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Depreciation charge will show massive losses on accounts

Hi everyone,

A Club is looking to buy a new building for the business costing £400,000. The Club currently breaks even on the accounts. If the new building is depreciated 20% per annum, the accounts are going to show a very large loss. Is there any ways to combat this? And, what is the best way to explain this to the members that will be funding this new building, and then getting terrible accounts?

Thanks in advance for any replies.

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20% ?
The first thing that strikes me as odd is the 20% depreciation.
If this is on cost then I presume it is due to the fact the £400k building is only going to last 5 years?
A more usual depreciation rate for buildings is 2% on cost - and you will need to seperate the cost of the land on which the building sits which is not usually depreciated.
One final thing with the purchase of commercial property - definately look into the value of fixtures & fittings.

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why depreciate?

First of all - as pointed out 20% is WAY too high for a building -

However,  given present conditions of the property market, although that depends on where the building is located, the land & buildings are more likely to appreciate in value, not depreciate - hence there is a case for not depreciating the building at all, but as pointed out above you may want to separate fixtures & fittings - and perhaps depreciate only that element

 

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Cash flow

As an alternative you may wish to provide a cash flow too to members and stress they look at this. Most members seem to be able to understand this better than the full accounts and it is the cash situation that can be critical. You don't say what type of financial organisation the club uses and whether it is unincorporated, limited or friendly society. This may have a bearing and it could be worth thinking about the structure of the club too.

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1% should be OK

20% is ridiculous, what is it made of: cardboard?

 

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Club is a very broad term.

 

Is this a members club? Can it be charitable and save the VAT on the building, ie is it involved in amateur sport or engaged in the community like a village hall, if so it can save 20%.  Is there an underlying IPS or CLG to hold the risk? If not do this now to protect the members before you start the build. Why are you depreciating the building? Why over 5 years? Is that the remaing lease? If so you need to extend the lease first. Phone or PM if you want to talk details 

Chris Smail BSc FCA DChA

 

   0161 491 3788      07843 942029

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I think you must depreciate, but I agree with the other respondents that 20% seems excessive.

Please be careful on not charging depreciation on the building if you think the value will appreciate. This is not correct as conceptually depreciation reflects consumption rather than a reduction in value. In other words, you are using up the asset therefore you must charge the profit and loss account - a 2.5% rate, or thereabouts, is reasonable.

SA

 

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Towards Excellence, I don't agree!

If the cost to the business for the use of an asset is nil, then I can see no need to depreciate.  I WOULD, though make a regular accrual for dillapidations, i.e. the cost of maintaining the building in order to keep it up to scratch,

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I agree you must depreciate

The depreciation should measure the cost of the consumption of the asset over its useful economic life. Of course you only need to depreciate down to the residual value - there is no need to depreciate to nil though it is perhaps easier to use nil over a long life (assuming you expect the building to last). There have been quite a few slapped wrists in the past for failure to depreciate.

 

I would not think an accrual for dilapidations would be appropriate (unless this is under a lease) as it does not seem to meet the definitions required for an accrual. Specifically there is no present obligation - you can choose to let the building look tatty!

 

 

 

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All tangible fixed assets, except land having an infinite life, should be depreciated to reflect their consumption over their useful economic lives.  I don't believe a fall in value is stated in SSAP 12 as being relevant when deciding on the depreciation of an asset, buildings or otherwise.

Paragraph 10 of SSAP 12 defines depreciation as: "the measure of the wearing out, consumption or other reduction in the useful economic life of a fixed asset whether arising from use, effluxion of time, or obsolescence through technological or market changes".

Paragraph 24 states that buildings are no different from any other fixed asset, albeit with a longer useful life.

Paragraph 90 of FRS15 contains a very similar definition but goes on to say that the only grounds for not charging depreciation are that the charge and accumulated depreciation are immaterial.

On the basis that the club is breaking even I would suggest even a small amount of depreciation could be considered material, though if charging 1% to 2% per annum (rather than 20%)  this wouldn't be a huge loss.  You can present the overall net result together with an 'operating result' or EBITDA (i.e. before any depreciation), and/or show them a cash flow report to give a fuller picture.  There is also the balance sheet effect to explain to the members and I assume there was an informed decision made by them when agreeing to the investment in the first place.

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Correct, but....

AdShawBPR wrote:

All tangible fixed assets, except land having an infinite life, should be depreciated to reflect their consumption over their useful economic lives.  I don't believe a fall in value is stated in SSAP 12 as being relevant when deciding on the depreciation of an asset, buildings or otherwise.

Paragraph 10 of SSAP 12 defines depreciation as: "the measure of the wearing out, consumption or other reduction in the useful economic life of a fixed asset whether arising from use, effluxion of time, or obsolescence through technological or market changes".

Paragraph 24 states that buildings are no different from any other fixed asset, albeit with a longer useful life.

Paragraph 90 of FRS15 contains a very similar definition but goes on to say that the only grounds for not charging depreciation are that the charge and  accumulated depreciation are immaterial.

All this is true, and well quoted, but there's always scope for a "true and fair override" and not charging depreciation if that reflects the organisations "true position" more accurately.

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same result?

I think you'd get the same result wouldn't you?  If the view truly was that the residual value of the building (or other asset) was not much less than original cost (or same or more), then the depreciation would be small and probably immaterial so, in line with the standards, no need to provide for it and no need to resort to a true and fair override...

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Depreciate or not to depreciate, is not the answer?

Having read the views of all contributors to the topic, I felt like offering a SUMMARY. No I shall not attempt that. I believe that accounting not being an exact science will continue to draw views as expressed. One thing almost all the contributors agreed on was that the 20% dep rate belong to the 'next world'. Thanks for your views

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Saving of existing cost?

You don't say where the club is currently based. Unless it has the use of free premises currently, the rent saved by moving into the new building will partly/wholly offset the depreciation charge in terms of overall profit/loss.

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