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At present, your properties are carried at their open market value at each balance sheet date. This principle is broadly the same under FRS 102 (which terms this ‘fair value’). However, the new standard requires that, in cases where obtaining the fair value for a property on an ongoing basis involves “undue cost or effort”, you must instead recognise the property at ‘cost’ (being the most recent valuation) and depreciate over the property’s useful life. If the fair value becomes available again, you must revert to fair value accounting.
It is generally understood that the “undue cost or effort” scenario will not apply in most cases. Determining if the costs of revaluation (whether you undertake this internally or outsource this to external valuers) can be considered “undue” means considering the balance between these costs and the benefits provided to users of the accounts, such as the business owner and lenders. If you think that this scenario may apply to one or more of your properties, we would be happy to discuss this further.
Note that properties which are let out to members of the same group are currently treated as trading rather than investment properties. This is no longer automatically true under FRS 102. You will need to consider, property by property, whether they are held for rental income and/or capital growth - and are thus investment properties - or for use in your trade (e.g. production, storage, administration etc).
Currently, gains or losses on revaluation of your investment properties are not shown as profits or losses in the year. Instead, they are included in a ‘statement of total recognised gains and losses’ in addition to the profit you generate from rental and other income less costs.
Under FRS 102, these gains and losses will instead appear in your profit and loss account for the year. You will not pay corporation tax on the profit relating to these gains immediately - instead tax will continue to be charged on the eventual sale of these properties. However the accounts will recognise a charge for ‘deferred tax’ to reflect the tax that would arise were the property to be sold at the balance sheet date. While this is an accounting charge and is not paid to HMRC, it will reduce your profits and your net assets in your accounts.
You will need to consider whether the inclusion of property gains and losses in your annual profit and loss account has any wider impact on the business. For instance, if you operate a profit-related pay scheme, you should consider the meaning of ‘profit’ interpreted in the scheme documents as this may now include such gains and losses. Similarly, if lending covenants are based on achieved profit figures, you may need to clarify with your lender whether this should include property gains/losses.
If you have financed the acquisition of properties with bank or other loans, the accounting for these may change under FRS 102 as follows:
If you provide incentives to lessees of your properties, such as rent-free periods or cashback deals, the expense for these is currently spread over the shorter of the lease term or the period to the first ‘break point’ in the lease. Under FRS 102 the incentives will be spread over the lease term.
This change in accounting treatment will increase annual profits as less incentive is charged per annum, and will lead to accelerated tax as a result. However, existing accounting for leases already underway at your transition date (broadly, two years prior to the first year-end for which FRS 102 accounts are prepared) can be continued if you would prefer to do so.
As a lessor, you will need to disclose more in your accounts about your lease arrangements than under previous standards. This includes the total of all committed lease income in today’s terms (split between amounts due in 1, 2-5 and over 5 years) and other details about significant leasing arrangements e.g. contingent rent, escalation clauses, subleases etc.
We want to ensure that you are prepared and informed about the impact of FRS 102, which includes (but is not limited to) the issues we have covered above. If you would like to arrange an initial meeting where we can begin to plan for the specific impact on your business, please contact Martin Wharin, Business Services Partner on 0114 251 8850 or firstname.lastname@example.org.
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