KPMG Motor Industry Services Alert December 2017 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name and logo and are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation.
2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name and logo and are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation.
AASB 16 impact on Dealer groups. EBITDA soars, while profit tanks. With the new accounting standard for leases (AASB 16 Leases) due for adoption just around the corner (for financial years commencing after 1 January 2019), it is expected that many companies will experience a sharp increase in their EBITDA as their profit before tax plummets, all without a single change in how your business operates, but simply through the mandatory adoption of the new accounting standard. Although the economic benefits and risks of leasing do not change, the new lease accounting model will change key financial metrics and KPIs and introduce volatility to the balance sheet and profit or loss due to continual re-measurement requirements. As such, careful communication of this impact to key stakeholders such as investors, banks and credit rating agencies will be critical for dealer groups. 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name and logo and are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation.
Expected impact to KPIs / ratios Income statement Balance sheet Ratios What are the impacts to your dealership? Impacts are not limited to financial reporting, other dealership wide impacts include (but are not limited to): EBITDA Profit before tax (in later years) Total assets Total liabilities Gearing new systems to capture data and perform calculations; executive and key management remuneration calculations for listed entities and private equity; Profit before tax and EPS (in early years) Net assets (in early years) Asset turnover Dealerships are likely to be significantly impacted and at risk as they normally hold multiple operating leases which are currently accounted for off balance sheet. The new accounting standard removes the concept of operating and finance leases for lessee accounting which currently exists, replacing it with a single accounting model under which lessees must recognise all leases (including property and equipment) on the balance sheet as a new right of use asset and lease liability. Operating lease expense will be replaced by depreciation and interest, changing not only the phasing of the expense recognition, but also its location in the income statement. Impact on the Australian Motor Industry 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 percent whilst experiencing reductions in profit before tax over 30 percent. Impacts to the balance sheet are just as wide ranging with increases to total assets over 30 percent, and total liabilities as much as 55 percent. Refer to the appendix 1 for a worked example of a property lease for a typical dealership in Australia. 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; and opex, capex approval processes and buy vs. lease strategies pre and post commencement of the new standard. This will 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. There are certain practical expedients as part of the transition process which management can adopt to limit the impact. This transition should be managed and carefully communicated to stakeholders before and at the transition date and on an ongoing basis post adoption of the new AASB 16 Leases. Additionally, when structuring new leases, companies can consider certain provisions and conditions to limit (or increase) the impact and maximise the benefit to your dealer group. 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity.
When do you need to act? If your dealership group hasn t begun its preparation for the adoption of the new leasing standard you re already behind and need to play catch-up. The first June year-end the new standard is effective for is 2020 (2019 for December year-ends). Comparatives are required, depending on your transition option, for periods beginning 1 July 2018 for June year-ends (1 January 2018 for December year-ends). Dealership groups, however, 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 ears; and If you need a hand, we can help. KPMG provide a range of services to help with your transition to AASB 16, including: running or supporting your implementation project; accounting advice; transition impact assessment; transformation and IT system change solutions; KPMG Leasing Tool for IBM TRIRIGA ; and leasing strategy advice and valuation services. when considering new acquisitions. What key actions must Dealership Groups take? Prepare a complete listing of all leases held (including service contracts that may contain elements that meet the definition of a lease (for leases). Consider the impact on management and executive remuneration structures. 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. The key is being prepared and to assess the GAP and IMPACT of the changes in the new leases standard. The summary of the changes and potential impacts must be shared and discussed with the owners/directors and executive management of the dealership group. 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity.
Appendix 1: Operating lease example: AASB 117 (current standard) vs. AASB 16 Leases (new standard). Typical operating leases (off balance sheet) for dealership groups may include the following: dealership operating property lease; service department equipment leases (hoists/lifts); photocopiers; staff drive cars; parts delivery vehicles; and computers/laptops/other IT hardware. Below we have worked an example of a typical operating lease for a dealership property from which it operates, showing the impacts on the P&L and Balance Sheet under the current leasing standard AASB 117 as compared to the new leasing standard AASB 16. Variables and assumptions used in the worked example. Balance Sheet: Total Assets: $50 million Total Liabilities: $40 million Profit and Loss (current lease standard AASB 117): Total Revenue: $100 million Total Operating Expenses: $96 million EBITDA: $4 million Depreciation & Amortisation: $0.5 million Interest: $1.5 million Profit Before Tax: $2 million Property Value: $20 million Lease term: 10 years with two extensions of 5 years (likely to execute both extensions for a total lease term of 20 years) Rental per annum: $1 million assumes 5 percent market rate of return for the property Operating lease commitments derived from the property lease: 1 year or less: $1 million 2 5 years: $3.5 million (present value at 5 percent) 5 years plus: $12.5 million (15 years at $1 million present value at 5 percent) Average borrowing rates assumed at 5 percent. 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity.
Current Results AASB 117 $m Notional adjustment under AASB 16 $m Simulated Results under AASB 16 $m Increase / decrease Example Dealer Balance Sheet and P&L Impact AASB16 Total assets 50.00 9.77 59.77 0.20 Total liabilities 40.00 9.90 49.90 0.25 Total operating lease commitment (off balance sheet) 17.01 (17.01) 0.00 (1.00) Total Revenue 100.00 100.00 0.0% Total Operating Expense 96.00 (1.00) 95.00-1.0% EBITDA 4.00 1.00 5.00 25.0% Depreciation & amortisation 0.50 0.61 1.11 122.2% Interest 1.50 0.52 2.02 34.6% Profit before tax from continuing operations 2.00 (0.13) 1.87-6.5% 70 60 50 FY17 Balance Sheet Off balance sheet operating lease commitments of $17 million come on to balance sheet, increasing assets by an estimated $9.7 million and liabilities by $9.9 million. 40 30 20 10 0 Total assets ($50m) Total liabilities ($40m) Total assets ($67m) Total liabilities ($57m) Actual (AASB 117) Simulated (AASB 16) The standard requires you to consider options to extend, which may result in an even larger impact in some cases. Actual results Lease component 1.4 1.2 1.0 0.8 0.6 0.4 0.2 0.0 Future Expense profile Total lease expense will be front loaded under the new standard, even when cash rentals are consistent. 1 2 3 4 5 6 7 8 9 10 Straight line expense / cash (AASB 117) Interest & amortisation expense (AASB 16) Property operating lease expense of $1million is replaced by an estimated increase in interest expense of $0.52 million and amortisation $0.61 million. Annualised EBITDA improves by 25 percent, but overall profit declines by 6.5 percent. Sources: https://home.kpmg.com/au/en/home/insights/2017/04/aasb-16-leases-standard.html https://assets.kpmg.com/content/dam/kpmg/au/pdf/2017/aasb-16-fundamental-overhaul-lessee-accounting.pdf 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity.
2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity.
Contact us If you would like more information contact: Steve Bragg KPMG Director, Consulting & Compliance Enterprise Advisory +61 2 8841 2118 sbragg1@kpmg.com.au Simon Irrgang KPMG Director, Enterprise Audit +61 2 8841 2163 sirrgang@kpmg.com.au Also, meet the broader KPMG Motor Industry Team: Brian Fellowes KPMG Director, Training & Dealer Groups Enterprise +61 2 8841 2112 bfellowes@kpmg.com.au Rohan Meyer Senior Manager Enterprise +61 2 8841 2124 rmeyer1@kpmg.com.au Wayne Pearson National Leader Motor Industry Services, KPMG Enterprise +61 2 9335 8679 wpearson1@kpmg.com.au David Pring KPMG Partner Enterprise Tax +61 2 9455 9996 davidpring@kpmg.com.au Stephen May KPMG Partner Enterprise Audit +61 2 9335 7257 smay@kpmg.com.au Bill Noye KPMG Partner Enterprise Advisory & Tax +61 7 3233 3253 wnoye@kpmg.com.au Aaron Street KPMG Partner Enterprise Advisory & Tax +61 7 5577 7545 astreet@kpmg.com.au Ian Kowalski KPMG Partner AKL PE +64 9367 5907 ikowalski@kpmg.co.nz Dean Robinson KPMG Specialist Advisor Deal Advisory M&A +61 2 9346 5792 drobinson5@kpmg.com.au Laura Pestell Learning Coordinator Enterprise +61 2 9335 8590 lpestell@kpmg.com.au KPMG.com.au The information contained in this document is of a general nature and is not intended to address the objectives, financial situation or needs of any particular individual or entity. It is provided for information purposes only and does not constitute, nor should it be regarded in any manner whatsoever, as advice and is not intended to influence a person in making a decision, including, if applicable, in relation to any financial product or an interest in a financial product. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. To the extent permissible by law, KPMG and its associated entities shall not be liable for any errors, omissions, defects or misrepresentations in the information or for any loss or damage suffered by persons who use or rely on such information (including for reasons of negligence, negligent misstatement or otherwise). 2017 KPMG, an Australian partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. The KPMG name and logo and are registered trademarks or trademarks of KPMG International. Liability limited by a scheme approved under Professional Standards Legislation. December 2017. QLDN14863ENT.