Component Accounting Briefing 6 October 2011

Background

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

Balance Sheet 2011 2010 £’000 TANGIBLE FIXED ASSETS   2011 2010 £’000 TANGIBLE FIXED ASSETS Housing properties – cost less depreciation 179,378 161,126 Less: Social Housing Grant (118,129) (104,433) Total housing fixed assets 61,249 56,693 Other fixed assets 4,086 3,295 TOTAL FIXED ASSETS 8 65,335 59,988 CURRENT ASSETS Housing properties for sale 9 1,611 3,166 Debtors 10 2,499 6,524 Cash 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

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

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

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

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

Grant split between land and buildings 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

Why Change?

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

What Is Component Accounting?

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)

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

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

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

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

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

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

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?

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

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

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

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?

Summary / Outcome Historical data Treatment of grant 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

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

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

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

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

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

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

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?

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

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

Example Land Buildings Major repairs Total £000 Cost 40 60 - 100 Depreciation 7.2 NBV 52.8 92.8

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

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

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

Example Land Structure Kitchen Bathroom Total £000 Cost 40 52 5 102 Depreciation - 6.24 0.6 0.25 7.09 NBV 45.76 4.4 4.75 94.91

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

Example Summary: impact on Association Balance sheet Old policy: New policy: Component accounting £ Cost 100,000 102,000 Depreciation (7,200) (7,090) Net Assets 92,800 94,910

Example Income and expenditure (2011) Old policy: New policy: Component accounting £ Depreciation charge 600 970 Write off component replacement / original 5,000 1,800 5,600 2,770

Example Income and expenditure (2010) Old policy: New policy: Component accounting £ Depreciation charge 600 920 Write off component replacement / original -

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