Comments from ACCA to the Financial Reporting Council (FRC), 2012.
In summary, ACCA does not support the issue of the Abstract in its current form. We have detailed below our reasons why it will not improve the information provided to leaseholders.
ACCA does agree that clarification is needed in the accounting for service charge transactions by Residential Management Companies (RMCs) and leaseholder groups.
The members of smaller RMCs, which are often owned and managed entirely by leaseholders, generally prefer to reflect all transactions and balances involving leaseholders in the statutory financial statements of the RMC.
Legally however, service charge monies are not an asset of the RMC, and there is doubt as to whether transactions involving leaseholders are disclosable as those of the RMC. Consequently, the statutory financial statements of the RMC should show far fewer transactions and balances than currently, and certain RMCs would in fact be dormant. As a Summary of Costs under s.21 Landlord and Tenant Act 1985 might not be requested by tenants or might not otherwise provide all of the additional information usually required by leaseholders, a Working Group, including professional accountancy bodies such as ACCA, has issued guidance which includes this additional information. The professional bodies are well-placed to contribute technical material through the Working Group, but are only able to do so as guidance.
As a result, the current situation for accounting by RMCs is unsatisfactory in two respects. The RMC’s members (the leaseholders) gain all of the information which they require by a method of accounting which is apparently legally incorrect. The guidance from ACCA and other bodies via the Working Group sets out an accounting method which is unpopular with RMCs and not compulsory under the law, although our practising members are expected to apply it to their RMC clients. We believe that the successor to the UITF (hereafter referred to as 'the UITF') is in a better position to issue an authoritative pronouncement.
In view of the above, we believe that the issues to address concerning RMCs are broader than what is set out in the draft Abstract. We appreciate that the request to the UITF, which has generated the draft abstract, was not to conduct a comprehensive review of accounting by RMCs and the information needs of leaseholders. However, we believe that such a review is required, and that any authoritative pronouncements made on this subject, such as through Abstracts, should be drafted with this wider need in mind. We note that the proposed Abstract does set out its aims in broad terms, such as the provision of clarity to the preparers of financial statements (Objectives section - A7, para (ii)).
A broadening and strengthening of accounting requirements is needed to establish common principles, and to provide leaseholders with a right to all of the information relevant to them. In our view, this is best achieved through the UITF with the assistance of the Working Group, and the Government where appropriate, and in consultation with ACCA and other interested bodies.
The draft Abstract’s main objectives are to improve the information provided to leaseholders, and to provide clarity around the question of whether a RMC is acting as a principal or agent. As set out below in our comments on specific aspects of the draft Abstract (principally, certain of its stated objectives), we have reservations about whether these aims are achieved, and believe that the UITF could do more. Further progress could be achieved by the UITF not just through its ability to make authoritative pronouncements, but also through obtaining considered opinions on the principal/agent issue.
In summary, ACCA does not support the issue of the Abstract in its current form, as we do not believe that it will represent a helpful improvement. We do wish to point out, however, our view that progress towards a comprehensive solution is possible, and need not be lengthy or complex in view of the relatively straightforward affairs of most RMCs. This progress could begin once the UITF is able to provide more definitive guidance on the principal/agent issue, possibly by taking legal advice on the manner in which RMCs typically operate. From this first step, it would be possible for the UITF, with the assistance of other parties such as the Working Group, to identify further requirements needed to achieve a framework which is both accurate and matches the information requirements of leaseholders, and to make these the subject of a fuller Abstract.
Taking separately the matter of the timing of the issue of the Abstract, if it is issued as currently proposed, then ACCA would have no concern about the proposed implementation date of accounting periods ending after 31 December 2012, with early implementation permitted. We believe that this timescale would provide sufficient time for RMCs and their advisors to prepare for the changes, considering the generally straightforward nature of service charge transactions.
However, if finalisation of the Abstract is delayed beyond September 2012 (which would be the case if the UITF accepts our concerns), we believe that the UITF would need to consider deferring the implementation date. At that point, it is likely that those RMCs which have a 31 March accounting reference date would not have sufficient time to prepare.
1. ACCA doubts that the draft Abstract will improve the information provided to leaseholders (Objectives section – A7, para (i)).
The draft Abstract prescribes very little information for leaseholders if the RMC is a disclosed agent. More information would be provided if the RMC is acting as principal or as an undisclosed agent, although not as much, or in such an understandable format, as where all transactions and balances are reflected in the statutory financial statements, notwithstanding that to do so is technically and legally incorrect.
The draft Abstract notes that some leaseholders are not being given all of the information which they need regarding service charges, despite their statutory rights and the guidance issued by professional bodies. There appear to be no provisions in the draft Abstract which would make leaseholders more likely to exercise their right to a summary of costs under s.21 Landlord and Tenant Act 1985. It is more likely to be the case that leaseholders are aware of their rights to receive accounts, where they are also shareholders of the RMC. We also do not see any provisions in the draft Abstract which would make RMCs and their advisors more likely to follow the guidance issued by the professional bodies.
ACCA is aware that the legislative framework for service charge accounting is somewhat incomplete and piecemeal, and that it is not within the remit of the UITF to be the sole proposer of wholesale revisions. Nonetheless, the UITF’s pronouncements carry more authority than those of the Working Group of which professional bodies such as ACCA are members, as this group is only able to issue guidance.
2. It is also doubtful that the draft Abstract will usually enable creditors to identify clearly the party with whom they are contracting (Objectives section – A7, para (iii)).
Where the RMC discloses that it is an agent for the leaseholders, and files dormant accounts, it would be clear to creditors that they are contracting with the leaseholders as a body, assuming that those creditors (who will frequently be small businesses) are aware of the provisions of the draft Abstract. Otherwise, where income and costs are posted to the Income and Expenditure Account, creditors will be unable to ascertain whether the RMC is the principal or an undisclosed agent. Whilst FRS 5 Application Note G considers an undisclosed agent to be analogous to a principal for accounting purposes, there may be differing legal implications.
3. ACCA believes that the draft Abstract needs to go further in assisting RMCs with determining whether they are acting as principal or agent when undertaking transactions with third parties (Objectives section – A7, para (iv)).
While ACCA supports the use of the principles in FRS 5 Application Note G as a starting point, we believe that it would be helpful for the UITF to consider and explain how these may be practically applied to the particular circumstances of RMCs. As a result, individual entities would be more likely to make an informed decision as to whether they are acting as principals or agents, and would do so a consistent basis with each other. Smaller RMCs are likely to have difficulty in determining the capacity in which they act, based solely on the principles in Application Note G. Their professional accountants will also benefit from focussed guidance, as this will enable them to advise their smaller RMC clients.
Most RMCs, particularly those run by the leaseholders in smaller blocks of dwellings, appear to be set up and to operate in a very similar manner. It may therefore be possible for the UITF to make an authoritative pronouncement, as a standard-setter, on the circumstances in which RMCs are generally acting as principal or as agent. In order to do so, we are aware that the UITF may need to seek legal advice on principal-agent aspects, and the application of asset recognition principles.
4. We believe that the draft Abstract needs to clarify the accounting required by RMCs acting as a principal or undisclosed agent.
An RMC which determines that it is acting as principal or undisclosed agent will record service charge expenses in its profit and loss account, concurrently recognising income by drawing from the service charge cash balances (Consensus - section 6, para (ii)). It is unclear whether this accounting should be on a cash basis or an accruals basis. The cash basis appears to conflict with the requirement for the statutory financial statements to show a true and fair view. If the draft Abstract envisages the adoption of the accruals basis, there is no mention of the balance sheet presentation, including the key figure for leaseholders of the remaining balance of service charge monies.