does not meet good governance standards as the committee could not be regarded as sufficiently independent from management given that two of the members were clearly internal. The Business Council of Australia (1993 p 12) is more emphatic stating that the Audit committee must have a majority of non-executive directors. In the USA, both the New York and American stock exchanges require the Audit Committees of listed companies to be composed of only independent directors (Anderson & Anthony 1986 p 139, Bosch 1995 p 163).

The membership composition of the HSH Audit Committee was not in accordance with good governance practice. A further problem, in terms of governance practice, was that HSH's external auditors were Price Waterhouse Coopers (PWC) and John Patten was a former partner of PWC. While Mr Patten's previous position does not preclude him from chairing the Audit committee, there could be a perception of a lack of independence. James Thomson in the BRW (Vol 23 No 14) wrote "the presence of a director at Harris Scarfe who formerly worked for PwC... raises questions of independence". In that same BRW edition Ted Role of the Australian Shareholders Association stated that "there are potential conflicts in these (HSH and HIH) cases". Additionally the committee had met only twice yearly for the past three years.

It might be argued that Messrs Trescowthick and Hodgson were quite familiar with the financial position of HSH in light of their executive roles, although subsequent events suggest otherwise. While frequency of meetings is not prescribed, the average is four per year (Bosch 1995 p 165). Van den Berghe and De Ridder (1999 p 107) report that various codes, standards and studies devote little attention to meeting frequency. However, they advocate that of the Board's committees, the Audit Committee should meet most regularly. At HSH this was not the case with the Remuneration Committee meeting more frequently. The Audit Committee is meant to be an independent body to ensure efficient and effective communication between external auditors and senior management.

The HSH arrangements jeopardise d this being achieved to the optimal extent. Role of Executive Chairman and CEO Bosch (1995 p 210) cites the "Corporate Practices and Conduct" paper which clearly states "the combination of the roles of Chairman and Chief Executive constitutes a concentration of power and can give rise to conflicts. Except where special circumstances exist the roles should be separated". In Denmark, the Netherlands and Germany this combination is actually forbidden (Van den Berghe and De Ridder 1999 p 62). While Bosch acknowledges practices elsewhere are different and in particular in the USA, where the roles are often combined, in Australia the "overwhelming preponderance of listed companies, government enterprises and charitable organisations see a separate chairman as an important role". Following the former CEO, Ron Baker's departure in the late 1990's Adam Trescowthick assumed the role of Executive Chairman.

While the matter is still pending, in light of subsequent events, it may well be that combining the two roles will prove to have been poor governance practice. The impact on stakeholders of this issue. Coulson-Thomas (1993 p 41) quoted the list of stakeholders identified by one Board. The stakeholders on that list relevant to the HSH case are; The company itself - this has succumbed to the weight of debt but it seems that the receivers will secure a sale, albeit of a "slimmed down" version of HSH in the very near future. Shareholders - many are likely to lose some or all of their investment. Bankers - ANZ Bank is owed $65 M and is the institution which called in the receiver a few days after the Board had appointed an administrator.

Employees - 50 were dismissed soon after the receiver was appointed and another 450 were terminated within four weeks of the first fifty. Because the business is still trading it appears that those remaining appear will have their entitlements "protected" and may well retain their employment. Customers - the effect is not clear but there will likely be a loss of faith by some because of the performance. Suppliers - many of these had already had a difficult time dealing with HSH because of payment terms were increased significantly. HSH's 2000 annual report confirmed that they had entered into a capital raising activity to improve terms of trade.

HSH's total debts are about $160 M, $65 M of which is owed to the ANZ bank. The balance is largely owed to suppliers who may or may not receive all that they are owed. As unsecured creditors they are the last to receive any disbursement from the sale proceeds. Business partners - the most relevant one here are the auditors about which there is discussion above. Other significant partners are HSH's landlords some of whom have lost money through terminated leases brought about by the closure of a number of stores by the receivers.

Government - the South Australian government has been called on to provide unspecified taxation relief to assist the purchase of HSH via a management buyout. When HSH's troubles first became public there were calls for the government to provide financial support. Those calls were dismissed. Local communities / public at large - there was nothing specific which impacted here but given the events in the business world with the collapses of Ansett, HIH and One Tel, all within a relatively short time there is likely to be a concern about the probity with which business is conducted.

One possible effect of this is an increasing cautiousness by so called "mum and dad" investors. Options for the participants. At the time of writing the matter is not resolved and all parties have not had the opportunity to have their say in the appropriate forum. Until that occurs the full range of options will not be evident. Regardless of the options specific participants might pursue, from a financial imperative if none other, it behoves the new owners of HSH to implement governance practices which are an improvement on those practiced by the previous Board.

"Adherence to good corporate governance practices will help improve the confidence of domestic investors, may reduce the cost of capital and ultimately induce more stable sources of funding" (OECD 1999 p 3). From the financial perspective alone, those improved practices are likely to enhance the entity's performance. To date an option some of the parties have taken up is to deny any wrongdoing on their own part and attempt to deflect blame to others. The Board did this initially by asserting that it had been mislead by the management for as long as six years as to the true state of the financial position. Former managers have made accusations about the behaviour of their former colleagues, who have predictably denied those accusations. Conclusions and expectations of the impact of this matter on the future governance debate.

Compared to Ansett, HIH and One Tel, all of which ceased trading and collapsed, the HSH episode is in a sense a "second tier" event. However it will likely add further weight to initiatives to improve governance and related practices. Audit is one area in which changes are likely. I think it is the most significant failing in the HSH matter (a view supported by Tim Burfield's revelation that Ernst and Young lost the account following the partner's refusal to sign off an audit). Indeed David Knott, Chairman of ASIC has said as much, "I note in passing that unlike accounting standards which have the force of law under the Corporation Act, audit practice standards are self regulatory.

That is one of the matters we should re-examine as we review the role of audit over the next two years" (ASIC 2001 p 10). In addition to the status of audit standards, conflicts of interest may also be examined. John Patten, chairman of the Audit Committee and deputy chairman of the Board is a former partner of Price Waterhouse Coopers. No evidence has emerged that impugns Mr Patten's performance on the Audit Committee.

However Mr Patten's role will surely raise questions of probity in some shareholders' mind about the extent to which he can have truly been independent from the external auditors and the potential conflict of interest his background presents. There is already a movement away from a "trust me" to a "show me" environment (Halliday, lecture notes 2001). The corporate governance policy in HSH's 2000 annual report is a good example of the frailty of taking a "trust me" position. While the policy may be a well crafted document it has meant nothing in light of the business' financial performance. Listed companies have been obliged since 1996 to include a statement of corporate governance in their annual report.

I think it is likely that regulators and organisations such as the Australian Shareholders Association will press for further changes to oblige companies to be transparent in their governance practices and demonstrate how governance policies are translated into actions. Conger, Lawler and Finegold (2001 p 150) regard the modern corporation as a powerful entity which once unleashed is difficult for its creators and government to fully control. They note that "the challenge from a corporate governance perspective is to harness corporations so that they serve the best interests of society, rather than just those of shareholders". Finding a balance between having sufficient regulation and control to reduce the likelihood of an HSH like collapse recurring, without unreasonably dampening the entrepreneurial spirit and shareholder desires for adequate returns, is a micro example of the broader difficulties governments and society generally. I do not pretend to have the answer but the debate will be interesting!

Bibliography

Anderson C A & Anthony R N, 1986, The New Corporate Directors;
Insights for Board Members & Executives, John Wiley & Sons, New York, Bosch H, 1995, The Director At Risk;
Accountability in the Boardroom, Pitman Publishing, Melbourne, Conger J A, Lawler E E & Finegold D L, 2001, Corporate Boards;
New Strategies for Adding Value at the Top, Jossey-Bass, San Francisco Corporate Governance: 1980's Revisited? , Mr D Knott, Chairman, Australian Securities and Investments Commission, Monash Law School Foundation Lecture, 23 August 2001 Corporate Governance, RMIT University, web Corporate Practices and Conduct, 2nd ed, 1993, Business Council of Australia, Information Australia, Melbourne, Coulson-Thomas, C, 1993, Creating Excellence in the Boardroom, McGraw Hill, London Guidance Note 9, Disclosure of Corporate Governance Practices: Listing Rule 4.
10, Australian Stock Exchange, July 2000 Halliday, B, 2001, Managerial Ethics & Governance Materials, I GSM, University of South Australia Independence and Auditing: When Companies Collapse, Background Briefing, ABC Radio National, 13 May 2001 OECD Principles of Corporate Governance, Directorate for Financial, Fiscal and Enterprise Affairs, Organisation for Economic Cooperation and Development, April 1999 Reviewing Corporate Governance: 7 Practical Steps, Mercer Cullen Egan Dell, 2001, unpublished Van den Berghe L & De Ridder L, 1999, International Standardisation of Good Corporate Governance;
Best Practice for Boards of Directors, Kluwer Academic Publishers, Dordrecht Whittred, G., 2001 "Another Case of Growing Broke", Australian Financial Review, 2 November URL: web URL: web URL: web URL: web URL: web Appendix 1 Brief History of Harris Scarfe The company's history goes back to the Tasmanian lamp maker Charles Davis, which opened for business in 1847.
It moved into hardware retailing and was listed on the stock exchange in 1911.
Charles Davis inherited the HSH department store in Adelaide's Rundle Mall when it acquired the Investment and Merchant Finance conglomerate in 1976.
The company bought the Tasmanian-based department store business G.P. FitzGerald in 1981, and made several hardware acquisitions in the 1980's, including the McEwan's hardware chain in 1986.
In 1987, Charles Davis announced a plan to expand the G.
P. FitzGerald chain throughout Australia. That was abandoned in 1998, when it decided to concentrate on hardware and sell its Harris Scarfe department store in Adelaide and the G.
P. FitzGerald business. But in 1990, Charles Davis sold its hardware interests into a new company formed out of the McEwan's business, and Harris Scarfe became its largest operating entity.
Charles Davis embarked on a national expansion of HSH and, in 1995, the G.
P. FitzGerald stores were converted to HSH stores and the Charles Davis name was formally changed to HSH. At its peak the company operated 35 (now down to 29) department stores in Victoria, South Australia, Tasmania, New South Wales, Queensland and Western Australia. HSH acquire dstore in December 2000 for $3 M.
HSH and Shell announce a joint venture, e-fill, which "will manage the transfer of goods ordered from dstore stored in a HSH warehouse and delivered for pick up at a Shell petrol station". (BRW Vol 24 No 12) Appendix two Corporate Governance defined In Creating Excellence in the Boardroom (1993 p 36, Reading 5), Coulson-Thomas describes corporate governance as involving;
1. "Understanding the context within which a company operates and the interests, attitudes, perspectives, needs and requirements of the various stakeholders. 2. Determining what needs to be done... 3. Creating the capability to do what needs to be done... 4. Deciding how to do what needs to be done... 5. Ensuring that what needs to be done actually is done... 6. Ensuring that what is done and how it is done satisfies legal and other requirements. 7. Reporting to stakeholders upon what has been achieved... ". Trickner in From Manager to Director: Developing Corporate Governors's trategic Thinking" (1955 p 15, Reading 7) is much more succinct defining corporate governance as being about the exercise of power over companies.
He asserts that this exercise then concerns the processes of the board of directors and the relationships between the board and the shareholders, top management, auditors, company regulators and other stakeholders. Trickner uses the diagram below to illustrate those relationships and the boundaries of corporate governance; Appendix three Australian Financial Review Article - 2 November 2001 CORPORATE FOCUS Another case of growing broke Greg Whittred When it collapsed, Harris Scarfe Holdings was one of Australia's largest department store chains, boasting more than 150 years of continuous operation.
It had 35 stores in a national network, sales of $406 million, more than 2,500 employees and 10,500 individual shareholders. When the end came, it was swift. What happened to HSH - and why - are questions that will no doubt be answered eventually. But why the symptoms of its prolonged illness were not diagnosed and treated earlier is difficult to understand. Since its reorganisation in late 1995, HSH had reported bottom-line profit growth, with reported profit growing from $4.
6 million to $13.2 million. However, a closer look at the accounts reveals that the growth is attributable to a profitable receivables securitisation operation rather than its department store operations per se. Included in total revenues are miscellaneous non-retail revenues, including the results of the "securitisation" operation. Unfortunately, existing accounting requirements do not require the disclosure of operating costs by line of business. This makes it difficult, but not impossible, to estimate the relative contribution of each to overall profitability. When you remove non-retail revenues (interest, dividends, trust distributions and sundry), net of the estimated costs of generating these revenues, along with any gain / loss on asset disposals, it is possible to draw the inference that in only one of the past six years has the department store operation been other than marginally profitable. And this as despite continuing sales growth, both in total and on a like-for-like basis, until 2000.
There are many things that must be done well to run a successful discount department store, among the most critical being efficient management of space, inventories, receivables and margins. In the case of discounters, the last translates into tight control of costs. HSH's growth on a store-for-store basis was impressive in a tough retail market. Much less impressive was the declining yield per square metre (psm) devoted to retail. In his 1999 report, the chairman said HSH had bought or opened 15 new stores in an 18-month period.
As the network expanded from 18 to 35 stores, sales declined from $2,710 to $2,110 psm (or 23 per cent). In contrast, Wal-Mart, which is arguably the world's leading discount department store, achieved sales of about $US 3,333 psm. Even in the upmarket retail sector, the David Jones department store business averages about $4,200 psm. Coles Myer, which sits in between the discount and upmarket sectors, averages between $3,000 psm (apparel and home) and $4,000 psm (Myer Grace Bros). The comparisons are noteworthy since those at the discount end of the market require higher (not lower) turnover to compensate for lower margins. HSH's aggressive growth strategy also should have raised concerns. Not only did it expand into two States where it had never operated before, it did so with stores significantly larger than its existing ones. At the end of the 1997 financial year, the average net retail space in its 24 stores was 5750 sqm.
Yet three of the five stores it bought from David Jones in 1998 were two to three times larger than this.
Any analysis of this aspect of HSH's performance is complicated by the suggestion of considerable accounting irregularities, related in part to the company's inventories. The irregularities are reported to have resulted in a cumulative overstatement of profits of $125 million - an amount far in excess of the cumulative reported profits for the past six years. But this is after the fact. What inferences might have been drawn before the fact? Getting a feel for HSH's retail efficiency (or inventory turnover) is problematic in the absence of disclosure of its cost of goods sold (COGS), although given the recently proposed changes in accounting standards, this situation will soon be remedied. At a macro level, it is evident that while HSH sales grew by 65 per cent between 1996 and 2000, its inventories grew by 146 per cent in the same period.
For each dollar of sales in 1996, it held 16 c of stocks at year-end.
In 2000, the value of stock held had risen to 23 c (Wal-Mart held 17 c of stock for each dollar of sales at this time, and David Jones held 19 c).
Another approach is to assume HSH's ratio of COGS to sales is equal to world best practice. For at least the last decade, Wal-Mart has operated at a gross margin of about 25 per cent - with COGS sitting consistently at about 75 per cent of retail sales. On this basis, HSH's inventory turnover (COGS to average inventory) declined by about a third: from 4.9 times in 1996 to 3.
3 times in 2000, with the number of days' worth of sales in inventory increasing from 74 to 112.
Different (higher) estimates of the ratio of COGS to sales do not change the underlying downward spiral. By 2000, HSH's inventory turnover was less than half that of Wal-Mart (3.
3 compared with 7.3). In recent years, it has been even lower than the inventory turnover of David Jones at the top end of the market. In short, while the "true" inventory position of HSH may not have been clear, even the reported numbers ought to have raised questions about its performance. On the basis of the reported figures, HSH's receivables turnover rose from about 15 to 36 times, with a reduction in the number of days in receivables from 23 to 10. This performance is due entirely to the fact that from 1993 HSH had securitised increasing proportions of its credit card receivables portfolio - a practice that both frees up capital and typically generates a revenue stream for the department store operation.
The notes to the accounts explain that these receivables were sold into a securitisation trust (in which the company retained a 10 per cent interest). The department store subsidiaries had the right of first refusal to repurchase any doubtful debts offered for sale by the trust and, as a matter of practice, had always exercised that right. This practice means the receivables have been effectively, though not technically, sold on a "with recourse" basis. Over the period of interest, the year-end balance of receivables in the trust grew from $26 million to $43 million. A different picture of how well the receivables were being managed is gained by recalculating the figures as if their sale had not taken place. On this basis, receivables turnover runs at between 7.4 and 9.5 times, with days in receivables between 38 and 49. The receivables operation does appear to have been the end of the business at which earnings were being generated. What can be said about the quality of these earnings? Two observations are possible, neither of which is fatal, but both of which would warrant further investigation. These observations relate to: (1) the adequacy of the provisioning for receivables; and (2) the revenue recognition principles adopted for the sale of receivables. With respect to the former, note that the provisions for doubtful debts relate to the estimated buybacks from the trust. In recent years, there have been no disclosures on this matter. But between 1993 and 1997 the company's footnote disclosures are instructive.
Repurchases from the trusts exceeded the provisions for doubtful debts in four of the five years - by amounts ranging from 10 to 214 per cent! Repurchases ran at 1.7 per cent of year-end receivables in 1997.
The provisions set aside in the three most recent years are somewhat lower and sit at about 1.3 per cent of year-end receivables. While HSH provides the required statutory disclosures in its operating statement, these are of limited assistance in assessing this aspect of its performance. It is clear from references in the chairman's addresses from 1999 onwards that the company was concerned about declining margins.
While gross margins were presumably positive, it is also clear that operating costs (selling, general and administrative costs) quickly eroded these. One of the company's largest single expenses was store rental (non-cancellable operating leases). This had more than doubled between 1995 and 200, from $11.
9 million to $25.1 million, or from 4.7 per cent to 6.2 per cent of retail sales - a number that ought to have raised a red flag. Discount operators, by definition, operate out of stores that are low-cost to fit out and cheap to run. Wal-Mart, for example, has rental expenses of 3 per cent of retail sales. The average for the US discount department store industry is 3.3 per cent. Closer to home, David Jones, whose stores should cost more than HSH's to fit out and operate, has rental expenses estimated at around 4 per cent of sales - lower than those of its discount competitor. With the advantage of hindsight, detective work is comparatively easy. But it does seem that, with some effort, the signs were there to be seen and had been for some time. It is, therefore, difficult to understand why the problems were not diagnosed and treated earlier. There are many contributors in a corporate collapse. Those that my analysis suggests are present in this case include the adequacy of the disclosures being made - particularly the lack of data on margins (by line of business); the adequacy of the corporate governance mechanisms; and management's strategy development and implementation. What is clear is that HSH is a textbook example of how to "grow broke" and a cogent reminder that we seem doomed to repeat the lessons of history. Greg Whittred is a professor of accounting and finance at the Australian Graduate School of Management. In 2002 he will join the University of NSW as dean of the Faculty of Commerce and Economics.