Businesses which hold property portfolios could have their company credit rating downgraded under a New Year accounting shake-up, two experts have warned.
Under revised accounting rules — which come into effect on 1 January, 2015 — companies with investment properties will see their profit and loss accounts change to allow annual headline results, such as pre-tax profit, to be used for credit scoring.
“This academic change may have a real-world unexpected effect on a business’s credit rating,” said Chris Billson (above), a director at commercial property firm Prop-Search, and Adam Shakespeare (below), a manager with Isis Business Solutions.
Traditionally companies with investment properties have followed existing UK Generally Accepted Accounting Practice (UK GAAP) which requires them to revalue each property annually. “Any changes to that market value have not been shown in the reported profit or loss for the year but were, in most cases, only a balance sheet entry,” explain the Northamptonshire-based consultants.
Under the upgraded version of UK GAAP — based on International Financial Reporting Standards and known as FRS102 — this new standard will be compulsory for small and medium sized enterprises and investment properties will still need a yearly valuation.
The big difference, add Billson and Shakespeare, is that any change in market value will now be shown as part of the reported profit or loss for the year. And there will be no revaluation reserve in the balance sheet, instead all the previous revaluation reserve will need to be shown as part of the profit and loss account reserve.
“A reduction in property value could be larger than the normal profit on the rental income, so there could easily be a reported loss for the year under these new standards where previously that reduction in value would have only been reported as part of the balance sheet,” they explain.
There is also a more flexible shift in how market values are handled. From January, investment properties will still be initially recognised at cost, but subsequently measured at a “fair value”, a notional value designed to replace the market value required under UK GAAP. But any “fair value” need only be included if it can be gathered “reliably and without undue cost or effort” — if not, then the property can be included at its cost.
Billson and Shakespeare also stress that although unrealised gains on investment property must now be accounted for in the profit and loss account, they are considered as non-taxable income. Similarly, unrealised losses will continue to be treated as non-deductible expenditure for corporation tax purposes.
“Another change is the way lease incentives are treated,” warn the pair. “At present any lease incentive received for entering into a lease — for example a rent free period — is spread over the period to the first break clause. Under the new standards the lease incentive would be spread over the period of the lease regardless of any break clauses.”
To allow the accounting shake-up to bed in, transitional rules will allow an existing lease to continue under UK GAAP, but any newly signed post-2014 lease will come under the new regulations. This allows the profit effect to have a major impact by being spread over a longer period, where previously there were long leases with short break clauses.
The New Year may still seem a long way away, caution Billson and Shakespeare, but all comparatives will still need to be changed to the new format and that takes time.
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