The Dilapidations Dilemma

The accounting for property dilapidation provisions is an area which is regularly identified as problematic in our file reviews.  

In this blog, we’ll take a quick look at how dilapidations provisions should be accounted for under FRS 102.

Types of property dilapidations

Property leases typically contain one or more of the following types of obligation:

• An obligation to replace specific items or undertake specific works at the end of the lease (e.g. to replace carpets or paint walls);
• An obligation to remove leasehold improvements at the end of the lease (e.g. to remove any internal walls and partitioning that has been installed); and/or
• An obligation to restore the building to its original condition at the end of the lease.

The basics

FRS 102 paragraph 21.4 requires an entity to recognise a provision only when:

• the entity has an obligation at the reporting date as a result of a past event;
• it is probable (i.e. more likely than not) that the entity will be required to transfer economic benefits in settlement; and
• the amount of the obligation can be estimated reliably.

The first of these points is likely to be most relevant when assessing when to recognise a dilapidations provision.

When a dilapidations provision is initially recognised, it should be measured at the best estimate of the amount required to settle the obligation at the reporting date. In other words, it should initially be recognised in present value terms.

The accounting

Obligations to replace specific items or undertake specific works

Where a lease mandates particular items which must be replaced, or specifies particular work which must be undertaken regardless of the condition of the property, at the end of the lease term, a provision should be recognised for the cost of such work upon signing the lease. This is because the work cannot be avoided.

Conversely, if the lease specifies that an item only needs replacing once its condition falls below a particular level, a provision will only be recognised at the point it is no longer possible to avoid replacing the item, but will be recognised in full at that point.

Obligations to remove leasehold improvements

Where the terms of a lease require the removal of leasehold improvements (e.g. internal partitions) at the end of the lease, a provision will need to be recognised for the cost of removing them. The provision will need to be recognised at the time the partitions are put in place since this is when the relevant event occurs.

Since the provision relates to a specific asset (the internal partitions), it is appropriate to treat the cost as a decommissioning cost. As such rather than charging the provision to the P&L, it will be capitalised as part of the cost of the underlying asset – i.e. Dr Leasehold improvements, Cr Provisions.

Obligations to restore the building to its original condition

Where the terms of a lease require the building to be restored to its original condition, the amount of the provision recognised should be based on the costs of restoring the property based on its condition at the balance sheet date.

In other words, if the property is still in its original condition at the balance sheet date, no provision will be required at the balance sheet date.

Conversely, if significant damage has been done to the property during the year, then one would expect the provision recognised at the balance sheet date to reflect this.

When recognising this type of dilapidation provision, the provision is charged to the P&L. As such, in a year in which significant damage is done to a property, there would be a bigger P&L charge.

The myth

There is a common misconception that it is acceptable to simply build up a dilapidations provision on a straight-line basis over the term of the lease. This is not compliant with FRS 102, and, as the examples above illustrate, is inappropriate because the obligation does not generally arise on a straight-line basis.

Final thoughts

Both accountants and auditors need to carefully consider the accounting for dilapidations to ensure the treatment adheres to the requirements of the accounting standard. This will involve careful review of the specific obligations contained within the terms of the lease agreement as each lease may well be different.