Component Accounting Briefing

6 October 2011

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Background

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• 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

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Historic Position

Balance Sheet     2011   2010     £’000   £’000TANGIBLE FIXED ASSETS         Housing properties – cost less depreciation    179,378   161,126Less: Social Housing Grant    (118,129)   (104,433)Total housing fixed assets     61,249   56,693Other fixed assets     4,086   3,295           TOTAL FIXED ASSETS 8   65,335   59,988

          CURRENT ASSETS         Housing properties for sale 9  1,611   3,166Debtors 10  2,499   6,524Cash at bank and in hand 11  21,542   18,145     25,652   27,835 CREDITORS: amounts due within one year 12   (9,288)   (5,826)           

NET CURRENT ASSETS    16,364   22,009           TOTAL ASSETS LESS CURRENT LIABILITIES    81,699   81,997          CREDITORS: amounts falling due after more than one year 13  64,185   66,350

CAPITAL AND RESERVES         Share capital – Non Equity 14  -   -Acquisition Reserve 16  -   -Income and expenditure account 15  17,514   15,647              81,699   81,997

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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

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• The requirements of the above determination required all registered social landlords to account for all property assets without the major repairs

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Accounting Requirements for Registered Social Landlords General Determination 1997 and 1998

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

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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

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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

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Why Change?

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Consistency of Accountancy• Globalisation

Borrowing on international markets

• UK accounting standards Adopting of the International Financial Reporting Standards (IFRS)

• Consistency of accounting treatmentMore clarity of treatment Better comparability

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What Is Component Accounting?

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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)

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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

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1. Identify and agree components to be accounted for

– Own records /Asset management strategy

– SORP suggested list

Key Steps

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Key StepsSORP Example components

• Land• Structure• Roofs• Windows• Lifts• Heating/boiler systems• Kitchens• Bathroom

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Key Steps2. 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

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Key Steps

3. Agree method for allocating original cost to individual components

– Costs of individual components may be difficult to identify

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Estimation techniques

• Use own data/records for similar schemes/properties

• NHF/Savills national matrix of property component

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Key Steps

4. 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?

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Key Steps

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

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Key Steps6. 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

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Key Steps7. 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

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Key Steps8. Set up or amend accounting systems to deal with new cost, grant and depreciation assumptions

• Asset management software• Spreadsheets• Can system cope?

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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

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Summary / Outcome• Transition (Prior year adjustment)

Examples– Previously capitalised nothing– Major repairs back to the balance sheet– Additional depreciation due to revised

components life

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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

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Summary / Outcome

• Should achieve greater consistency, butDifferent 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

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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

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

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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

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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?

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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

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Example

Pre component accounts: accumulated depreciation

• 12 years at 1% on £60,000(£7,200)

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ExampleLand Buildings Major repairs Total£000 £000 £000 £000

Cost 40 60 - 100Depreciation - 7.2 - 7.2

NBV 40 52.8 - 92.8

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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

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ExampleUnder 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

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Example

Under component accounting

Structure:

• Cost £52,000• 12 years depreciation £6,240• Annual charge £520

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ExampleLand Structure Kitchen Bathroom Total£000 £000 £000 £000 £000

Cost 40 52 5 5 102Depreciation - 6.24 0.6 0.25 7.09

NBV 40 45.76 4.4 4.75 94.91

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ExampleDepreciation charge31 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

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Example

Balance sheet Old policy: New policy:Component accounting

£ £Cost 100,000 102,000Depreciation (7,200) (7,090)

Net Assets 92,800 94,910

Summary: impact on Association

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ExampleIncome and expenditure (2011)

Old policy: New policy:Component accounting

£ £Depreciation charge 600 970Write off component replacement / original

5,000 1,800

5,600 2,770

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Example

Income and expenditure (2010)

Old policy: New policy:Component accounting

£ £Depreciation charge 600 920Write off component replacement / original

- -

600 920

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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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