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Component Accounting Briefing

Component Accounting Briefing. 6 October 2011. Background . Historic Position. Accounting for housing properties:

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Component Accounting Briefing

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  1. Component Accounting Briefing 6 October 2011

  2. Background

  3. Historic Position • Accounting for housing properties: • Prior to accounting period ending 1997/1998 all property assets in registered social landlord’s accounts were capitalised including major repair expenditure and included in the balance sheet

  4. Balance Sheet

  5. Historic Position • No requirement for depreciating property assets • Depreciation • A method of allocating the cost of a tangible asset over its useful life. • Depreciation is used in accounting to try to match the expense of an asset to the income that the asset helps the company earn • Some registered social landlords account for property at valuation

  6. Accounting Requirements for Registered Social Landlords General Determination 1997 and 1998 • The requirements of the above determination required all registered social landlords to account for all property assets without the major repairs

  7. Accounting Requirements for Registered Social Landlords General Determination 1997 and 1998 • Accounts of social landlords reflected this change in 1997/1998 and major repairs previously capitalised were removed from the balance sheet • The principle being that cost of bringing the property to its original standard treated as an income and expenditure cost

  8. The General Determination 2000 was announced in Circular R2-04/01: Accounting requirements for registered social landlords • Required social landlords to retrospectively depreciate the building element of housing property assets over its useful life • Required to ascertain the land element of the housing asset to calculate the depreciation charge

  9. The General Determination 2000 was announced in Circular R2-04/01: Accounting requirements for registered social landlords • Grant split between land and buildings • Useful economic life of buildings based on the judgement of Housing Associations and their Auditors

  10. Why Change?

  11. Consistency of Accountancy • Globalisation Borrowing on international markets • UK accounting standards Adopting of the International Financial Reporting Standards (IFRS) • Consistency of accounting treatment More clarity of treatment Better comparability

  12. What Is Component Accounting?

  13. Overview of requirements • Statement of Recommended Practice (SORP) Accounting by registered social housing providers Update 2010 “A housing property will always comprise several components with substantially different useful economic lives, each component should be accounting for separately and depreciated over its individual useful economic life” • Similar text in Financial Reporting Standard 15 (FRS15)

  14. Overview of requirements • International Accounting Standard 16 “Each significant part of an item of PPE (property plant and equipment) should be depreciated separately” Therefore for property asset: Anything material which has a substantially different useful economic life from the rest of the building • Applicable accounting periods beginning 1 April 2011 or earlier

  15. Key Steps • Identify and agree components to be accounted for • Own records /Asset management strategy • SORP suggested list

  16. Key Steps SORP Example components • Land • Structure • Roofs • Windows • Lifts • Heating/boiler systems • Kitchens • Bathroom

  17. Key Steps • Ascertain life assumption for each components • Standard life of components? • Asset management strategy based on own experience • RICS build cost data • Will still have inconsistency between Associations

  18. Key Steps • Agree method for allocating original cost to individual components • Costs of individual components may be difficult to identify

  19. Estimation techniques • Use own data/records for similar schemes/properties • NHF/Savills national matrix of property component

  20. Key Steps • Determine major repair costs (asset replacements) amounts previously written off to income and expenditure account to be reinstated in the balance sheet • How good are the records?

  21. Key Steps 5. Determine accumulated depreciation on major repairs (previously expensed amounts) to be reinstated in the balance sheet

  22. Key Steps 6. Determine grant treatment • Initially land and building structure in proportion to respective costs • Then allocate to all components proportionately • Major repair grant should be allocated against the relevant components

  23. Key Steps 7. Calculate prior period adjustment – day one of comparative period • I & E March 2012 – new basis • I & E March 2011 – restate on new basis • Prior period adjustment prior to 1 April 2010 • Impact will depend on prior treatment

  24. Key Steps 8. Set up or amend accounting systems to deal with new cost, grant and depreciation assumptions • Asset management software • Spreadsheets • Can system cope?

  25. Summary / Outcome • Historical data • Likely to be gaps • Work backwards from the asset: • Age of asset and how much life remaining • Treatment of grant • Clear treatment of original grant • Major repair grant should be allocated to components

  26. Summary / Outcome • Transition (Prior year adjustment) Examples • Previously capitalised nothing • Major repairs back to the balance sheet • Additional depreciation due to revised components life

  27. Summary / Outcome • Homebuy/shared ownership • Components are not the Association’s asset therefore do not component account • Service charge items are not included in component accounting e.g. lift equipment • Early replacement of asset impact on the results as the component and the related accumulated depreciation is written off

  28. Summary / Outcome • Should achieve greater consistency, but Different assumptions and interpretations vary: • Components division of original costs • Life estimations not consistent • Some Associations account for property assets at valuation • Greater volatility in balance sheet values and income and expenditure accounts due to variation in property values

  29. Conclusions on impact of component accounting • Very different effect depending on pre-component accounting policy on major repairs capitalisation • Increases comparability as all Associations required to account for the components and therefore capitalisation policy similar • Could change reported net assets and surpluses significantly

  30. How the balance sheet and operating statement is affected by the changes

  31. Example • One property acquired in 2000 for £100,000 (no grant) • Replaced kitchen in 2009 for £5,000 • Replaced bathroom in 2011 for £5,000 • Building life 100 years • For simplicity, assume no grant

  32. Example • Judged kitchens to have 25 year life and bathrooms 20 year life (no other components) • Original split judged to be Land £40,000 Structure £52,000 Kitchen £4,000 Bathroom £4,000 • How will the numbers be reported in March 2011 financial statements?

  33. Before component accounting • Firstly, let us look at accounting before component accounting changes are made whereby the accounting policy is that no major repairs are capitalised

  34. Example Pre component accounts: accumulated depreciation • 12 years at 1% on £60,000 (£7,200)

  35. Example

  36. Example Under component accounting Kitchen: • Original cost £4,000 • 9 years depreciation (25 year life) £1,440 • NBV (written off in 2009) £2,560 • New kitchen cost £5,000 • 3 years depreciation (25 year life) £600

  37. Example Under component accounting Bathroom: • Original cost £4,000 • 11 years depreciation (20 year life) £2,200 • NBV (written off in 2011) £1,800 • New bathroom cost £5,000 • 1 year depreciation (20 year life) £250

  38. Example Under component accounting Structure: • Cost £52,000 • 12 years depreciation £6,240 • Annual charge £520

  39. Example

  40. Example Depreciation charge 31 March 2011 • Structure £520 • Kitchen (25 years) £200 • Bathroom (20 years) £250 • Total £970 31 March 2010 • Structure £520 • Kitchen (25 years) £200 • Bathroom (20 years) £200 • Total £920

  41. Example Summary: impact on Association

  42. Example

  43. Example

  44. Summary Impact of Component Accounting • Higher depreciation charge - Assets spread over shorter lives - Asset renewals now capitalised • Charge recognised when components replaced early • Replaced components capitalised not expensed • Prior year adjustment to reserves

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