KPMG Motor Industry Services has released its latest checklist of essential business areas that must be addressed by dealers in the lead-up to the end of this financial year, and the new treatment of leases under dramatically changed international accounting standards is seen as the number one action item for all dealers.
The changes, which will apply to all businesses in Australia, seek to place the assets of companies on the balance sheet for all to see and to eliminate carrying assets “off balance sheet” by way of leasing.
KPMG says that this different treatment will mean that companies with a heavy reliance on leasing will see steep rises in EBITDA (earnings before interest, tax, depreciation and amortisation), but profits before tax will plummet.
This will happen without the dealership trading any differently from before the standard is applied.
In addition, KPMG says there will be a big increase in the complexity of preparing company accounts under the new rules.
KPMG is saying that the changes, if not correctly addressed in a timely way, could put dealerships in breach of their loan covenants with the lenders funding their businesses.
It could also adversely affect the ability of the businesses to raise capital because of the possible huge changes to the company’s EBITDA and profit before tax.
There are also significant implications for dealers planning to buy or sell dealerships, as normal beachmarks like EBITDA and profit before tax will be different.
KPMG says that dealers entering into leases now need to understand the implications of the changes to avoid making a mistake because the treatment of those leases will change in two years
The firm says every current leasing agreement must be reviewed individually and its implications under the new standards identified. This could amount to reviewing hundreds or even thousands of lease agreements in some businesses.
KPMG added that dealers entering into leases now need to understand the implications of the changes to avoid making a mistake because the treatment of those leases will change in two years.
KPMG says that, while the new standard will not be put in place for most companies until June 30, 2020, dealers need to get started immediately because the processes are complex and time consuming and not being ready is not an option. In some cases, dealers should have already started preparing for the changes from January 1, this year.
KPMG director of enterprise audit, Simon Irrgang, told GoAutoNews Premium that dealers entering into leasing agreements today should understand they will be treated for accounting purposes in one way now, but in two years time they are going to be treated completely differently.
“So decisions about whether they should enter into leases or, in fact, buy the assets, need to be made now because these are going to start having an impact,” Mr Irrgang said.
“The structure of any leases being entered into now needs to make sure that they get the most advantageous outcome from an accounting perspective.
“They also need to think about the impact of these changes around borrowing and the like.
“If dealers are entering into a borrowing agreement which has a covenant set up a certain way – whether it is based or driven by EBITDA and profit before tax – the calculation of that number, how it is now versus what it will be in two years time, will be completely different.
“And so they will be entering into agreement now that in two years time will no longer be within the covenant when really the business has not changed at all. It will just have changed in the accounting.
“If dealers are not cognisant of those changes now and are not aware of what the impact is going to be, they will not be able to forsee those issues and the impact it will have.
“If dealers do not address these issues now it is going to happen all of a sudden and they will then have to deal with it on the run. For a lot of dealerships which don’t necessarily have a lot of flexibility in their arrangements it could be quite detrimental,” Mr Irrgang said.
KPMG director of consulting and compliance, Steve Bragg, said that, as part of the standard, all companies will have to go through every leasing contract they have entered into that is an explicit lease or lease-type arrangement.
“Just imagine having to review all of those documents which are usually 10 or 20 or 30 pages long,” he said. “In larger groups there will be hundreds if not thousands of these lease agreements.
“You have to assess the impact on a lease-by-lease basis. You cannot average it. It is not something you can do in bulk.”
Mr Bragg said that attempting to process the change in the last six months before the deadline would not work.
“The issue will be for the dealers who are not on top of it trying to do it at the last minute. That just won’t work because of the enormity of the work involved.
“Apart from missing the deadline, they also need to be able to assess the impact on the business before it is too late. When you see what the impact is going to be you can use that impact to your own advantage rather than being forced to be react to it.
“For example, if it is going to have a big impact on your EBITDA or your profit before tax, you can take that information to your bank and explain that the new accounting standard is going to have an impact on your reported results and you are going to need to adjust your covenants so you don’t go into breach when the new accounting standard comes into place.
“It is a matter of getting ahead of the game rather than being reactive.”
Pre-registrations – are your books right?
Mr Bragg said that KPMG had heard that pre-recorded registrations of cars to meet sales targets were on the rise again and added that dealers need to make sure they have made correct provisions “in case the music stops”.
“When the OEMs and the dealers play the game of pre-registrations, if you are the one holding all the stock when the music stops you have a massive provisioning issue to make sure that the stock is at market value. What is it going to cost to exit that vehicle? How much discount is needed to sell that car?”
Mr Bragg said: “The problem there is that it is too late at year end. If you have a lot of these cars at the end of June and the market falls off when your audit is happening then your advisors are going to come in and say that you have a huge problem here so they are going to make a million-dollar provision and you have basically accumulated too many of these pre-registered cars by May-June.
“So it it is important to make sure that dealers are thinking ahead. They need to ask how many pre-registered cars they have – do they have an accurate count of those cars – and have they set aside a provision so they can exit that stock.
“Again it is more about being proactive than reactive because if you are stuck with this stock when the music stops it can be very painful. It is a matter of being aware of the implications of these cars.
“There are many examples of dealers who have suffered in the past 12 months who have registered a lot of these cars and did not really keep track of it,” Mr Bragg said.
Capital improvement treatment can free up cash
KPMG said that the many dealers who have been renovating or rebuilding their dealerships need to make sure they are maximising their available tax deductions associated with this spending.
Mr Irrgang said that many dealers take the easy way out by putting everything in the same bucket and depreciating it over quite a long period.
“From an administrative perspective that is the simple answer but from an accounting perspective it is not always the right answer.”
He said that a building might be depreciated potentially over 30 years but, if it is broken down into all the individual parts, many of those parts can be depreciated over a shorter time.
“So what is most effective is getting a quantity surveyor’s report done so we can break that asset up into all its individual components. That means you can start bringing forward that depreciation to better reflect their useful lives.
“So you are getting those deductions up front when you are actually using the asset; not 20 years down the track.
“It puts cash in your hand. The deduction is the same over the life of the asset, it is just changing the timing to better reflect your use of the asset.”
He said that, individually, the numbers were not very big but when “added up across the whole building, it puts a pretty big amount of cash in your hands now that you can use to run your dealership instead of it being tied up in the capital value of the building”.
When it is time to exit you want to be in a position where someone can assess your business quickly and easily. The more a buyer has to ask questions and the more untidy the accounts it will tend to devalue your business because it raises risk and raises doubts
Consolidation – preparing for a sale
KPMG said that consolidation of the industry was going ahead at a breakneck pace with the buying and selling of dealerships.
Mr Bragg told GoAutoNews Premium: “Now is a good time for dealers to have their ownership and operational structures up to date in the best form for them to exit should the opportunity come along.
“This includes having their accounts clean and tidy so, when the sale process begins, there are no surprises.
“I tell dealers: this is your life’s work, you have put in a lot of effort and you want to make it look the best that you can.
“So when it is time to exit you can maximise the value. You want to be in a position where someone can assess your business quickly and easily. The more a buyer has to ask questions and the more untidy the accounts are will tend to devalue your business because it raises risk and raises doubts.
“So if you are in the market or you want to be in the market it is important to get yourself ready by producing accounts that are sensible, easily readable and very tidy so there are no surprises,” Mr Bragg said.
By John Mellor