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Component Accounting; does it equal the sum of the parts?

Posted on January 1st, 2015 in News

i.s.4 on why it’s a good thing for us all.

The introduction of component accounting has resulted in the usual round of “free” corporate seminars, the sort that accompany any significant change in accounting rules, whether you’re in housing finance or any other type of finance. However, rarely have I attended one where one of the questions from the floor was such a “direct hit”! In a way it was a chance set of circumstances that made it so memorable, the question on its own was one that we have all probably asked in the context of component accounting. It wasn’t as if the direct hit was a “bullseye” with one of the speakers, either, it was another member of the audience. For me the moral of the story is; if you work for the regulator and you’re in the audience at a presentation on a controversial subject….just keep your head down, or better still, go in disguise!

So, what was the question? Simply this; “What’s the value to the tenant of implementing component accounting?” Unfortunately, a well-known face from the TSA was in the audience, and the question was quickly redirected along the lines of “what’s the TSA’s perspective on this?” It was an aspect of component accounting that the TSA didn’t appeared to have considered as part of its membership of the SORP working party!

So why are we using a lot of resources to rework the sector’s fixed asset records? There is certainly a good technical argument that adopting component accounting will give a more accurate view of organisations’ asset base, investment and maintenance programmes in the accounts. However, the real benefit is the saving of time and energy lost, every year, in trying to align the practical needs of the annual maintenance budget with the requirements of the SORP so that enough maintenance can be capitalised, to meet both tenants’ expectations and the interest cover covenants! Sound familiar? Under the new rules associations’ maintenance and investment teams will no longer have to provide information to Finance, so that Finance can justify to the auditors the assertion that the work will result in an increase in the future net income stream. In the future the decision of accounting treatment will be driven by the type of work being undertaken, the maintenance teams can concentrate on the needs of the tenant and finance can concentrate on funding the work.

Of course this assumes that depreciation is outside the interest cover covenant. If it is, then adoption of component accounting can allow the accountants to focus on managing the cashflow to fund investments and not spend time looking over their shoulder at the interest cover covenants restricting investment because the expenditure needs to go through the income & expenditure account. It also means that it will be possible to avoid a property having two bathrooms…from an accounting point of view, that is.

Other benefits that would not necessarily be obvious in the short term include the opportunity to invest in a proper fixed asset register, another load of Excel spreadsheets can be consigned to the bin. If the component categories match the categories used in the stock condition survey then there is a better chance that when it comes to the long term financial plan, the budget, the management accounts and the statutory accounts there will be a clear link between the maintenance/investment records and the finance records. That’ll save some time and effort!

So what about implementation? I suspect there are almost as many variations on this as there are housing providers. At least the technical guidance in the SORP clearly recognises the need to be pragmatic, and that it will not necessarily be practical to reconstruction an organisation’s historic asset records, either because of the sheer size of the task or the lack of information. The starting point feels like a two-by-two matrix; on one axis is how old/new is the organisation/property portfolio? The older it is the more likely that the implementation will need to be based on some robust assumptions, however at the other end of the spectrum it might be better to do it at a more detailed transaction level, especially if the exercise is being combined with a new fixed asset register. The other side of the matrix is balance sheet or income and expenditure; which is likely to have the more material adjustments? So, if you’re responsible for a relatively young organisation and the implementation will have a significant impact on revenue reserves brought forward and surplus in the future, then detailed analysis may well be necessary to understand and explain the impact. On the other hand if it is thirty years of building up a portfolio of 30,000 units, and they’re held at valuation, it is likely that the only way forward is to use robust assumptions applied to large chunks of property.

Finally, don’t forget the impact on covenants; when talking to funders remember two things; firstly this should not fundamentally change the viability of the business, it is the accountants changing presentation, and secondly, everyone has to do it.

So, does it equal the sum of the parts? I think the answer is yes, let’s face it tidying up the sector’s fixed asset records is probably long overdue and getting some consistency and transparency to how we account for maintenance and investment expenditure is also a worthwhile move. But the potential for making it easier to implement investment programmes will be a major benefit for tenants.

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