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Investment property nightmare!! (FRS105)

FRS 105 nightmare for investment property client - looking for guidance on best solution

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We have taken on a new Ltd Co (property rental portfolio) and since FRS was introduced, was put on FRS 105 by previous Accountant (bad choice in my opinion!).

Anyway, to make that worse....this Accountant has not even depreciated the properties since the transition to FRS 105 either! Neither have they reversed out the revaluation reserve. So, two major errors here. We are talking multi-million pound figures too.

So...after reversing out the revaluations, and applying depreciation from the time the properties were first acquired, the balance shet could be going from £2.9m to NEGATIVE £200k.

Major! My question is, how would you sort this? Ideally I would like to "reverse" the idea of the client moving to 105 and pretend they chose 102, and prepare 5 annual accounts since on this basis. Is this allowed?

Instead would it be a large PYA in this next set, including a transition from 105 to 102? Would that help the situation anyway?

Any advice welcomed :) 

Replies (24)

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By johnt27
22nd Sep 2020 10:23

I agree with you that the choice of FRS 105 for an investment property business is not a particularly good one.

Let's break your problem down:
1. Pre-existing revaluation reserves, correct this is an error and needs a PYA to correct. You can't go back and retrospectively apply FRS 102.

2. Charging of depreciation. The way that depreciation is calculated under FRS 102/105 has changed since old UK GAAP. It would appear that if the property valuations still hold that the residual value of the properties matches at least their acquisition cost, possibly their carrying value. If this is the case then you could argue that the depreciation charge should be Nil, as you would ordinarily depreciate down to residual value. Therefore, no adjustment may be necessary, but what have the accounts said in respect of the accounting policy choice/application?

3. Transition to FRS 102. If you were to do this I think you would have to apply it from the latest accounting period not yet filed and the full transition notes etc would be needed. Don't forget you'd need to calculate deferred tax on the FV gains/losses that should have been disclosed under old UK GAAP but rarely where and won't have been considered under FRS 105.

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Replying to johnt27:
Ben Steele
By Ben Steele
22nd Sep 2020 10:39

Thanks for responding to this.

2. Per 105 rules, I thought all investment property gets treated as PPE (very diff to 102 rules) and therefore would have to be depreciated? Along side this FRS 105 then states an annual impairment test

3. If moving to 102 from 105 - do we add back all previous revaluations, or would you simply just revalue as at the latest accounting period end?

How would you target this? Even if we move to 102 in this latest year, the previous 5 years are extremely incorrect, i.e. £2m+ incorrect, surely this cannot be left as it is? It would also mean dividends were illegal over last 5 years too

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Replying to BSteele:
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By Wanderer
22nd Sep 2020 10:52

Quote:

2. Per 105 rules, I thought all investment property gets treated as PPE (very diff to 102 rules) and therefore would have to be depreciated? Along side this FRS 105 then states an annual impairment test

It's not the whole property, it's just the buildings element.
So could you argue that the residual value of the buildings is at least cost and therefore no depreciation?
Quote:
It would also mean dividends were illegal over last 5 years too
Have they been paying dividends based on revaluations then? Or is this the case purely because of no depreciation?
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Replying to Wanderer:
Ben Steele
By Ben Steele
22nd Sep 2020 11:06

Absolutely (regarding split of property/land). I wasn't aware you could argue no dep'n? I thought under 105 you still had to depreciate, even if over 50-100 years

In the last 5 years, under 105, it is possible depreciation has been missed, and therefore if included would have made dividends illegal in those 5 year periods due to lack of retained earnings

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Replying to BSteele:
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By Wanderer
22nd Sep 2020 11:13

Quote:

Absolutely (regarding split of property/land). I wasn't aware you could argue no dep'n? I thought under 105 you still had to depreciate, even if over 50-100 years

Yes, but if residual value is at least cost then surely no deprecation?
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Replying to Wanderer:
Ben Steele
By Ben Steele
22nd Sep 2020 11:28

How can you say residual value will be the same as its cost at the end of it's useful life?

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Replying to BSteele:
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By Wanderer
22nd Sep 2020 11:33

Just thinking out loud here without referring back the the FRS but if you bought some bricks, lead roof and copper pipe and used that to build a house now, what do you think the scrap value of that would be in 300 years time, when the house is at the end of its useful life?

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Replying to Wanderer:
Ben Steele
By Ben Steele
22nd Sep 2020 11:42

Very good question, no idea, who knows in 300 years! That's why sometimes these rules are ridiculous aren't they!

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Replying to Wanderer:
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By johnt27
22nd Sep 2020 12:00

Quote:

Just thinking out loud here without referring back the the FRS but if you bought some bricks, lead roof and copper pipe and used that to build a house now, what do you think the scrap value of that would be in 300 years time, when the house is at the end of its useful life?

It's somewhat erroneous as the standard refers to equivalent assets. So if you could find another house built with the same materials, same construction technique etc you might tick the boxes.

Also, if you were buying a house, or any other asset, for scrap it wouldn't be a fixed asset but stock :)

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Replying to johnt27:
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By Wanderer
22nd Sep 2020 12:08

I was answering the question stated and specifically said "without referring back the the FRS".

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Replying to BSteele:
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By johnt27
22nd Sep 2020 11:43

The standard doesn't ask this question (that's old UK GAAP) what the standard asks is this:

If you bought a brand new building today for £250k, would you buy the equivalent building which is say 50 years old (it's UEL) for the same amount?

All things being equal, and the way the UK property market works, you may well pay the same.

But, don't confuse this argument with saying, I wouldn't pay the same because the roof would need replacing on the old building in 10 years. These aren't necessarily equivalent assets, and you'd also trigger a seperate part of FRS 105/102 and end up applying a shorter UEL to the roof, compared to the rest of the bricks and mortar.

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Replying to johnt27:
Ben Steele
By Ben Steele
22nd Sep 2020 12:05

Completely agree with that. The only that makes me uncomfortable to argue is that FRS 105 says:
" A micro-entity shall assume that the residual value of an intangible asset is zero
unless:
(a) there is a commitment by a third party to purchase the asset at the end of its useful
life; or
(b) there is an active market for the asset and:
(i) residual value can be determined by reference to that market; and
(ii) it is probable that such a market will exist at the end of the asset’s useful life."

So by this definition I agree with you, we could check todays market for 1930's houses for example and find they are very expensive today, WAY more than original cost.
However, it is being able to argue that this will be the same in another 150 years time - especially with advances in technology

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Replying to BSteele:
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By Wanderer
22nd Sep 2020 12:07

Do you consider the properties to be intangible assets then?

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Replying to Wanderer:
Ben Steele
By Ben Steele
22nd Sep 2020 12:22

Woops wrong quote pasted!

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Replying to BSteele:
Hallerud at Easter
By DJKL
22nd Sep 2020 10:59

Ignoring deferred tax for the moment, and depreciation, were the dividends declared anyway relying upon the revaluation reserves which would itself have been incorrect given these were not capable of distribution.

I suspect it is possible that the declarations of dividends were possibly correct/incorrect irrespective of adoption of FRS102 or FRS105.

I would be very surprised if the client did not desire to have revaluations reflected within the accounts, especially if the company has lenders, if you have not already asked the client I would.

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Replying to DJKL:
Ben Steele
By Ben Steele
22nd Sep 2020 11:04

Prior to 105, the client knowingly had revaluations made in the accounts, that isn't the issue.

Since adopting 105, revaluations aren't allowed and should have been reversed, that is the issue in question.

In the last 5 years, under 105, it is possible depreciation has been missed, and therefore if included would have made dividends illegal in those 5 year periods due to lack of retained earnings

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Replying to BSteele:
Hallerud at Easter
By DJKL
22nd Sep 2020 13:21

I appreciate all that.

What I am more saying is I would consult the client- it may be that he/she did not appreciate reporting under FRS105 would require revaluations to be removed and therefore, if earlier accounts do need tidied, the client might prefer they were corrected to FRS102 not FRS105.

Given you appear to have FRS102 layout accounts re numbers but FRS105 layout re presumably narratives/disclosures, there is a debate to be had as to whether the numbers were incorrect or the disclosures/narratives were incorrect, redoing under FRS102 surely solves a lot of issues.

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Replying to DJKL:
Ben Steele
By Ben Steele
22nd Sep 2020 13:35

Very much agree with that. I believe this Accountant (from speaking with another of their ex-clients) didn't ask for opinion or give choice, and put all clients on FRS105.

I doubt my new client in question even knew there was a change or what it meant.

I think my best option would be to consult with the client, but advise we move them to 102 this year, and enable them to bring in up to date revaluations again (as well as ongoing).

My concern is the incorrect previous 4-5 years of VERY incorrect Accounts (£2m+ errors). Do we just leave that? Doesn't feel correct to....

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Replying to BSteele:
Hallerud at Easter
By DJKL
22nd Sep 2020 13:59

Well if you redo at least the last prior year you then do not need to deal with PYAs re the first year you do for real, so there might be some merit.(Though if the accounts have revaluations in them already may be few if any PYAs to do anyway)

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Replying to BSteele:
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By johnt27
22nd Sep 2020 11:06

You're correct that investment property is treated as PPE, but as I said the rules for depreciation changed following the change to FRS 102/105 such that you depreciate down the residual value (that bit isn't different from old UK GAAP) but the change is the assessment of residual value is now based on evidence today not what you anticipate in the future. So if you buy a property today for say £250k and expect you'll recover that £250k in a future sale then you're depreciable amount is nil (£250k - £250k). If you thought you'd recover £200k then depreciable amount is £50k (£250k-£200k). It's a common mistake to assume that residual value is going to be £Nil, which I think is rarely the case when dealing with property.

The definition from FRS 105 for residual value: The estimated amount that an entity would currently obtain from disposal of an asset, after deducting the estimated costs of disposal, if the asset were already of the age and in the condition expected at the end of its useful life.

On your impairment point, again this has to be done, but if you have a positive revaluation reserve (which I assume you do) then there are no indicators of impairment and so no charge to P&L.

For the transition take a look here: https://www.frc.org.uk/document-library/accounting-and-reporting-policy/....

I'm a bit unclear on your divis point. Assuming depreciation is no longer an issue the profits earned whether you apply FRS 105 or 102 should be the same so divis can be taken from these. If dividends have been distributed from the FV (revaluation) reserve then these are not realised reserves and you would have an issue with illegal dividends.

The resolution of the above is normally to recognise a debtor for any excess divis paid illegally as they are repayable to the company under CA2006. This could cause you s455 issues.

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Replying to johnt27:
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By Wanderer
22nd Sep 2020 11:21

Quote:

The resolution of the above is normally to recognise a debtor for any excess divis paid illegally as they are repayable to the company under CA2006. This could cause you s455 issues.

I'd see if Re Burnden Holdings (UK) Limited (in liquidation) was in point before making the adjustment.
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Replying to johnt27:
Ben Steele
By Ben Steele
22nd Sep 2020 11:27

Thanks for the response, that has been really helpful!

Agree on the depreciation point - if no depreciation to bring in, then the dividends will be ok as not made from reval. reserve.

Having read some more, I agree with the residual value point to an extent, but after say 100 years, surely we couldn't argue that the value would be the same and not depreciate at all?

I know the reality is the useful life of the property is so long that dep'n would become immaterial in amount, I am sure I have seen legislation to say this concept cannot be used as an argument to not depreciate the property

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Replying to BSteele:
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By johnt27
22nd Sep 2020 11:34

Quote:

Having read some more, I agree with the residual value point to an extent, but after say 100 years, surely we couldn't argue that the value would be the same and not depreciate at all?

This is the reason FRS 102 1A requires you to disclose management estimates, and full 102 extends this to judgements. The UEL and residual value are key estimates which, is clear from the comments previously made, can have a significant impact on the results reported.

FRS 105 doesn't have the same onerous requirements to disclose such considerations.

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Replying to johnt27:
Ben Steele
By Ben Steele
22nd Sep 2020 11:45

This is also where 105 massively differs to 102 - 105 doesn't allow any type of revaluation at all.
Just dep'n and impairment. I doubt there will be impairment ever, but still leaves the dep'n situation.
Even if the management value the properties at the same or more, it becomes irrelevant under 105, as you valuations do not come in to it at all

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