Garry Bartecki Internal audit
Back in the good old days I used to spend a lot of my professional life auditing equipment dealers and construction companies. Also did a lot of franchise work, which kind of ties in with the OEM-Dealer relationships.
I was always fascinated with the full-service equipment dealers because of all the departments they had to manage to make the dealership work, keep the OEM and banks happy while also keeping the customer’s coming back.
I was also lucky enough to get first-hand experience with the long-term lease (rental) with maintenance programs, which kind of locked in a relationship for 60 months or so. It was kind of pushing down the dealer management requirements down to the individual lease contracts because you were selling or renting equipment, buying and using parts, providing service, and hopefully in the end wind up with a rental unit for short-term purposes or part of the used equipment units held for sale. And in some ways the rental contracts could become even more complicated than the dealer management because of all the types of rental contracts offered.
I just loved the entire program from start to finish. Though the dealer CEOs were exceptional business folks and still believe that to be true.
So, I started thinking of how we used to audit these dealerships in order to complete a year end audit and give them a clean bill of health. Because of the nature of the dealer business the audit planning required some thought so that the end results were supported by the audit work performed and the documented audit results on file. Considering that we were dealing with both accounting and tax issues, planning could be more complex than expected.
Listed below are the basic steps we took to audit your company. They are a bit different when compared to today’s digital techniques.
We would review the prior year audit files, especially looking for the problem area for that period so we could see that the faulty issues were corrected and expected produce the correct data and conclusions in the year under audit.
We would then prepare tests to determine that internal controls were working as planned, revenue and expenses are being reported in the right period and for the proper amounts, asset and related asset values are properly reported on the Balance Sheet. Bank loans and other financial contracts would all be reviewed to determine compliance with the documents.
One big area was the accounting and value of fixed assets, which was primarily the fleet. What is the orderly liquidation value and what is it on the books for. This test covered both new units (and how long they have been sitting as part of the floor plan) used units and what they were on the books for compared to what they would sell for. The same questions applied to the rental units as well. IN TODAY’S ENVIRONMENT THIS WOULD BE ONE OF THE KEY TESTS GENERATED.
There was also the question surrounding the maintenance contracts and how you record the maintenance revenues as part of the rental payments. I think we can all agree that recording the collection of the maintenance revenue on a straight- line basis is probably not the correct process to follow.
Another questionable accounting practice was not backing out the inter-department profits, which generated higher than actual sales numbers. You are not supposed to do that, but I cannot remember more than 3-4 companies that followed this required accounting rule. And finally, the required practice of reporting current assets and current liabilities to be able to calculate working capital sometimes does not work for companies with large rental fleets.
Large rental fleet assets are recorded as long-term assets, but when the current portion of the note payments are in the current liability section, you wind up with poor working capital position when in fact it may not be. This is why rental companies prepare unclassified balance sheets without the current assets and liabilities broken out.
We also spent a lot of time analyzing financing agreements and bank loans, along with the required covenant calculations. Having the bankers question the accounting for their covenant calculations was to be avoided at all costs. And supporting the inventory (new and use) and rental unit values was a big part of this annual exercise.
In the end our work was to determine that all the debits and credits were basically correct and recorded in the right accounting period. We also had to determine that adequate cash flows are being generated to cover debt service and other obligations. In short, that your company is a “going concern” and will not default in the near term or next 12 months.
The auditors would then prepare a Management Letter spelling out suggestions for improvement and where a weakness in a control needs further review. The Department Heads were never happy with the Management Letter. Sometimes the banks weren’t either.
I believe that the prior audit procedures pushed down the problems, discussions, and solutions to all levels of management to a greater degree compared to the current digital audits. Considering that all department heads had goals to meet to ensure operating results that meet the financial plan, the more they became aware of a problem along with the processes of devising solutions to mitigate the problem as well as implementing the solutions, the more chance there is to correct the problem, keep them from reappearing, and reaching the profit and cash flow goals planned for.
As far as the important parts of the audit report are concerned, I find the Cash Flow report is the first page I look at. If the cash flow is adequate and there are no known potential stumbling blocks on the horizon, I am much more comfortable with the rest of the report.
I guess my point this month is that there may be an opportunity available for dealers not required to provide a full audited set of financials to pick up some extra profits or cash by implementing an internal review of accounting controls and reporting systems in use related to the major margin contributors to determine if the reporting is correct without leaving any money on the table. I would also suggest quarterly cash flow projections provided by all department heads for inclusion in a full company cash flow estimate. If there ever was a time for this type of internal work ….it is NOW.
I would further suggest you outsource this review if staffing is a problem, or if you just feel an independent inspection is in order.
About the Columnist:
Garry Bartecki is a CPA MBA with GB Financial Services LLC and a Wholesaler columnist since August 1993. E-mail [email protected] to contact Garry.
