CLICK HERE TO VIEW KPMG’S REPORT

A DESIRE by local and international accounting standards boards to expose the real value of assets within Australian companies, and end the practice of using leases to effectively park assets “off balance sheet”, is likely to have a big impact on all Australian businesses in general but will hit dealerships in particular.

GoAutoNews Premium has been told that the change will have a big impact on companies such as Qantas, which has billions of dollars worth of aircraft on lease that will now have to appear on its balance sheet.

In the car retailing sector, observers are saying that large dealer groups which tend to lease rather than own their dealerships, could see their pre-tax profit fall significantly whereas dealerships that tend to own their properties would be less affected.

But it is not just large businesses such as dealerships. The new rules involve all businesses right down to owner-operators just renting a small shop.

Leading accounting practice, KPMG, through its Motor Industry Services division, has warned dealers that the mandatory accounting standard change will have a major impact to the bottom line of a dealership business “without a single change in the way the business operates”.

In a special report to clients, KPMG says that “dealerships are likely to be significantly impacted and at risk as they normally hold multiple operating leases currently accounted for ‘off balance sheet’”.

The impact of the new standard will mean that results for the business will see steep rises in EBITDA (earnings before interest, tax, depreciation and amortisation) but pre-tax results will plummet.

In addition, the report warns of a big increase in the complexity of preparing company accounts under the news rules.

The KPMG report said: “We have modelled the initial impact on a number of our clients within the Australian motor industry and anticipate increases to EBITDA up to 90 per cent whilst experiencing reductions in profit before tax over 30 per cent.

“Impacts to the balance sheet are just as wide ranging with increases to total assets over 30 per cent, and total liabilities as much as 55 per cent.”

KPMG warned that this is likely to affect valualtions of the business in buy-sell discussions, bring potential discomfort of lenders as to the fundamentals of the business and potentially inhibit the ability of the company to raise capital for business initiatives – even though nothing has changed other than an accounting rule.

The changes are proposed for 2020 but some companies, depending on their reporting dates, will have to be making preparations from January 1, 2018.

The new accounting standard removes the current concept of classifying leases as operating or finance leases for lessee accounting.

This is replaced in the new accounting standard with a single accounting model under which lessees must account for the value of all leases (including property and equipment) on the balance sheet as a new “right of use asset” and “lease liability”.

Also, instead of charging leasing payments on an operating lease as an expense, the new standard will see the expense replaced by depreciation and interest. This will not only change the phasing of the expense recognition, but also its location in the income statement.

The lease/rent expense will be replaced by depreciation and interest and EBITDA will be positively impacted but the front-end loading of expenses will have a negative impact on profit before tax.

Typical operating leases (off balance sheet) for dealership groups can include the following:

• Dealership operating property lease
• Service department equipment leases (hoists/lifts)
• Photocopiers
• Staff drive cars (and will also affect truck, agriculture and construction dealers)
• Parts delivery vehicles
• Computers / Laptops / other IT hardware.

Impacts are not limited to financial reporting, the KPMG report said. Other dealership-wide impacts include (but are not limited to):

• New systems to capture data and perform calculations
• Executive and key management remuneration calculations for listed entities and private equity
• Tax balances (i.e. Thin Capitalisation for foreign owned entities)
• Dividend payment in early years of the lease term
• Debt covenants and credit ratings, given new debt on balance sheet
• Impairment tests and tax effect accounting, given increase in assets and liabilities
• Opex, capex approval processes and buy vs. lease strategies pre- and post- commencement of the new standard

This may also tip most entities that are close to the audit threshold into ASIC’s requirement for an audit with the additional “right of use asset” being recognised on the balance sheet.

KPMG said that dealership groups already need to consider the impacts of the new standard when:

• Renegotiating or entering into new lease contracts
• Refinancing or entering into new borrowing arrangements
• Disclosing the impact of the new standard in their current financial statements
• Budgeting for profit and loss results for future years
• When considering new acquisitions

The report outlined the key actions dealer groups need to take:

• Prepare a complete listing of all leases held (including service contracts that may contain elements that meet the definition of a lease)
• Quantify impact of the change in the new lease standard on key financial metrics, including EBITDA, Total Assets and Debt Covenants
• Determine which transition option is more beneficial to apply to your dealership group
• Inform key stakeholders (banks and shareholders) of the impact of the change
• Renegotiate existing contracts to consider the impacts of the change in the leasing standard (e.g. debt covenants)
• Prepare disclosure for financial statements identifying the impacts of the change

CLICK HERE TO VIEW KPMG’S REPORT

By John Mellor