The QMFR has many traps for the unwary. It is essential that any licensee or advisor has a good understanding of the regulations and how they work. This will require any advisor to regularly consult with the QMFR.
Lesson 5.1 Purpose
Breaches can occur in many ways and can be straight forward through to very technical interpretations of the regulations and Accounting Standards. A non-exhaustive summary follows.
Lesson 5.2 Compliance with Accounting standards
Is following the Accounting Standards enough to calculate your compliance with the MFR?
The simple answer is, no. It is not enough to calculate the Net Tangible Asset position or Current Ratio position off those financial statements without the adjustments that the QMFR require.
The starting point for any compilation of financial statements for all category of licensee is the Accounting Standards per s 8(2) QMFR and schedule 3 dictionary definitions of “prescribed accounting standards”, “internal management accounts” and “signed financial statements”.
The QMFR makes various adjustments to those same financial statements before calculating a licensee’s compliance with the MFR. That is, holding enough Net Tangible Assets and maintaining a current ratio of 1 or more – refer to s 14, 17G & H QMFR. The most well-known of these adjustments are those excluding assets from being included in Net Tangible Assets. For example, intangible assets such as goodwill, unlisted investments and certain types of related party loans – refer to s 14 and 17(1) QMFR.
This is one of the simplest but most common misapplications of the MFR that can occur. This will more commonly occur with interstate advisors with no knowledge of the Queensland compliance regime or those who have insufficient building and construction experience in Queensland. It should be noted that no other State or Territory has stringent financial requirements like Queensland.
When do you need to follow the Accounting Standards and how many?
There are two parts to this question:
- Annual Reporting – No, you do not need to apply all Accounting Standards and the accounts can be your internal management accounts unless you are a category 4 to 7 licence holder – refer to s 9 QMFR and schedule 3 dictionary definitions of “internal management accounts” and “signed financial statements”.
However, if a licensee wants to understand whether they have enough Net Tangible Assets or have maintained their Current Ratio of at least 1, then they will need to have considered any Accounting Standard adjustments to your management accounts. As they say, a catch 22, you don’t need to apply the Accounting Standards for Annual Reporting, but if you don’t, how do you know if you are compliant with the MFR?
- MFR Report – Yes, a MFR report must be based on the use of all applicable Accounting Standards at the time for all categories of licensee, not solely category 4 and up – refer to QMFR schedule 3 dictionary definitions of “MFR Report”, which requires the inclusion of “signed financial statements” as defined, which in turn requires the use of “prescribed accounting standards” as defined.
This change to the use of all “prescribed accounting standards” is a significant departure to the old MFR. While the old MFR required the use of Accounting Standards, they were not stipulated to the same extent. In the past, licensees would use the same financial statements used to prepare their tax return for the basis of any MFR report before making any adjustments such as disallowed assets. This will no longer be enough where an MFR report is required, nor if you are correctly trying to assess your compliance with MFR. In many cases, existing advisors may find that they have insufficient Accounting Standard skills to prepare these accounts, given this is normally the domain of auditors and audited accounts.
If you are preparing a MFR report or are trying to assess your compliance with it, what are some of the Accounting Standards that are not normally applied to unaudited accounts?
For a building and construction licensee, these are the standards to consider the most in the 2020 financial year as it will see the application of several new or revised standards:
- AASB 15 Revenue from Contracts with Customers – This revised standard involves a more rigorous examination of building contracts to calculate any work in progress (WIP) asset or income in advance liability. This may in many cases reduce the carrying value of any WIP asset and/or increase the value of any liabilities.
At a minimum, we would suggest that each licensee at least calculates their WIP on a monthly or quarterly basis to be able to assess their compliance with MFR.
- AASB 16 Accounting for Leases – For most licensees, this standard will only apply commencing with the 2020 financial year. This requires capitalisation of a lease with the asset depreciated and lease taken up as a liability. For most licensees, these would be expensed through the profit and loss statement as each lease payment is deductible for tax purposes. While the tax treatment will not change, the recording of leases has fundamentally changed under this standard.
A licensee should give thought to ensuring they are compliant with AASB 16 in their financial statements each year as this may significantly impact their MFR calculations. This is due to the leasing standards effect on the current ratio. This occurs as you must record all the asset as non-current, such as a vehicle, but must split the lease liability between current and non-current portions.
Doing this will have two significant impacts:
- This will reduce a licensee’s current ratio in all circumstances. For example, one years’ lease payments are current with the balance being non-current.
- As you do not own the asset, it is referred to as a “right of use” asset and disclosed as such, e.g, motor vehicle (right of use) in plant and equipment. However, the asset is an intangible under current QBCC interpretations. This is based on the ASIC media release you can access here. With this in mind, the QBCC included a new s 4B of the QMFR on 27 March 2020, which now allows another 12 months before the standard takes force. It’s hoped that the QBCC revisits this issue in the same way that ASIC has on 7 July 2020 per this release – see the release here.
For any licensee that has been audited in the past, you will understand the further costs that you will need to incur where a MFR report must be prepared. For those not already calculating WIP correctly or at all, this will also cause some difficulties.
It should be noted that the QBCC do have staff with enough experience to assess your compliance with these standards.
Lesson 5.3 Statement of Cashflows
Do you need to provide a “Statement of Cashflows” with Annual Reporting?
Perhaps a good starting point is to understand what it is and what it is not. It is not a 12 month forecast that a licensee’s management or bank might use. It is a one-page statement that summarises the cash incomings and outgoings over a year. This is then broken down into its separate components of operating (general business revenue and outgoings), investing (plant & equipment & other fixed assets) and financing activities (debt facilities, capital raising).
The preparation of the statement is governed by AASB 107 Cash Flow Statements and is required to be provided as part of “Annual Reporting” – refer to QMFR schedule 3 dictionary definitions of “internal management accounts”(d) and “signed financial statements (a)(iv)”.
Failure to provide this document for a Category 1 to 7 licensee will mean that you have not provided all the required information in relation to Annual Reporting. Accordingly, this may lead to suspension of your licence. It should be noted that it would be rare that a licensee who is not audited would have this document prepared. Accordingly, a licensee’s external advisors will need to prepare this document as part of the financial statements on an annual basis. Another new impost of the QMFR that was not readily apparent when the rules were introduced.
See example here: “Statement of Cashflows” taken from a listed entity – pg 145 of 252.
Background on the purpose of a Statement of Cashflows
The Statement of Cashflows is a document that analysts pay attention to in analysing listed ASX entities to look at the conversion of profit into cash. The analysis will involve looking at how much of a business’s profit is converted into cash, to ascertain the quality of those profits. Most licensees will be aware that profit recorded in the accounts does not mean that there will be cash in the bank!
For those that have been following the “reverse factoring” arrangements of BHP, Rio Tinto and Telstra in the news, will be aware that there has been an intense focus on how these companies recorded the use of this supply chain finance in the Statement of Cashflows. In addition to this has been the complaints of suppliers in the contractual claim about being forced onto these “supply chain finance arrangements” often provided by Greensill. Presumably, the QBCC has introduced this statement as part of their risk assessment of a licensee.
Lesson 5.3 “Related entity” loans breaches
We have little doubt that this will be one of the most common breaches under the new QMFR. It has become extremely difficult to include related entity loans both as an asset and as a “current asset” – refer to s 15(1)(l) QMFR. It is a very clear target area of the QBCC. We know this from personal experience and in dealing with other advisors from Big 4 Accounting Firms down.
So, to recap Module 1:
- What is a “Related Entity Loan”? (refer to s 15(1)(l) QMFR) – It is not unusual for a licensed entity to have made various advances to directors, shareholders or other entities controlled by the owner. These will often be shown as “Loans” in the balance sheet with the classification split between current and non-current assets. Similarly, a licensee may have received advances from related parties shown as current or non-current liabilities.
- What is a “Related Entity”? (refer to schedule 3 dictionary definition of “related entity”) – a loan from your bank will not be a related party loan, only those entities that are “related entities by way of s 19 of the “Building Industry Fairness (Security of Payment) Act 2019”. As a general guide, most entities a licensee or its directors control will be related parties. For example, the directors and family members of that person and any trusts or companies they otherwise control. The definition at s 19 is broad. For most, this will be a straightforward assessment.
- What has changed under the new QMFR? Under the prior policy, the main requirement was to be able to show that the loan was “collectible” before it could be included as an asset – refer to s 2.6 MFR policy effective 9 October 2015. This can be something of a more subjective test and lead to many arguments with the QBCC. In addition to this, the QBCC often found that the related entity did not have enough assets to repay the loan, if at all.
The new QMFR has introduced several more “objective” requirements before a related party can be included as an asset. There is then a further test before it can be classified as current. It should be noted that these objective requirements are still far more generous than a Licensees assessment under the Queensland Governments prequalification financial requirements (often referred to as PQC), where related entity loans are excluded as assets – refer to s 2.0
These changes are as follows:
For a loan made to a “related entity” to be included as an asset:
- the related entity must have net tangible asset of at least $0;
- have a current ratio of at least 1 based on the same financial tests that a licensee would – refer s 15(1)(l) QMFR; and
- the related entities net tangible assets must be worked out on the same basis as a licensed entity – refer s 15(2) QMFR.
How is an unpaid present entitlement asset of a related entity treated?
Per QBCC Frequently Asked Questions they are regarded as “related entity asset loans” for the purposes of the QMFR.
As a point of interest, this interpretation does not appear to be supported by the QMFR, which does not appear on the face of it, to deem an “unpaid present entitlement” (“UPE”) to be a “loan”. For those advisors who advise licensees on tax matters, they would be aware that a UPE is not a loan as a point of law up until when the beneficiary calls for payment of that amount and enters some type of loan arrangement with the trust. For completeness it is noted that s 109D(3) Division 7A of the Income Tax Assessment Act 1936 deems a UPE to be a loan by way of that expanded definition. However, that will not make it a “loan” for general legal purposes or the accounting standards. Although, there is no doubt that it is an asset under the accounting standards subject to normal rules of impairment.
In practice, this will mean that the related entity financial statements will need to be prepared on the same basis as the licensees when doing an MFR report to ensure an accurate assessment. This will include directors and family members who will not ordinarily prepare financial statements at all.
For a loan made to a “related entity” to be included as a current asset:
The related entity on the day of the calculation of the current ratio, has current assets that are enough to repay the loan in full – refer to s 17H(3)(b)(v).
Where a loan does not pass this requirement, then it would be included as a non-current asset.
It is perhaps unclear exactly how this additional test operates. Would the related entity having a current ratio of 1 or more be enough to satisfy this requirement? In our view, no. Does the related entity need to show that cash is available after payment of all other current liabilities to pay out a related entity loan? There is little doubt that this would meet the requirements but might be a high bar for many, requiring a current ratio of far more than 1. In our view, if the related entity loans are included as current liabilities in the related entity and that entity has a current ratio of at least 1, then this should be enough to meet this requirement. However, given QBCC activity in this area it would be prudent to engage with the QBCC in advance.
Do not underestimate this change. We have already seen many related parties find that they did not meet the Net Tangible Asset requirements once assessed disallowed assets under the QMFR. Related entities with significant Net Tangible Assets will often fail the current ratio. For example, significant investment trusts and companies with significant equity in property will often fail. That is, all the property assets are non-current assets. However, there will be current portions of bank debt or related entity debt.
Expect the QBCC to target any licensee who has a significant portion of their net tangible asset position covered by related entity loans. It is noted that the new online lodgement system specifically requires a licensee to fill in a box detailing these loans. Restructuring of related party loans in advance of any review by the QBCC is highly recommended. This may involve both tax and legal advice as to the consequences and documentation required.
Lesson 5.4 Problems with loans in general
Ignoring “related entity” loans, it is critical to understand whether a loan is current or non-current under the accounting standards as well as any further adjustments that the QMFR require. Current assets and liabilities are generally those assets and liabilities continuously circulating in a business’s operations. For example, cash, accounts receivable and payables, work in progress and BAS debts.
Lesson 5.5 Current or non-current assets?
s 17H(3) & (4)
For the most part, s 17H(3) is consistent with the accounting standards and a properly prepared set of accounts will be enough. However, under s 17(H)(4) there are several exclusions. The most significant being that real property cannot be included as current unless:
- the property is listed on the market for sale when the current ratio is calculated; and
- valued under the accounting standards at either cost or net realisable value – refer to s 17H(4).
This can be a significant issue as a residential builder with a display home that is expected to be sold, would often be included as trading stock under the accounting standards and for tax purposes. Such an asset would not be treated as current unless it was listed on the market. Unfortunately, this will not automatically mean that any finance would be treated as non-current. Depending on the bank facility the entire debt may be current. A licensee in this case could quickly find themselves failing the current ratio. For a licensee attempting to show that a property is current, they must be able to evidence that the property is listed on the market. For example, on realestate.com.
Current or non-current liabilities? – refer to s 17H(5)
Liabilities tend to take a more legalistic approach then assets when doing an assessment. A list of some key items or errors in calculating current liabilities under the QMFR:
- Finance facilities need to be split between current and non-current portions. For example, vehicle and plant finance. This will include leases from the 2020 financial year. Any repayments to be made on the facility over the coming 12 months would be treated as current liabilities.
Beware balloon payments on facilities coming up within 12 months that might significantly increase current liabilities. We have seen circumstances where finance facilities had to be refinanced before their term ended to overcome this problem.
- Related entity liabilities – unlike related entity assets, which are difficult to include as net tangible assets and even harder to include as current, many related entity liabilities will be current. Most liabilities of this type are often undocumented “at call loans”. This means that the related entity has the capacity to call for repayment at any time and so the full amount must be included as current. This is regardless of the fact that in substance this is unlikely.
It should be noted that an unpaid present entitlement (“UPE”) of a related party would be a current liability on the same basis. Albeit, it would not be a loan until the UPE is placed on that footing for legal purposes.
This is easily overcome by way of documenting the loan or upe only being repayable at least 12 months after being called upon. There are legal implications that must be considered along with documentation.
- Covenant breaches on finance facilities – Where in breach of a loan covenant this may technically allow the lender to call in the loan. Where this is the case it will normally require the entire loan to be treated as current unless a legal waiver is granted before year end – refer to AASB 101 74 and 75. Breaches of related party loans should also be considered.
It should be noted that the old MFR policy had a more specific definition at 2.0 Liabilities dealing with breaches of banking covenants. However, this is not necessary under the new QMFR due to the requirement to follow the accounting standards.
In these circumstances, technical advice on the application of the Accounting Standards should be sought as well as legal determination of any covenant breach and waivers that are required.
For liabilities, there are no significant departures from the Accounting Standards. The real issue is preparing the financial statements correctly under the accounting standards.
As can be seen, great care should be taken in any analysis of current and non-current assets.
Lessons 5.6 Problems with Revenue
On of the basis of the QMFR, a licensee’s revenue cannot exceed Maximum Revenue by more than 10% without providing an updated MFR report – refer s 11L QMFR. It is then important to understand what is revenue for these purposes. “Actual Revenue” for a licensee includes all revenue the licensee receives during the year on an accrual’s basis – see schedule 3 dictionary definition of “actual revenue”.
A list of some of the common breaches that occur:
- Revenue includes all revenue from all sources to the licensee. This includes revenue that does not require the use of a QBCC licences. Dividends and other investment income would also be included. The gross sale price of a display home or property would be revenue.
For this reason, it is often prudent to quarantine QBCC licence turnover in a stand-alone entity. It is common for interstate licensees to use a Queensland only subsidiary to avoid holding enough net tangible assets for their Australia wide and in some cases International revenue.
- Maximum Revenue exceeded – A licensee cannot exceed their Maximum Revenue without providing an updated MFR report. It is not enough for a licensee to have the Net Tangible assets. A licensee should always monitor their current and anticipated turnover against their most recently lodged Maximum Revenue in the MFR report. This is one of the more common breaches and where detected by the QBCC will lead to a demand for updated MFR report. Where a licensee cannot comply, they may have their licence suspended.
- Maximum Revenue no longer required – A licensee must continue to hold enough net tangible assets to support its Maximum Revenue up until providing an updated MFR report. This is often missed where a licensee no longer requires the higher level of revenue and no longer has enough net tangible assets. Refer to s 11M QMFR.
There are several exclusions from Revenue, such as GST and salary and wages – refer to s 11Q QMFR.
Lesson 5.7 Calculation of Work in Progress “WIP”
A licensee must calculate their WIP under AASB 15 for each individual contract to calculate the value of asset or liability. In very simple terms, the aim is to only recognise profit on each job over the length of the contract based on the stage of completion. For example, if you are 50% of the way through a contract then you would only recognise 50% of the estimated profit on a job at that point in time.
A non-exhaustive list of issues with WIP:
- No or incorrect calculation of WIP – Many smaller licensees, often up to category 3, will not ordinarily calculate WIP on a monthly or annual basis. While a prudent licensee should do so now under quarterly accounting, this is often not the case – refer s 11E QMFR regarding quarterly accounts. Where it is calculated, we see numerous instances of both licensees and advisors doing the calculation incorrectly. This can be for a multitude of reasons, poor accounting and job cost records along with misunderstanding of how to do the calculation (and this is before we consider the more subjective components of contract valuation, i.e, estimating the profit over the life of a job).
- WIP calculations can only result in an asset – This is incorrect and the calculation of WIP can result in both an asset and/or liability. The calculation of each contract must be split into its current asset and current liability portions on a job by job basis. It is not unusual for the calculation to result in a liability where project claims are made in advance of work being completed (this does not mean that the contract is unprofitable). Although contractors down the project chain will often find themselves with a WIP asset.
- Contract with a loss – While profit on a contract can only be realised over the life of a job, a contract with an expected loss must be brought to account immediately. This can bring forward an unexpected liability.
- How is WIP often recorded in financial statements under AASB 15?
WIP asset – Contract Asset, Work in progress
WIP liability – Income in advance, unearned income, revenue received in advance
- Is my WIP asset recoverable? – Like Accounts receivable, the question always arises as to whether WIP will ultimately be converted into Accounts Receivable. Unlikely where the customer has gone into administration or liquidation. Expect the QBCC to require evidence of building contracts and job by job calculations out of your accounting system to justify a WIP asset.
- Estimation on a contract can be difficult – No doubt the amount of profit a licensee estimated they would make on a contract will change over the life of a job. A licensee is required to constantly update their forecast of estimated profit and bring that updated estimate to account. Variations that are not signed off by the customer would not ordinarily be included in the estimated profit under AASB 15. Variations can prove challenging, but under AASB 15 a more conservative approach is required and so a WIP asset might quickly be reduced to $nil or a liability where profit is sufficiently uncertain.
The QBCC consider WIP to be a prime target area as to the correctness of the calculation or its likely recovery can make a material difference to a licensee’s compliance with MFR. Over the 20 years of the MFR’s existence, many myths around its calculation remain.
Please note that this is a very abbreviated explanation of WIP, and professional advice should be sought in its calculation.
Lesson 5.8 Not taking account of all Intangible or Disallowed Assets
Failure to take account of all licensee “intangible assets” or “disallowed assets” is one of the most common issues that the QBCC detect – refer s 14 QMFR.
The calculation of net tangible assets, which in turn determines your Maximum Revenue is based on s 14, which is as follows:
Total assets worked out under s 15
Licensee liabilities in general and then under s 16
Intangible assets s 14(b) per AASB 138, 3, 112 and 123
Disallowed assets s 17
= Net Tangible Assets
Some points to note regarding the calculation of Net Tangible Assets:
Total Assets s15
- Prepayments – While perhaps intangible in nature, they are not intangibles for the purposes of s 14(b) and so may be included as current assets.
- Debtors – s 15(1)(d) & (e) Only 50% of a debtor owing can be included where the invoice is between 180 days and 365 days from date of invoice. It should be noted that WIP and retentions are not debtors for these purposes.
- Retentions – Similar to WIP, there are many myths about retentions. A retention is and always has been an asset and will be an asset for these purposes – s 15(1)(c). This is confirmed by the QBCC in their “Guide to Annual Financial Reporting” at pages 8 and 10. This is also referenced in QBCC Q and A webinars. As a retention is not a debtor you do not need to reduce it by 50% under s 15(1)(e). However, impairment under the accounting standards must be considered.
Intangibles s 14(b)
- Borrowing costs & deferred tax assets – Easily missed. However, both assets are intangibles and so must excluded.
- Goodwill, franchise/licence fees paid, patents and trademarks are intangibles and are excluded. This is especially problematic where a licensee has borrowed to make these payments as the debt is not excluded, despite the asset being ignored. For this reason, local and interstate licensees must take great care in structuring their affairs where buying and selling businesses or entering franchise or licensing arrangements that require capital payments.
- Right of use assets under the new Leasing standard AASB 16 discussed in this module and which will impact on financial statement periods for the 2021 financial year after the introduction of the new s 4B QMFR.
- Real property s 15(1)(k) – The value of real property, e.g. real estate, may be included at its value under the Accounting Standards. However, as detailed earlier in this module, if the property is included as a current asset under s 17H(4), then the property can only be valued at the lower of cost or net realisable value The reason as to why the QMFR has been drafted on this basis is not clear.
Liabilities s 16
- Trust deficits s 16(1)(b) & (2) – Where a trust has less assets then liabilities as calculated under the QMFR, that deficit must be taken up as a liability against the trustee. If the trustee is a licensed $2 shelf company this will normally leave the company licensee with a deficit. A licensee in this case is precluded from using a deed of assurance – refer s 12(1). Another reason to be beware of trust structures.
Disallowed Assets s 17
- In substance, s 17 “Disallowed Assets” is the 3rd tier of assets that might be excluded. That is, by this point a licensee is likely to have found that they have already adjusted or removed assets under s 15 licensee assets and under s 14(b) intangibles.
- Recreational vehicles, unregistered vehicles, racehorses, collectors’ items & private furniture s 17(1)(a) to (d), (f) & 17(2) – It is easy to see why these assets have been excluded due to their inherent difficulties in realising their value and converting easily to cash.
- Unlisted Investments s 17(g) & (k) – Investments in private companies and unit trusts are excluded. Accordingly, licensed entities with subsidiary entity stakes may run into difficulties in passing these tests.
- Debtors over 365 days old s 17(1)(n) – A debtor that is over 365 days since invoice being provided to the debtor is excluded as an asset
- As a point of interest, several of the disallowed assets under s 17 are not in fact assets in the first place when stepping through the s 15 definition of licensee assets.
This list of issues is not exhaustive. One must step carefully though each of the sections to get a compliance assessment or MFR report correct.