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.
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