New rules to fix company bad debt reporting
New rules to fix finance company bad debt reporting
New international accounting rules should help give investors a better picture of the level of bad debts in New Zealand’s finance companies says KPMG Partner, Matt Prichard. “One part of the recent focus on finance company disclosures has been to criticise reporting of bad and doubtful debts. New accounting rules in this area should significantly improve this information” he says.
New Zealand historically lacks accounting rules on how finance companies should calculate their provision for doubtful debts. Current practice by most finance companies has been to review large individual loans for specific problems, then carry a “general provision” to cover problems that may exist in big portfolios of smaller loans.
“The general provision provided a kind of cushion” says Prichard. “The problem with the cushion from an investor’s point of view is that it is too slow to respond and can hide the impact of escalating bad debts when trouble hits”.
The problem for investors and their advisors has been working out how big a cushion was being carried, and whether it was enough. KPMG’s 2006 Financial Institutions Performance Survey shows an average “cushion” of just under 1% of gross loans and advances, but a wide range between and within sectors.
General provisions as % of gross loans
Sector Average Range
Motor vehicle financing 1.09% 0.00% - 3.78%
Property Development and commercial finance 0.55% 0.00% - 2.17%
Diversified finance 0.50% 0.00% - 0.76%
Consumer finance 2.35% 0.18% - 3.95%
Overall 0.96% 0.00% - 3.95%
Source: KPMG Financial Institutions Performance Survey 2006 (44 largest finance companies)
All New Zealand companies must adopt new international accounting standards by next year at the latest. The international rules fill a gap in New Zealand accounting in this area by requiring a much more dynamic approach to recognising doubtful debts. “The general provision cushion gets replaced by an estimate of exactly what bad debts exist today in the finance company’s books.” Under the new rules, a finance company must more accurately estimate its doubtful debts by looking at the current and recent performance of the loans.
“Loss events” such as missed or late payments, or environmental factors such as a fall in the market value of security held because used car prices fall, should be quickly reflected in a dynamic provisioning model.
New Zealand’s large banks and some of the top end finance company’s have already moved to the new rules, and demonstrated the potentially significant impact by releasing large portions of the general provisions previously held. This is to be expected from banks and finance companies who have held conservative general provisions in the past” says Prichard. “The really useful side of the equation in the current environment is to see what happens to the provisions of finance companies who have perhaps been slow to recognise that they’ve got bad debt issues under the old practices.
“Although provisions will still only be as good as management’s judgement and honesty, having some accounting rules around doubtful debts would have benefited from them during this tough period” said Prichard.