This is the second blog on the SORP Working Party’s Invitation to Comment (ITC) on its proposals for the 2014 SORP. The first blog covered the housing property and employee benefit aspects of the proposals. This blog will look at grants.
The final blog on this subject will look at financial instruments and other issues in the ITC.
The new FRS allows two different accounting treatments for grants:
- The performance model
- The accrual model
If the performance model is adopted then grants are written off to the income and expenditure account when the performance conditions of the grant are satisfied. The ITC confirms that in the SORP Working Party’s opinion it is likely, for SHG, that in most cases the performance conditions of the grant are satisfied on completion. In other words, the SHG would stay in the balance sheet (as deferred income) until the houses were complete and then be released to the income & expenditure account.
So for a building project with £1m of costs and £400k of grant – the £400,000 grant would be written off as income when the houses are complete. The other effect of this would be that depreciation charges on new built housing would be much higher as depreciable cost is no longer reduced by the grant.
The alternative accounting treatment is the ‘accrual model’. Under this treatment grants are classed as deferred income and written off to the Income & Expenditure Account on a systematic basis over the life of the related asset. The release of deferred income will be compensated by a higher depreciation charge – as the grant, is again, no longer deducted from the cost of the housing when calculating depreciation.
Only government grants can use the accrual model so grants received from for example the Lottery will have to use the performance model.
So which model did the SORP Working Party recommend for RSLs?
Answer – it depends on what basis your housing property is shown in the balance sheet.
For those RSLs that have their housing property on a historical cost basis (i.e. the vast majority) then SHG should be accounted for using the Accrual Model. Whereas, if you account for housing property on a valuation basis then you account for SHG on a Performance Model basis.
So the accounting treatment for SHG will be determined not by the substance of the transaction, but by the accounting policy of the related asset. This is unusual, but you can see why the SORP Working Party have come to this conclusion.
The Working Party are of the view that “the accrual method most appropriately matches the substance of SHG.” (Para 34). However, if you apply this method to an RSL that carries its housing properties at valuation a significant problem arises. The total of the SHG received will become a liability where previously it had ‘disappeared’ off the balance sheet.
So in a scenario of an RSL that its properties valued under EUV-SH at £45m, if it has spent £100m on that housing property, for which it received SHG funding of £60m, then the RSL would have Housing Property of £45m in the balance sheet, but also a £60m liability (deferred income for grant). Reserves would have to be reduced by £60m when the SORP is adopted.
In order to avoid this the SORP Working Party are recommending that where the housing property is held at valuation that the performance model is used. This will result in the SHG being written off when properties are complete and avoid the £60m problem highlighted above.
The ITC also considers how SHG, accounted for under the accrual model, should be amortised. The Working Party’s view is that the grant should be amortised over the useful economic life of the asset’s structure (excepting where grant has been allocated to components in the event of high grant rates and major repairs grant). So it would appear that so long as grant levels are high that it would be legitimate to amortise SHG over the life of the asset that the grant is allocated to.
However, we have issues with the suggestion that grant should be allocated to the ‘structure’ component. Firstly, the grant is not to fund the construction of the structure – it is to fund the construction of the house, and secondly, due to the inconsistency in sector in determining what is, and what isn’t a component, the make-up of what is included in the ‘structure’ will differ from RSL to RSL – so this approach will not lead to more consistency.
For many RSLs this will be critical as amortising SHG over 50 years (or similar) while the housing is depreciated over a range of years from 10 years to 50 years will mean a substantial increase in the (net) depreciation charge and therefore earnings and reserves.
With other issues on the horizon such as welfare reform and pension provision, a decrease in operating surpluses (albeit due to a non-cash item) is something RSLs could do without.
The last in this series of blogs will be on Financial Instruments and other issues raised in the ITC. If you can’t wait to find out what will be in the blog, or you want to respond to the ITC it can be found at the following link: