As specialists in the audit of Residential (and Commercial) service charge accounts we were highly interested in a recent case (Wenghold -v- Egleton – 4 September 2013) heard by the Upper Tribunal (Lands Chamber) which may have far-reaching effects on accounting for service charges.
Until recently, the accruals basis of accounting was accepted as the correct approach for service-charge statements. The Landlord & Tenant Act 1985, the principal source for service-charge regulation, states at Section 21(5)(a) that the summary of relevant costs – the annual statement of service charges – should include a note of “any of the costs in respect of which no demand for payment was received by the landlord within the period…”
This is what we accountants call ‘accruals’. Let’s illustrate with an example. Suppose that the service charge financial year-end is 31 March but that at the end of January you received an electricity bill for charges up to that date. The next bill is not due until 30 April, i.e. after the year-end. The accruals principle, universally accepted, is that a further two months’ charges should be included in the service-charge summary and if no bill is available, then this figure should be estimated. The converse of accruals is also relevant namely that if, in January, the managing agents receive a bill for, say, renewal of a maintenance contract for 12 months, then only 2 months of that relates to the particular financial year and an adjustment should be made to ‘carry forward’ the charges relating to the subsequent 10 months because that relates to the following service-charge year. This is what accountants would call ‘prepayments’.
The idea is that expenditure is matched to the period to which it relates, not to the date when a bill is received which may be some time later. The above principles are only fair. If you think about it, only the costs relating to a particular period are borne by that period and this becomes relevant when there are changes in ownership of leaseholds. It would be unfair if one owner of a flat bore costs that really related to the previous or subsequent owner. Readers will be aware that on the sale of a property there is invariably an apportionment of costs and this really is always an adjustment to recognise accruals/prepayments.
So what is now different? Well, in the particular case, because of some oversight, the landlord’s managing agents had not received invoices from an electricity supplier for several years. Hard to believe but we have seen it ourselves in a number of the blocks of flats for which we are service-charge auditors. Section 20(b) of the Act imposes an 18-month time limit on the recovery of costs following the expiry of which the costs cannot be recovered from the tenants.
The Wenghold case decided that charges were ‘incurred’ when the electricity company rendered its invoices. What this meant in practice was that for several years, no costs were recovered from the tenants for electricity and then all of those costs were to be recovered in the year in which the bills were received from the electricity company.
We think this is very contentious. It seems to imply that the accruals basis is no longer valid. After all, can the Tribunal have it both ways, i.e. that the Act makes it clear that the accruals basis is the correct one yet leaseholders seem to be able to argue, if they follow the Wenghold case, that the managing agents cannot recover costs until such time as they have actually received bills.
No doubt there will be further developments which we await with anticipation.
In the meantime if you wish to discuss this case, or any aspects relating to service charge accounts please call us.
Parag Kakkad Keith Graham
020 7553 7109 020 7553 7122
Westbury Accountants and Business Advisors is an accountancy practice based in London. Westbury have been providing Accounting and Tax solutions to small and medium sized businesses since 1936.Talk to the team at Westbury on 0207 253 7272 or visit http://www.westbury.co.uk.