UK: 2007 SORP – What To Expect

The 2007 SORP consultation phase has just ended. Whereas the previous updates in 2002 and 2005 were well received, it is going to be much harder to predict the reaction to this draft.

Our expectation is that significant changes will be made to the phrasing of the 2007 SORP, but not to the actual substance. If this expectation holds, the document is going to have a dramatic impact on the financial position of many RSLs. Given the low levels of surplus reported by the sector, relatively small changes to the accounting treatment will have a dramatic impact on the bottom line.

The most significant changes that we expect to be implemented are as follows.

The draft SORP suggests that the costs of the first tranche disposal should be included in current assets and a profit or loss incurred on disposal. This is very different from the present treatment of deducting the net proceeds from the carrying value of the property, and may lead to earlier recognition of profit or loss, depending on the type of scheme.

The major concerns include whether earlier recognition of profit is prudent, and a number of worrying corporation tax implications. However, under the proposed new accounting treatment of mixed scheme accounting, earlier recognition of profit is not recognised if the shared ownership component is subsidising other parts of the scheme.

The accounting treatment should be based on the overall financial position of the scheme rather than on the financial standing of the individual elements. Unfortunately, this is not clearly explained in the draft SORP and the wording needs to be more comprehensible. The intention is best illustrated by an example.

Imagine a scheme in which half of the properties are to be sold outright and half are for general needs. The overall cost is £20 million with a grant of £2 million. The properties for sale realise £12 million and the EUV-SH of the general needs properties is £7 million.

Under ‘normal’ accounting, assuming that the sold properties cost the same as the general needs properties, a surplus of £2 million on the disposal would be recorded (£12 million proceeds less costs of £10 million). The general needs properties would be recorded at cost (£10 million) less the grant (£2 million). Although the net cost is £1 million higher than the EUV-SH, no impairment provision would be made, assuming that the occupancy was high, on the basis that this was a scheme that had gone to plan and was fulfilling the objectives of the RSL. In effect, it is a planned impairment and thus no provision is required.

However, under the proposals in the draft 2007 SORP, the treatment would be very different. The general needs properties would be recorded so that the net book value was EUV-SH, i.e. a cost of £9 million and a grant of £2 million. Consequently, the cost of sale of the properties sold would increase to £11 million, reducing the surplus to just £1 million.

The expanded commentary in the draft SORP envisages that there may be situations where commitments to provide public benefits might create onerous contracts. However, the commentary does not provide any guidance on when this might occur or how it should be accounted for.

One scenario where this might apply is in relation to commitments given to tenants, leaseholders and local authorities during the transfer of local authority housing stock to RSLs. Sometimes these commitments are so specific that the RSL is unable to avoid the expenditure. Does this create a liability? Unfortunately, the SORP does not make this clear.

The draft SORP confirms that in some circumstances, it is not just housing properties that are being transferred but actual businesses. In these situations, a different method of accounting for the transfer must be applied. This method involves deriving fair values for the assets and liabilities acquired, and recognising any difference between these and the fair value of the purchase price as ‘goodwill’. In some cases, the goodwill amounts will be substantial.

The draft SORP further encourages component accounting in certain circumstances, but makes it clear that it cannot be used selectively. This amendment will most probably result in some controversy, as there are many RSLs which are currently not compliant with these proposals. A leading RSL’s adopted accounting policies are used to illustrate this. Housing Association X capitalises expenditure on replacing windows, kitchens and bathrooms, and depreciates this expenditure over 15 years.

Implicitly, X does not expense previously capitalised amounts to the replaced item, e.g. the windows installed when the property was first constructed. It also does not depreciate components for new schemes separately over the 15 years. However, the draft SORP requires all or nothing. All the windows, kitchens and bathrooms would need to be separated for all of the RSL’s housing properties, and individually depreciated over 15 years (via a prior-year adjustment that restates the balances to what they would have been had the accounting policy been adopted from the outset). Alternatively, the items that are currently being capitalised separately should be expensed (again via a prior-year adjustment), unless they meet the general tests for capitalisation of an improvement to a property.

In a number of cases this change in treatment will have a catastrophic effect on the reported results.

At this stage, it could be argued that there is little RSLs can do since the final content of the SORP is not known. However, it is clear that these proposed changes will affect many RSLs and therefore early planning will be essential for the final SORP publication in March 2007. In particular, some RSLs will see a significant impact on their reported results and covenant compliance.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.