Dealer Insights - July/August 2011 - Preparing for the Annual Audit
“The auditor is a watchdog and not a bloodhound,” a British lord justice once wrote. And although a team of auditors converging on your dealership may feel disruptive — team members won’t bark or bite, but they often ask a lot of questions — remember they’re there for the right reasons. Ultimately, their visit likely will be of business value to you.
You can make the engagement run smoothly for your auditors — and thus smoothly for you — if you have general knowledge of the audit process and your role in it.
Who should perform your audit?
Experience begets efficiency. You’ll waste a lot of time and energy getting green auditors up to speed on the auto industry and your specific dealership.
So, ask for the same audit team members from year to year. Although lower-level staff may turn over quickly, it never hurts to seek consistency. Also look for auditors with auto industry specialization.
What will your auditors examine?
Your audit will go faster if you think like an auditor and anticipate workpaper requests. Auditors typically ask dealerships to provide documents such as a trial balance,monthly manufacturers’ statements, and bank reconciliations. Auditors will accept copies for some items. For others, such as vehicle titles, floor plan statements and vendor invoices, they’ll want to see originals.
You’ll likely find that these requests change little from year to year. So a review of last year’s workpapers can help prepare you the next time around.
What does change annually is the sample of transactions that auditors randomly select to test your account balances. For example, they may look at December cash transactions one year and at November transactions the following year. The element of surprise is important to auditors because it keeps bookkeepers honest.
What about inventory?
At your year end, an audit team member will arrange to observe your inventory. Most firms assign inventory observations to an experienced auditor along with a more junior person. So, be sure to have at least two of your experienced personnel available to assist the auditors with their test counts.
The auditors will randomly count items from your parts inventory and compare test counts to your inventory records. Misstatements may require more testing or extrapolation over your entire inventory balance.
Auditors also will compare each new and used vehicle’s VIN to your inventory listing. Expect to provide explanations for any missing vehicles, including demos and loaners. And tidy up your lot. Excessive snow, icy or dirty windshields and inaccessible vehicles make it harder for the auditor to peer in the window to verify a VIN.
What about advice?
Good auditors will present a list of management points when they deliver your financial statements. These are ideas gathered throughout the audit process to help improve your operations and build value.
Sometimes outsiders bring fresh perspective. For example, your auditor might suggest ways to improve your operating gross, such as F&I menu selling or process improvements to strengthen internal controls, such as establishing check logs or lock boxes to safeguard customer payments.
Auditors also may share their financial analysis tools. Here, your auditor benchmarks your store’s performance over time and against industry averages. Auditors use analytics to boost audit efficiency. In turn, you can use this information to explore your store’s strengths and weaknesses.
Finally, your auditor can help you determine whether a change in inventory accounting methods would be appropriate to help lower your taxes. Accounting options for new-vehicle inventory include:
The specific identification method. This option expenses the factory base price of the specific vehicle sold. Most dealers currently use this method, because it’s based on the actual flow of units sold.
The last-in, first-out (LIFO) method. A more complicated alternative, LIFO places the last costs incurred into cost of sales and retains the earliest costs as the ending inventory. Essentially, this method removes inflation from your ending inventory and expenses it in the current accounting period.
LIFO allows an indefinite tax deferral in an inflationary market. When inventory levels or factory base prices drop, however, “LIFO liquidation” may take place — and a LIFO-basis dealer may incur additional taxable income. Such surprises are increasingly common in today’s discounted, lean operating environment.
When else should you contact your auditor?
The audit engagement and accounting for inventory aren’t the only times you should be in contact with your auditor. Call him or her during the year about major transactions and accounting questions, including if you plan to add (or eliminate) a franchise, move to or add a new location, change banks, or implement a new accounting or tax rule or trade discount.
Your auditor might have some reporting tips that will help to lower taxes. Plus, the fewer surprises auditors encounter in the field, the faster they’ll wrap up the job.
Learn from the experience
Although you want the audit to be completed efficiently, don’t shoo your auditors out the door too quickly. The information you learn during the financial reporting phase — as well as in the planning phase — can clarify your understanding of your dealership’s overall financial health and help you strategize going forward.
Dealer Insights – July/August 2011