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 £125,000CR Creditors £125,000 DR Fixed Asset £46,043CR Provision £46,043Being 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 £17,104CR Accumulated depreciation £17,104DR Interest (P&L) £2,302CR Provision £2,302Being 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.