Lisa Warren Head of Client Accounting at ARMA member Residential Management Group and regular speaker at the Association's regional briefings, gives an expert view on the impact that FRED 50 will have on the residential leasehold management sector.
In 2012 the Institute of Chartered Accountants in England and Wales (ICAEW) approached the Financial Reporting Council (FRC) asking for help in dealing with the unresolved argument of whether Resident Management Company’s (RMCs) act as Principal or Agent for the purpose of company accounting and what the correct treatment should be for transactions carried out during the year given that cash balances should not be included.
This request was the result of a long running industry debate which started in 2009 and culminated in 2011 in the issuance of &lsquo Tech Release 03/11 – Residential Service Charge Accounts’. This document was prepared by a working group made up of representatives from ICAEW, ACCA, ARMA, ICAS and RICS with the intention of setting out best practice for the industry. Unfortunately, best practice is not mandatory and as such the document did not rule out differing treatments and opinions.
The FRC responded to the request by issuing ‘UITF Abstract 49: Residential Management Companies Financial Statements’ in May 2012. This document stated that despite the legal opinion obtained by ICAEW confirming cash balances are to be excluded from statutory accounts each RMC would be required to determine for itself whether or not it was acting as Principal or Agent by referring to ‘FRS 5 – Reporting the Substance of Transactions’ and in particular ‘Application Note G Para G62-66 – Presentation of turnover as principal or agent’.
It then aimed to leave the decision in the hands of the RMC and instructed that if acting as Principal then transactions should be recorded in the accounts and if acting as Agent then they should be excluded with a note to confirm that the information can be found in the Service Charge Accounts. This provided a way of dealing with the Principal v Agent argument, albeit leaving it open to interpretation, but did nothing to address the concern as to whether or not it is right to report transactions within accounts that do not include the related cash balances. To try and address this the UITF viewed three different principles: ‘Abstracts 32 & 38 – Trusts’, &lsquo Statement of Principles for Financial Reporting (SOP)’ and ‘Generally Accepted Position for Pension Scheme Trusts’ and determined that none were appropriate to apply to this specific scenario:
- Abstracts 32 & 38: Trust’s – Employee Stock Ownership Plan Trusts (ESOP’s) are similar to Service Charge monies in that they are held in trust but ESOP’s are required to report cash balances as assets. It was acknowledged however that ESOP’s have a right over how the funds are invested whereas RMCs do not.
- Statement of Principles – Chapter 2 states that boundaries of reporting are determined by two elements: The ability to deploy resources and the ability to benefit from their deployment. It also states that the dual control approach is not applicable to trusteeships and given that in this scenario the trusteeship is referring to the cash balances this only confirms what is already known.
- Pension Scheme Trusts – The generally accepted principle for pension schemes is to exclude transactions from the statutory accounts due to the regulatory regime in place which ensures that financial statements of a trust are prepared and made available to members. It was decided at this time that this wasn’t comparable to the environment within which RMCs sit.
While UITF 49 was being developed independent legal advice was sought by both ICAEW and FRC on the Principal v Agent debate. Both opinions advised that RMCs always act as Principal in their third party transactions therefore there was no need to take the UITF 49 consultation any further. It was therefore removed in July 2012 and replaced with FRED 50 which instead aimed to address the accounting treatment concerns rather than the legal ownership of the transactions.
Due to the work already undertaken in UITF 49 and the legal opinions received FRED 50’s starting point was to assume all RMCs act as Principal and that cash balances shall not be recognised in the company accounts balance sheet. It also revisited the conclusion reached by UITF 49 when comparing Pension Scheme trusts to RMCs and determined that although a regulatory regime was in place via the Landlord and Tenant Act the risk levels associated with an RMC far outweigh those of a Pension Scheme. As such it was agreed this principle could not be applied.
Financial Reporting Standard for the UK
FRED 50 then took a different approach and applied the principles of The Financial Reporting Standard for the UK (FRS 102). Applying this standard and considering the legal opinions received that RMCs act as Principal it was proposed that RMCs profit and loss accounts should reflect transactional activity to comply with the requirement to give a true and fair view. It was considered as to whether there was an argument for offsetting the income and expenditure as the two happened simultaneously but it was concluded that this would not give a true and fair view and therefore was not appropriate. In addition to this it was determined that any outstanding balances between the trust and the RMC and the RMC and third party suppliers could not be offset and any balances should be reported on the statutory balance sheet even though the cash balance would not be required.
The document was put out for consultation and received a varied response. 70% disagreed with both the approach being proposed and the conclusion reached, a further 20% agreed with the principle of what the document was trying to achieve but did not fully agree with the approach being taken. The remaining 10% agreed and accepted the proposed outcome with no further recommendations.
During this time some additional legislative changes got underway which, along with the feedback above, would contribute to the removal of FRED 50.
Small Companies Regulations
The Small Companies Regulations 2013 were introduced in November 2013 and are applicable to the financial statements of all micro-entities for accounting periods ending on or after 30th September 2013. They only apply to eligible companies incorporated under the Companies Act 2006 and may not be applied by any other type of entity applying the Financial Reporting Standard for Smaller Entities (FRSSE). The regulations limit the presentation requirements and restrict the heading categories to be used on both the profit and loss and the balance sheet. The scope and grouping specified would not provide the level of detail to leaseholders that could be achieved through the use of service charge accounts and the introduction of these changes most likely had influence over the FRED 50 consultation responses.
The Small Company Regulations meant that amendments to the FRSSE were required to ensure that entities could be compliant with both documents. The FRC took this one step further and undertook a review of the Financial Framework as a whole. This review was aimed at simplifying the structure and consolidating the existing standards where appropriate. They took the opportunity to remove FRED 50, given that it wasn’t widely well received, and instead proposed to include a high level sub-section within ‘FRS 102 Section 34 Specialised Activities’. The main difference between this proposal and FRED 50 was the removal of any disclosure requirements as most RMCs will be small or micro entities for which company law limits the mandating of disclosures. Again the feedback was largely against this as it wasn’t felt that such a global accounting policy should be used to specify such industry specific guidance. The assumption has to be made that this feedback was taken into account as when the new Financial Framework was announced there was no statement made within the ‘Specialised Activities’ section of FRS 102 nor was there any amendments to ‘FRS – 105’.
The only conclusion to draw from this is that the FRC have no intention of issuing specific guidance on RMC accounting and as such there will be nothing legislative that can be used to further inform existing best practice. Therefore, unless changes take place in the future it would appear that ‘Tech Release 03/11 – Residential Service Charge Accounts’ will remain as best practice and continue as the basis for accounting requirements within the ARMA-Q Consumer Charter.