July 16th 2020 / BY: Wisteria

Accounting for delapidations

Delapidation provisions are the liabilities to put back a property at the end of the lease into the same condition it was when you commenced the lease.  Therefore, any change in the condition of a property during the lease my creates a liability.  This is one area that companies often fail to account for correctly.

 

  • If it is probable that you will need to pay delapidations and you can reliably estimate the cost – you should provide.

 

  • If it is probable that you will need to pay delapidations but you cannot reliably estimate the cost – you should not provide, but you should disclose.

 

  • If it is possible that you would need to pay delapidations and the likelihood of this is not remote – you should not provide, but you should disclose.

 

  • If it is possible that you would need to pay delapidations and the likelihood of this is remote – you should do nothing.

 

The most common failings are:

  • Getting the above wrong; or
  • Calculating the delapidations on a straight line basis; or
  • Not considering a break clause.

 

Calculating dilapidation provision

The easiest way of explaining the calculation needed is by providing an example:

A lease is taken on in 2020 on a 10 year lease.  The property requires £125k to install some fixtures and fittings.  The probability is that there will be £75k dilapidation liability to pay in 10 years’ time.

The double entry initially is:

 

DR Fixed Assets £125,000

CR Creditors £125,000

 

DR Fixed Asset £46,043

CR Provision £46,043

Being the net present value of £75k assuming a rate of interest of 5%.

Future Value 75000
Annual Interest Rate 0.05
Number of Years 10
Present Value =+C2/(1+C3)^C4

 

Future Value £75000
Annual Interest Rate 5%
Number of Years 10
Present Value £46,043

After one year the double entry is:

DR Depreciation expense £17,104

CR Accumulated depreciation £17,104

DR Interest (P&L) £2,302

CR Provision £2,302

Being the net present value of the effective interest (£75,000-£46,044=£28,957)

WACC 0.05
Total Intrest 28957
Years 1 2 3 4 5 6 7 8 9 10 Total
Discount Factor =+(1+$C1)^C3 =+(1+$C1)^D3 =+(1+$C1)^E3 =+(1+$C1)^F3 =+(1+$C1)^G3 =+(1+$C1)^H3 =+(1+$C1)^I3 =+(1+$C1)^J3 =+(1+$C1)^K3 =+(1+$C1)^L3 =SUM(C4:L4)
Present Value =+C4/M4*C2 =+$C$2/D4 =+$C$2/E4 =+$C$2/F4 =+$C$2/G4 =+$C$2/H4 =+$C$2/I4 =+$C$2/J4 =+$C$2/K4 =+$C$2/L4 =SUM(C5:L5)

 

WACC 0.05
Total Intrest 28957
Years 1 2 3 4 5 6 7 8 9 10 Total
Discount Factor 1.05 1.10 1.16 1.22 1.28 1.34 1.41 1.48 1.55 1.63 13.21
Present Value £2,302 £26,265 £25,014 £23,823 £22,689 £21,608 £20,579 £19,599 £18,666 £17,777 £198,322

Issues that require further consideration:

  • Lease that has a break clause
  • Agreement to pay the landlord a fixed sum
  • Agreement to waive the delapidations costs since the tenant extends the lease
  • Auditors would require the necessary evidence and workings to be able to become comfortable that the treatment has been performed correctly.