I

TABLE OF CONTENTS
TABLE OF CONTENTS ............................................................................................................................... I
EXECUTIVE SUMMARY ........................................................................................................................... II
1 ABOUT HARVEY NORMAN .................................................................................................................. 1
1.1 Principal Resources of Revenue and Productions ............................................................................... 1
1.2 Operation ............................................................................................................................................. 1
1.3 Competitors and Market Share............................................................................................................ 2
1.4 Regulations Affecting HVNs Operations .......................................................................................... 2
2 PEST ANALYSIS ...................................................................................................................................... 3
2.1 Political ............................................................................................................................................... 3
2.2 Economic ............................................................................................................................................ 3
2.3 Social ................................................................................................................................................... 4
2.4 Technical ............................................................................................................................................. 5
3 AUDIT RISKS ........................................................................................................................................... 6
3.1 Earnings Management ......................................................................................................................... 6
3.2 Foreign Exchange Rate Exploitation .................................................................................................. 7
3.3 Obsolete and Overvalued Inventories ................................................................................................. 8
3.4 Deliberate Misclassification of Interest Expense ................................................................................ 9
4 THE AUDIT PLAN FOR PROPERTY, REVENUE AND EXPENSES ................................................. 10
4.1 Investment Properties ........................................................................................................................ 10
4.2 Sales .................................................................................................................................................. 10
4.3 Expenses ........................................................................................................................................... 10
REFERENCE .............................................................................................................................................. 11


II


EXECUTIVE SUMMARY
Harvey Norman Ltd (HVN) is one of the largest retailers in Australia. With market capitalisation
of approximately A$3 billion, the firm uses its capital to operate various classes of asset such as
investment properties and technological products (inventories for sale) to generate revenue. Its
operations are mainly based in Australia, but extend to foreign countries as well such as New
Zealand and Malaysia. This report presents key findings on the operations of HVN based on
rigorous research of the core business of the firm. It is aimed that users of this report to be able to
understand key business risks to the business and consequently the inherent audit risks to the
auditors.
The main activities of the HVN are described in Section 1 of the report, where it is determined
that there are three revenue-generating core activities for the firm, namely electronic/household
retail business, franchising, and property investments. Together, these activities contribute 99%
of the firm's revenue and hence are critical determinants that affect the performance of the firm.
Section 2 covers PEST analysis for the HVN, which intends to identify crucial internal and
external business factors that would determine the profitability of the company. Using the
outcome from the PEST analysis and information from financial statements of the previous
financial year, four key audit risks and their relevant assertions are outlined in Section 3. These
audit risks are believed to be areas/accounts, which are most prone to material accounting
mistreatment.
Finally, Section 4 covers the audit plans, relevant audit assertions, and appropriate tests
recommended on the firm's Property, Revenue and Expenses to ensure these accounts be fairly
and reasonably stated.

1

1 ABOUT HARVEY NORMAN
1.1 Principal Resources of Revenue and Productions
HVN is an Australian-based public company, whose principal activities consist of an integrated
retail, franchising and property investment (HVN, 2012d).
Retail business is the main source of HVNs revenue. Its franchises specialises in sales of
retail computers, electrical products, furniture, bedding, carpet, flooring and home
improvements (ASX).
The second largest revenue originates from franchising operation, including income from
franchise fees paid by franchisees and interest on franchise loans (IBISWORLD, 2012d).
Another significant revenue, which is generated from property investment, is constituted of
rental income from franchisees and third parties.
Three principal revenue sources are listed below (HVN, 2012a):
Segment FY 2012($000) FY 2011($000)
Retail sales 1,407,342 (58%) 1,556,384 (59%)
Franchising operation 723,050 (30%) 784,855 (30%)
Property investment 273,078 (11%) 248,400 (10%)
Other revenue 26,083 (1%) 28,362 (1%)
Total revenue 2,429,553 (100%) 2,618,001(100%)
1.2 Operation
Under HVNs operation structure, each section such as electrical, furniture operates as separate
franchise. Consequently there are three or four franchisees in a superstore, contributing revenue
through lease payments and a portion of sales. Accordingly, HVN has adopted an Omni
Channel Strategy.
Retail sales: HVN operates 76 discount department stores in Australia, New Zealand,
Singapore, etc., offering a number of different products (HVN, 2012a). It purchases
products from manufacturers directly, and resells them to consumers for profit. Recently,

2

HVN has adopted a clicks-and-mortar strategy to connect their physical and digital stores.
Franchising operations: HVN operates Harvey Norman, Domayne, and other branded
department stores, under which it grants franchise to independent business operators and
allows them to sell their retail products for a fixed period under the franchising contract.
Investment property: the company owns the land under about 1/3 of its stores in Australia,
New Zealand and Slovenia. HVN leases them to franchisees and third-party tenant for retail
operation and fixed rental income (HVN, 2012a).
1.3 Competitors and Market Share
HVN trades as a multi-sector business in domestic and international market. Therefore it faces
intense competition in different industries from both Australian and overseas market. The table
below lists HVNs major competitors and market share in different retailing industries in
Australia:
Retailing industries Primary archrivals Market share
Computer and software JB Hi-Fi, Dick Smith, office work, Woolworths 23.6% (IBISWORLD, 2012a)
Furniture Freedom Group, Super A-Mart 12% (IBISWORLD, 2012c)
Domestic appliance BSR Australia, Good Guys, JB Hi-Fi 14.9% (IBISWORLD, 2012b)
1.4 Regulations Affecting HVNs Operations
The Competition and Consumer Act 2010 regulates the retail industry and protect
consumers rights. Retailers can be heavily penalised for misleading consumers. Under this
act, HVN is also required to comply with the Franchising Code of Conduct, Product Safety
and Labelling, Warranty and Refund Obligation, Anti-Competitive Price Signaling and
Information Disclosures.
Under the Retail Trading Act 2008, retail trading hours regulation posts a potential threat to
HVN. The restriction increase costs on retailers since capital investment is not fully utilised
(Foreshew, 2011). It narrows the range of time available for shopping, imposes costs on
employees who prefer to work outside of the regulated trading hours as well (Goos, 2004).

3

2 PEST ANALYSIS
2.1 Political
2.1.1 Competition and Consumer Act 2010
Competition and Consumer Act 2010 (Commonwealth, 2010) regulates the retail industry, where
any breach will lead to lawsuits, heavy penalties, and eventually affect the companys reputation.
For example, HVN was penalised $1.25 million for misleading advertising in 2011. HVN was
also ordered to publish corrective notices in regional and metropolitan newspapers as well as on
the HVN website, which has severely tarnished the companys reputation (ACCC, 2011).
2.1.2 Exchange Rate
From the chart (RBA, 2013a), high exchange rate of
Australian dollar has caused foreign goods to be
cheaper compared to domestic goods, which might
motivate more consumers shopping online. This can
negatively affect the retail sale of HVN, especially for
small appliances, electrical products above $1,000.
2.1.3 Low Value Import Threshold (LVT)
Due to low value import threshold in Australia, imported goods worth less than $1000 are
exempted from GST, which allow foreign retailers have a competitive advantage over local
retailers (Deloitte, 2011). This would cause outflow of retail sales due to relatively cheaper
foreign goods and consequently affect sales targets of domestic retailers.
2.2 Economic
2.2.1 Pricing Discrimination in IT Products
Australian consumers are paying more for IT software and hardware products than other foreign
countries. For instance, Australians are paying on average 34% more for software, 51% more for
iTunes music, 88% more for Wii games and 41% more for computer hardware than US
consumers (Cartwright, 2012). This is mainly caused by higher wholesale cost in Australia due
to international price discrimination from large foreign companies. The result is higher retail
prices which could hurt consumers as well as retailers like HVN in Australia.

4

2.2.2 Trading Environment
The retailers in Australia has been underperforming for a number of years and the trading
environment is set to be equally challenging, if not worse, in 12/13 with further deflation,
volatile consumer confidence, weak labour market, and so on. With further overseas expansion
and new entrants into the Australian market in 2013, competition among the Australian retailers
will be much more aggressive (Deloitte, 2013) and would adversely impact sales target.
2.2.3 Interest Rates
Retail industry is sensitive to changes of consumer spending behaviour. Interest rates, being one
of the macroeconomic factors affecting consumer spending, would cause a shift from buying
cycle to saving cycle among consumers when rates are significantly reduced. From the charts
(RBA, 2013b), the cash rate (proxy for interest rates) has been declining over 2012-13 period.
This would stimulate consumer spending and growth in the retail industry could be expected.

2.3 Social
2.3.1 Corporate Social Responsibility
Retail industry like HVN is under pressure to implement socially responsible business practices,
such as selling environmentally-friendly products, placing warnings or restrictions on potentially
harmful goods, and removing recalled or controversial products from the shelves.
2.3.2 Brand Loyalty
These days, brand name is no longer a strong indicator of the quality of a product as before.
Since there is enormous information about various products, people can conduct their own

5

research online and make informed purchase decisions based on personal preferences. This is
likely to cause retailers like HVN to focus on the price/performance ratio instead of brand loyalty.
2.3.3 Consumer Behaviours
Facing the continually changing consumer behaviours, an increasing number of retailers have
been seeking multi-strategies to expand their reach to various segments of markets and
customers. In this case, HVNs Omni Channel Strategy is aimed to attract Australian
consumers and provide HVN with strategic advantages over its competitors (HVN, 2012b).
2.4 Technical
2.4.1 New Inventions and Developments
New inventions and developments will lead to the changes in business operating model - such as
the development of information system that will improve technological platform and automate
operational processes. These efforts are made to retain their competitive advantage, thus
preserving their existence, especially for the retailers like HVN in a competitive market.
2.4.2 Technological Obsolescence
Technical obsolescence usually occurs when a new product or technology supersedes the old,
and it becomes preferred to use the new technology in place of the old, even if the old product is
still functional. Technological obsolescence is one of the factors contributing to overstocking and
poorer-than-expected demand. Besides tying up funds, technological obsolescence increases the
risk of heavy write-offs in inventories for HVN if they were overly optimistic on sales forecast
and acquired excessive seasonal and technology merchandise, such as electrical, computers &
communications, and similar household appliances (DELL, 2012).
2.4.3 Online Shopping
According to Forrester Research, Australian online retail sales will increase from $16.9 billion in
2009 to $33.3 billion in 2015. Even though HVN had publicly declared that there was no
revenue from online sales in late 2008, HVN like other Australian retailer later discovered that
there is definite marketing strategy that can prevent consumers from pursuing the best deals
online and development of online sales strategies was a matter of life and death for the retail
industry (Deloitte, 2011).

6

3 AUDIT RISKS
It was noticed during the audit planning, that the company adopts a remuneration strategy that
emphasises on both financial and non-financial targets set by the board of executive. These
remunerations for managers, which are outlined in the remuneration report section, include
both cash incentives and share options exercisable at a future date. Therefore there are risks
where managements are motivated to manipulate financial figures to obtain short-term benefit
for themselves. The following are audit risk, which could lead to litigation for the audit firm if
careful assessments are not thoroughly undertaken.
3.1 Earnings Management
There is a risk where domestic retail sales are overstated due to poor outlook on retail
environment and pressure for managers to maintain the minimum financial target / performance.
Key Account: Income Statement / (Domestic) Sales Revenue
Assertion: Occurrence
The PEST analysis reveals that local retail environment will remain challenging, with many
retailers expect price cuts and more aggressive competition from competitors. There is also a
significant shift in spending behaviour of domestic customers, where more Australians move
towards the saving culture. Therefore the external business environment of HVN is expected to
adversely affect the performance of the company, and thus there is a pressure for management to
manipulate critical earning figures to window-dress the financial statements.
Furthermore, HVN's profitability, which
was measured from its Earnings Per Share
(EPS), has been on a downward trend and
has been significantly lower compared to its
competitors. This is expected to be another
motivation for earnings management by the
managers of the company in order to
resurrect the reputation of the firm. Since it
is difficult for auditors to accurately gauge the reported sales figures in the financial statement,
managers might exploit the sales figures improve the financial performance of the firm. Thus

7

there is a risk where sales recognition might not be appropriately applied or artificial sales are
created to in order to momentarily increase sales volume and hence operating profit. A
substantive analytical test is therefore required to properly assess the reported sales figure.
3.2 Foreign Exchange Rate Exploitation
There is a risk where foreign retail sales are overstated by exploiting the huge fluctuations in the
Australian Dollar (AUD) foreign exchange rate against many other major currencies.
Key Account: Income Statement / (Foreign) Sales Revenue
Assertion: Accuracy
All of HVN's operations outside
Australia are company-operated
stores and are wholly owned by
HVN. During consolidation of the
financial statements the company
needs to adopt Translation Method,
which requires the entity to translate
income statement items from foreign operations at the corresponding exchange rate when the
transactions occurred (HVN, 2012c). A more practical approach is to apply the weighted average
exchange rate instead. However, the trend of the exchange rate for AUD is expected lead to
lower AUD equivalent revenue during consolidation as the AUD strengthens against most
foreign currencies. A good example of such strengthening is the trend of AUD against New
Zealand Dollar.
In order to meet the required performance for its overseas operations, managers might
manipulate overseas' sales figures by exploiting the fluctuation in exchange rate over the
year. As the exchange rate fluctuates with time, it becomes almost impossible for less-
sophisticated financial statement users to accurately apply the appropriate exchange rate, hence
raising a concern where favourable rather than appropriate exchange rates are used to perform
the translation to produce a better financial performance. A substantive analytical test is therefore
recommended to estimate the appropriate exchange rate and assess the reported foreign sales.

8

3.3 Obsolete and Overvalued Inventories
There is a risk where inventory is overstated due to potential obsolescence of technological
products and hence lower net realisable value.
Key Account: Balance Sheet / Inventory
Assertion: Valuation & Allocation
The intensified competition from competitors in the retail industry is expected to remain as a
major factor that would cause difficulties for retailers to achieve their target sales. This might
cause stock-piling of inventories or technological products if the sales forecast significantly
deviates from the actual sales figures. Eventually heavy inventory write-off is inevitable.
Compounding the issue is the fact that technological products become obsolete very quickly due
to rapid product development, causing the net realisable value of technological product to
decrease dramatically even within a short time frame of sales difficulties.

Furthermore, the outlook for the retail industry is expected to remain weak. Even though the
trend of consumer confidence looks promising over the past 3 months, there are still
uncertainties and lack of confidence on the Australian economy (Economics, 2013). Thus
consumers are expected to spend less on retail products, and there is a risk where the company
might have acquired too much inventory, and find difficulties in achieving projected sales. This
could lead to heavy write off or discounting on inventories, which would serve as an indication
that net realisable value is lower than management perceived. Therefore, there is a risk where
inventories are overvalued and proper substantive test is required to ensure inventory is reported
at fair value.


9

3.4 Deliberate Misclassification of Interest Expense
There is a risk where interest expenses are wrongly classified in order to increase the interest
coverage ratio and reduce investors perceived risk.
Key Account: Income Statement / Finance Cost (Interest Expense)
Assertion: Classification / Completeness
Harvey Norman 2012 (HVN, 2012c) 2011 (HVN, 2011) 2010 (HVN, 2010)
Finance Cost $49,455,000.00 $42,984,000.00 $33,638,000.00
EBIT $276,864,000.00 $416,919,000.00 $420,100,000.00
Interest Cover 5.60 9.70 12.48
A quick calculation would reveal that the HVN's ability to service is debt has significantly
decreased from 10/11 to 11/12. This is evident by evaluating the firms interest coverage ratio,
which has decreased from 9.7 to 5.6. This was mainly caused by the sharp increase in borrowing
(Interest Bearing Loans & Borrowings), increase in financing cost and the sharp fall in
profitability as can be measured from the firms EBIT (Earnings Before Interest and Tax). The
downward trend is also consistent when compared to the figure from 09/10.
As interest coverage ratio is a tool for investors to gauge the riskiness of their investments in a
firm, the decrease in a firms ability to service its loan will certainly affect the perceived risk by
investors on their investments in the company. Share prices tend to fall as this unfavourable
information unfolds and would reflect badly on the management of the company. As profitability
of the company is not expected to significantly improve for this financial year, it is reasonable to
expect that interest coverage ratio of the firm would fall further. Therefore there is an incentive
for managers to manipulate the financing cost in order to deceive investors in regards to the
solvency of the firm. One way of achieving this is by inappropriately classifying some financing
cost into other expense accounts, therefore improving the perceived solvency. A substantive
analytical test should therefore be developed to estimate the interest expense (finance cost) in
order assess the reported finance cost in the firm's 12/13 financial report.

10

4 THE AUDIT PLAN FOR PROPERTY, REVENUE AND EXPENSES
4.1 Investment Properties
Key Account: Investment Properties Assertion: Valuation & Allocation
There is a risk that investment properties are overstated, because only one-sixth of investment
property portfolio is independently valued, with the remaining five-sixths valued by HVNs
directors. Therefore management has the motivation to strengthen HVN's balance sheet by
overvaluing investment properties (HVN, 2012b).
Test: Substantive Test of Detail (with subsequent Substantive Test if necessary)
Evaluate a sample of the remaining five-sixth investment properties portfolio using market
values of similar properties in the same area. If the valuation differs significantly from the
reported value, a qualified property valuer will be engaged to provide a formal valuation on the
same sample of investment properties.
4.2 Sales
Key Account: Franchising Revenue Assertion: Occurrence / Accuracy
There is a risk where rental and franchising revenue is overstated as the determination of these
revenue streams is not immediately apparent to users of the financial statement. As we saw
closures of some HVN stores over the 12/13 period, there is an increasing risk for such
misstatements to eventuate.
Test: Substantive Test of Detail
Pick a sample of rental income/ franchise fee from the ledger and check if the stores/invoices
exist. The auditor can further assess the reported franchising revenue by determining how
franchise fees are calculated and reconcile the expected franchise fee/rental income from the
same sample with the reported franchising revenue in the financial statement.
4.3 Expenses
Key Account: Expense Assertion: Completeness / Accuracy
There is a risk that expense is understated. The risk may eventuate due to misstatement of
depreciation expense on investment properties or capitalisation of other miscellaneous expenses
that are not related to improvement of PPE.
Test: Substantive Test of Detail
Pick a sample of PPE from the ledger and ensure that the depreciation method is appropriate. The
investment properties must also be physically inspected to verify that any reported capitalisation
by HVN is related to genuine improvements to its PPE.

11

REFERENCE
ACCC. 2011. Harvey Norman holdings ltd penalised $1.25 million for misleading advertising [Online].
Available: http://www.accc.gov.au/media-release/harvey-norman-holdings-ltd-penalised-125-
million-for-misleading-advertising [Accessed 22 April 2013].

ASX. Harvey Norman Holdings Limited (HVN) [Online]. Available:
http://www.asx.com.au/asx/research/companyInfo.do?by=asxCode&asxCode=HVN [Accessed 6
Aprial 2013].

CARTWRIGHT, M. 2012. CHOICE research exposes price discrimination [Online]. Available:
http://www.choice.com.au/media-and-news/consumer-news/news/choice-lodges-submission-
on-it-price-discrimination.aspx [Accessed 1 May 2013].

COMMONWEALTH. 2010. Competition and Consumer Act 2010 [Online]. Available:
http://www.comlaw.gov.au/Details/C2011C00003 [Accessed 20 April 2013].

DELL. 2012. Managing Inventory Obsolescence For Improved Retail Performance [Online]. Available:
http://i.dell.com/sites/content/business/smb/sb360/en/Documents/wp-retail-r4-fa.PDF
[Accessed 1 May 2013].

DELOITTE. 2011. Australia's Retail Revolution [Online]. Available:
https://www.deloitte.com/assets/Dcom-
Australia/Local%20Assets/Documents/Industries/Consumer%20business/Deloitte_Charter_Andr
ew_Griffths.pdf [Accessed 29 April 2013].

DELOITTE. 2013. Global Powers of Retailing [Online]. Available: http://www.deloitte.com/assets/Dcom-
Australia/Local%20Assets/Documents/Industries/Consumer%20business/Deloitte_Global_Powe
rs_of_Retail_2013.pdf [Accessed 23 April 2013].

ECONOMICS, T. 2013. Australian Consumer Confidence [Online]. Available:
http://www.tradingeconomics.com/australia/consumer-confidence [Accessed 3 May 2013].

FORESHEW. 2011. Systems review refreshes Woolworths [Online]. Available:
http://www.theaustralian.com.au/australian-it/systems-review-refreshes-woolworths/story-
e6frgakx-1226208489311 [Accessed September 5 2012].

GOOS, M. 2004. Sinking the blues: the impact of shop closing hours on labour and product markets.
London School of Economics.

HVN. 2010. 2010 HVN Annual Report [Online]. Available:
http://www.harveynormanholdings.com.au/pdf_files/2012_Annual_Report_Final.pdf [Accessed
3 May 2013].

HVN. 2011. 2011 HVN Annual Report [Online]. Available:
http://www.harveynormanholdings.com.au/pdf_files/2012_Annual_Report_Final.pdf [Accessed
3 May 2013].


12

HVN. 2012a. 2012 HVN Annual Report [Online]. Available:
http://www.harveynormanholdings.com.au/pdf_files/2012_Annual_Report_Final.pdf [Accessed
6 April 2013].

HVN. 2012b. 2012 HVN Annual Report [Online]. Available:
http://www.harveynormanholdings.com.au/pdf_files/2012_Annual_Report_Final.pdf [Accessed
25 April 2013].

HVN. 2012c. 2012 HVN Annual Report [Online]. Available:
http://www.harveynormanholdings.com.au/pdf_files/2012_Annual_Report_Final.pdf [Accessed
3 May 2013].

HVN. 2012d. Harvey Norman Company Profile [Online]. Available:
http://www.harveynormanholdings.com.au/pdf_files/Company_Profile_2012.pdf [Accessed 6
April 2013].

IBISWORLD. 2012a. Computer and software retailing major companies [Online]. Available:
http://clients1.ibisworld.com/reports/au/industry/majorcompanies.aspx?entid=1836#MP3662
[Accessed 6 April 2013].

IBISWORLD. 2012b. Domestic Appliance Retailing [Online]. Available:
http://clients1.ibisworld.com/reports/au/industry/majorcompanies.aspx?entid=1838 [Accessed
13 April 2013].

IBISWORLD. 2012c. Furniture retailing major companies [Online]. Available:
http://clients1.ibisworld.com/reports/au/industry/majorcompanies.aspx?entid=411#MP3662
[Accessed 13 April 2013].

IBISWORLD. 2012d. Harvey Norman Holding Ltd - Premium Company Report Australia [Online]. Available:
http://www.ibisworld.com.au/car/default.aspx?entid=3662 [Accessed 6 April 2013].

RBA. 2013a. Exchange Rates [Online]. Available: http://www.rba.gov.au/chart-pack/exchange-rates.html
[Accessed 19 April 2013].

RBA. 2013b. Interest Rates [Online]. Available: http://www.rba.gov.au/chart-pack/interest-rates.html
[Accessed 19 April 2013].