By Marilou C. Vroman, CPA, CFE
As the weather begins to cool, the days grow shorter, and the leaves begin to change, we start to sense the nearness of another year coming to an end. With the fourth quarter upon us, it is time to shine and bring in a strong finish to our dealerships both operationally and financially, with final push coming in the month of December, generating record sales. While dealers both desire and expect to show strong performance at year end, it is also a time for some dealers to attempt to minimize their taxable income through appropriate tax strategies, typically recognized in the financials at year end. As we know, dealers produce twelve monthly financials from January through December. What on earth is a 13th month statement? For those unfamiliar with the 13th month, this is the reporting period where adjustments may be recorded to the financials which are deemed to be “non-operating” or for “tax efficiency” purposes. Essentially, the option to generate a 13th month financial statement enables the dealer to separate adjustments such as LIFO, cost segregation studies, or extraordinary items, for example, from the operating income of the dealership.
Typical 13th month adjustments are proposed by the dealer’s CPA and/or recorded by the dealership’s Controller or CFO. As entries are identified for 13th month purposes throughout the year, these adjustments are typically accumulated on the balance sheet in a prepaid expense account until the 13th month is opened. Entries are then recorded against income without impacting the operating financial results. So, if the 13th month is appropriate why should the dealer be worried?
While use of a 13th month has many benefits, this reporting period can also be used to manipulate earnings. We have encountered, often through dealership due diligence and forensic work, transactions recorded by the dealership’s accounting department which have been unduly influenced by operational management such as a COO, General Manager or others who are compensated on the bottom line.
Pay plans often disregard entries made in the 13th month, which is appropriate when the 13th month is used for tax related entries. However, while your COO, General Manager or Controller are getting paid on operational results, operational transactions may be finding their way to the 13th month, essentially coming out of the dealer’s bottom line, but not the income of management. We have seen items such as warranty chargebacks, incentive audit chargebacks, sales tax penalties, wholesale losses, among others deferred to the 13th month because they were deemed to be “extraordinary” or “non-operating”. Interestingly and conversely, we have rarely encountered “extraordinary income” recorded in the 13th month. Extraordinary or non-operating income tends to conveniently remain in the operating financials and flow through to net income when calculating the compensation of dealership management.
As we approach the end of the year be sure to know which transactions are headed for your 13th month financial statement. Review items charged to prepaid expense throughout the year and when the preliminary 13th month statement is produced, insist upon a reconciliation between your December statement and the final 13th month statement. Perhaps you will find 13 is a lucky number after all.