Please note: Responses to this Invitation To Comment (ITC) can only be made online via a survey and any email responses received will not be accepted. To respond to the Invitation To Comment and to receive a link to the survey please email policy@housing.org.uk. STATEMENT OF RECOMMENDED PRACTICE (SORP) Accounting by registered providers of social housing INVITATION TO COMMENT ON THE 2014 SORP: 3 April 2013 PREFACE 1. This Invitation to Comment (ITC) sets out proposals for a fourth edition of

the SORP for Registered Providers of Social Housing before it is fully exposed as a draft SORP in Autumn 2013. This edition of the SORP replaces the third edition first published in January 2008 as amended by a SORP Update in 2010. The 2014 SORP reflects the transition ‘FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland’ (FRS 102) which is based on the IASB’s IFRS for SMEs as well as developments in the social housing sector since the 2010 SORP Update. The 2014 SORP will apply to accounting periods commencing on or after 1 January 2015 but earlier adoption is permitted under certain circumstances.

2. The Financial Reporting Council (FRC) will not undertake a

comprehensive review of the draft SORP but a review to ensure consistency with FRS 102 will be performed. Paragraph 9 of the Policy and Code of Practice requires the SORP-making body to invite public comment and to allow a period of time for interested parties to respond.

3. The National Housing Federation, the Scottish Federation of Housing

Associations and Community Housing Cymru (collectively the SORP-making body), represented by the SORP Working Party, welcome comments on any aspects of this ITC. However, the SORP Working Party particularly welcomes comments on the proposed amendments and questions raised by this ITC (the questions are listed at the beginning of the ITC and included throughout in its relevant sections). It would be helpful if respondents were to support comments with reasons and where applicable preferred alternatives. Comments should be received by Friday 17 May 2013. Comments received will be analysed and reviewed by the SORP Working Party on 18 June 2013.

4. The SORP Working Party is now consulting registered providers and other

interested parties. Responses should be sent in an electronic format via the survey monkey. If you have any queries please contact John Butler, Finance Policy Officer, National Housing Federation, john.butler@housing.org.uk

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5. Responses to this ITC will be regarded as on the public record unless confidentiality is specifically requested. Copies of all the correspondence will be provided to the FRC.

Joseph Carr Finance Policy Leader National Housing Federation

CONSULTATION QUESTIONS

Housing properties

1 Do you agree that guidance over the treatment of housing property tenure types as either ‘Property, Plant and Equipment’ or as ‘Investment Properties’ should be included in the SORP?

2 If yes, do you agree with the proposed amendments in relation to housing property tenure types? If not, what alternatives would you propose and why?

Employee benefits (including pensions)

3 Do you agree that both SHPS and SHAPS should be accounted for as defined contribution schemes? If not, please give your reasons and alternative accounting treatment.

4 Do you know of any other multi-employer pension plans where there is insufficient information on a reasonable and consistent basis available to social landlords to identify their share of the plans underlying assets and liabilities? If yes, please give details of these pension plans.

5 The draft SORP will require the past service cost liability for SHPS, SHAPS and other multi-employer plans that are accounted for as defined contribution plans to be recognised as a liability in the statement of financial position? What impact will this change in accounting policy have on social landlords’ financial statements?

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Grant (and impact on valuation accounting)

6 For those social landlords accounting for their assets at historical cost, do you agree that the accrual model for government funded Social Housing Grant (SHG) is the most appropriate model to apply? If not, please give your reasons why, including: a) how the performance model is a more appropriate treatment of grant; and b) the reasons why allowing a choice between the accrual model or performance model is appropriate and will achieve consistency across the sector.

7 For those social landlords accounting for their assets at valuation, which of the following options do you believe is most appropriate for government funded SHG:

a) the performance model with subsequent review of impairment of the assets for which the SHG was given; or

b) the accrual model being consistent with those social landlords that hold their assets at historical cost, recognising the potential impact on net assets.

Please state your reasons. If none of the options above, please give your alternative and the reasons why this would be more appropriate. In addition indicate whether the impact of the above models would cause you to reconsider carrying property assets at valuation.

8 Do you agree that SHG should be amortised over the useful

economic life of the asset’s structure only? If not, please give your reasons why and alternative accounting treatment.

9 Do you agree that RCGF should not be recognised at the point of disposal of the asset but rather be disclosed as a contingent liability? If not, give your reasons why and alternative accounting treatment.

10 Do you agree with the accounting treatment detailed in the

illustrative example of showing amortised and residual SHG as a contingent liability? If not, please give your reasons why and alternative accounting treatment. Provide an illustrative example.

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Stock swaps

11 Do you agree that the fair value of the purchase price when considering stock swaps should be the EUV-SH of the properties that are acquired? If not, please give your reasons why and alternative accounting treatment?

12 Do you agree that the government grant linked to the assets swapped between social landlords should be recognised as an obligation by the receiving social landlord? If not, please give your reasons why and alternative accounting treatment. For example, do you agree with the alternative view expressed in paragraph 48?

13 Do you have a view on the wider implications of the treatment proposed by the SORP Working Party in paragraph 47, for example on the treatment of grant in consortium and/or inter-company transactions?

Agreements to improve existing properties

14 Are you of the view that guidance over the treatment of agreements to improve existing properties should be amended in the SORP to comply with FRS 102 and ensure that agreements to improve existing properties are recognised on a gross basis?

15 If yes, do you agree with the proposed amendments in relation to agreements to improve existing properties? If not, why not and what alternatives do you support (with reasons)?

Financial instruments

16 Do you agree that the SORP should not repeat Section 11 or Section 12 in relation to financial instruments, but rather clearly reference to FRS 102 and provide a technical note? If not please explain your reasons.

17 The technical note to the SORP is intended to provide worked examples of how to account for common financial instruments that social landlords have. What are the common financial instruments social landlords have which should be included in the technical note?

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Transitional arrangements

18 Do you agree with the key changes to accounting policies considered in this ITC? If not, what other key changes do you believe should be considered separately by the SORP Working Party?

19 Do you agree that other changes to accounting policies, changes to terminology and changes to the presentation and disclosures are best addressed in a ‘transitional’ section of the revised SORP? If not, please give your reasons why and alternative suggestions.

20 Are there any exemptions in paragraph 35.10 of FRS 102 that you believe should not be available to social landlords? If so, please give your reasons why and alternative treatment.

Narrative reporting

21 Do you agree that there is value in narrative reporting as part of the financial statements beyond the requirements of statute, for example the Companies Act?

22 Do you agree that all social landlords with more than 5,000 homes in management should prepare an OFR? If not, please provide an alternative threshold or state the reasons why you believe an OFR should not be required.

23 Do you agree with the current reporting requirements of an OFR, including the required headings that are to be included in an OFR? If not, provide those headings that you believe should be required.

Adoption date

24 Given the timescales outlined in paragraph 66 above do you plan to early adopt the new SORP based on FRS 102 for the year ended 31 March 2015. If yes, please state your reasons.

Questions can be downloaded in electronic format from the National Housing Federation website at www.housing.org.uk

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THE 2014 STATEMENT OF RECOMMENDED PRACTICE 6. The first SORP for Registered Social Housing Providers was published in

1994. It was subsequently revised in 1999 and 2008, and updated in 2010. The 2014 SORP is being entirely rewritten and restructured to comply with the ‘The Financial Reporting Standard 102 applicable in the UK and Republic of Ireland’ (FRS 102) which will replace all current standards extant under UK GAAP.

7. This ITC seeks comment on the significant amendments required to the SORP as part of the transition to FRS 102. Following this consultation exercise a fully revised SORP will be exposed for comment (currently planned for Autumn 2013).

REVISION OF THE 2010 SORP 8. As noted above, this is the fourth revision of the SORP for Registered

Providers of Social Housing. The SORP Working Party is of the view that there is a need to review the content of the SORP to ensure it is compliant with FRS 102. In doing so the SORP Working Party has identified a number of areas where there will be significant change to current practice. These areas are listed below and the SORP Working Party would welcome any comments that you may have.

Housing properties;

Employee benefits (pensions);

Grant (and impact on valuation accounting);

Stock swaps;

Agreements to improve existing properties;

Financial instruments; and

Narrative reporting

9. The conversion to FRS 102 also requires a significant number of changes to the format, language and drafting of the current SORP. Many of these revisions will require preparers of the accounts to make changes to the current format of the accounts. Whilst these changes are not significant they do need to be considered and understood and as such the SORP Working Party proposes to include a ‘Transitional Arrangements’ section in the 2014 SORP to help preparers manage the transition to FRS 102 effectively. The SORP Working Party would welcome any comments that respondents may have on this approach.

10. The 2014 SORP will also include various minor amendments and updates

where required to ensure compliance with FRS 102. These amendments are not subject to consultation at this time but you will have the opportunity to comment when the 2014 SORP is fully exposed in Autumn 2013.

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HOUSING PROPERTIES 11. Housing properties represent a significant part of a social landlord’s financial

statements. Social landlords hold an increasing diversity of tenure types of housing properties for reasons of social benefit and income generation and capital appreciation. The recognition and measurement of different tenure types of housing properties is considered in FRS 102 and the accounting treatment is different depending on the reason why a social landlord holds a particular tenure type or class of asset.

12. FRS 102 considers that if a housing property is held for social benefit it is

appropriate to treat this asset as ‘Property, Plant and Equipment’ at either historical cost or revaluation and then depreciate and consider impairment accordingly.

13. FRS 102 also considers housing assets that are not held for social benefit and considers these to be ‘Investment Properties’. FRS 102 defines an Investment Property as property (land or a building, or part of a building, or both) held by the owner or by the lessee under a finance lease to earn rentals or for capital appreciation or both, rather than for:

(a) use in the production or supply of goods or services or for administrative purposes, or (b) sale in the ordinary course of business.

Assets held by social landlords such as head office properties would not normally meet the definition of investment properties above.

14. Mixed use schemes shall be separated between investment property and

property, plant and equipment. 15. The SORP Working Party is of the view that the SORP does not adequately

address the issue of whether tenure types should be recognised as ‘Property, Plant and Equipment’ or as ‘Investment Properties’ to ensure a consistent approach in the sector.

16. The SORP Working Party proposes that the SORP should include guidance so that the most common tenure types held in the sector are consistently treated as either ‘Property, Plant and Equipment’ (for example general needs properties) or ‘Investment Properties’ (for example market rented properties) in accordance with FRS 102. Draft guidance is included in Appendix 1 to this ITC).

17. The SORP Working Party is of the view that this proposal increases the

transparency of reporting, thus enabling readers of the accounts to understand the business rationale for holding different property tenures.

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Consultation Questions

1 Do you agree that guidance over the treatment of housing property tenure types as either ‘Property, Plant and Equipment’ or as ‘Investment Properties’ should be included in the SORP?

2 If yes, do you agree with the proposed amendments in relation to housing property tenure types? If not, why not and what alternatives do you support (with reasons)?

EMPLOYEE BENEFITS (INCLUDING PENSIONS)

18. Social landlords provide a number of employee benefits that will be accounted

for in accordance with FRS 102. This includes short-term employee benefits, termination benefits, long-term employee benefits and post employment benefits. The key changes will be the recognition of holiday pay accrual and application of the multi-employer exemption for multi-employer pension plans.

19. FRS 102 defines short-term employee benefits as benefits wholly due within twelve months after the end of the period in which the employees render the related services. This includes wages, salaries, social security contributions and short-term compensated absences such as paid annual leave and paid sick leave.

20. Although there is no conceptual difference between FRS 102 and current UK GAAP (as reflected in FRS 12), in practice many UK reporting entities did not provide for holiday pay and will need to consider this when applying FRS 102.

21. The SORP Working Party is of the view that the recognition of holiday pay accrual should be applied by social landlords in accordance with FRS 102. This will be addressed within the transitional guidance in the revised SORP.

22. A large number of social landlords are members of multi-employer pension plans, for example the Social Housing Pension Scheme (SHPS) and the Scottish Housing Association Pension Scheme (SHAPS). FRS 102 provides an exemption for multi-employer plans to be accounted for as defined contribution plans where there is not sufficient information on a reasonable and consistent basis available to allow participants to identify their share of the plans underlying assets and liabilities.

23. The SORP Working Party considered that the starting point for SHPS and

SHAPS is that the schemes should be accounted for as a defined benefit scheme and has discussed with the Pensions Trust the availability of information to enable participants to identify their share of the plans underlying assets and liabilities.

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24. However the Pensions Trust has stated that it is unable to provide participating employers with a full analysis of their share of SHPS/SHAPS assets and liabilities. Given this position, it is therefore the view of the SORP Working Party that SHPS/SHAPS should be accounted for as a defined contribution scheme, as there is not sufficient information on a reasonable and consistent basis available to allow social landlords to identify their share of SHPS/SHAPS underlying assets and liabilities. Individual social landlords should continue to confirm this position with the Pensions Trust in preparing their individual financial statements.

Consultation Questions

3 Do you agree that SHPS and SHAPS should be accounted for as defined contribution schemes? If not, please give your reasons and alternative accounting treatment.

4 Do you know of any other multi-employer pension plans where there is insufficient information on a reasonable and consistent basis available to social landlords to identify their share of the plans underlying assets and liabilities? If yes, please give details of these pension plans.

25. FRS 102 also states that there may be a contractual agreement between the multi-employer plan and its participants that determines how the deficit in the plan will funded by the participants. A participant in a multi-employer plan with such an agreement that accounts for the plan as a defined contribution plan shall recognise the liability that arises from the contractual agreement and the resulting expense in profit or loss.

26. The SORP Working Party is of the view that the contractual agreement amount for multi-employer schemes that are accounted for as defined contribution schemes such as SHPS or SHAPS relates to the past service cost of the scheme. Further, the amount of the resulting asset or liability is known to social landlords. The SORP Working Party has concluded that this past service cost should be accounted for in the financial statements of social landlords.

Consultation Questions

5 FRS 102 will require the past service cost liability for SHPS, SHAPS and other multi-employer plans that are accounted for as defined contribution plans to be recognised as a liability in the statement of financial position? What impact will this change in accounting policy have on social landlord’s financial statements?

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GRANT (AND IMPACT ON VALUATION ACCOUNING) 27. The treatment of grant has previously followed the principles of SSAP 4

‘Accounting for government grants’. FRS 102 addresses the treatment of grants in section 24: Grants. There are fundamental differences between the treatments of grant under FRS 102 compared with current GAAP.

28. The first difference is that FRS 102 does not allow grants to be off-set against the carrying value of an asset. Where grants are recognised as deferred, these are to be classified as a liability in the statement of financial position.

29. The second difference is that FRS 102 allows a choice of accounting treatment between the ‘performance model and the ‘accrual model, however the accrual model is only available for government grants (rather than all grants), which is consistent with EU-adopted IFRS. The different models are explained in paragraphs 30 and 31.

30. Performance model An entity applying the performance model shall recognise grants as follows: (a) A grant that does not impose specified future performance conditions on the recipient is recognised in income when the grant proceeds are receivable. (b) A grant that imposes specified future performance conditions on the recipient is recognised in income only when the performance conditions are met. (c) Grants received before the revenue recognition criteria are satisfied are recognised as a liability. The performance model requires social landlords to consider whether there are conditions attached to the grant it receives that would prevent it from recognising the grant in the statement of comprehensive income in which case the grant should be held as a liability, namely deferred income, until such performance conditions are met. In the context of social housing grant it is most likely all of the conditions have been met on completion of the property for which the grant has been given. In this case the grant should be recognised immediately as income. An alternative view is that the performance conditions are in essence never met, due to the continuing obligation to hold the property for which the grant is given as affordable housing. In this case the grant will always be held as a liability until it is repaid (unless the building is no longer in use). The Working Party’s view is that in almost all cases the substance of the transaction is that the conditions attached to the grant have been met on completion of the property.

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In the case of the performance conditions being met on completion of the property, the initial recognition of income will be offset in future periods by a higher depreciation charge (as the cost is no longer sheltered by grant) over the life of the asset. In the unlikely case where performance conditions are not/never met this higher depreciation charge will still be recognised over the life of the asset however there will be no income to offset this.

31. Accrual model

An entity applying the accrual model shall classify grants either as a grant relating to revenue or a grant relating to assets. Grants relating to revenue shall be recognised in income on a systematic basis over the periods in which the entity recognises the related costs for which the grant is intended to compensate. A grant that becomes receivable as compensation for expenses or losses already incurred or for the purpose of giving immediate financial support to the entity with no future related costs shall be recognised in income in the period in which it becomes receivable. Grants relating to assets shall be recognised in the income on a systematic basis over the expected useful life of the asset. Where part of a grant relating to an asset is deferred it shall be recognised as deferred income and not deducted from the carrying value of the asset. The accrual model says that grant classified as a grant relating to assets, being the significant proportion of the sector’s grant, should be recognised as income on a systematic basis over the life of the asset. Therefore the grant will be amortised and will to some extent offset the higher depreciation charge. If the grant is deferred for any reason then it should be treated as a liability, namely deferred income.

32. As stated in paragraph 28, only government grants will have the choice to apply the accrual model. This choice could lead to social landlords having inconsistent accounting policies as all non-government grants must be accounted for under the performance model.

33. As both the performance and accrual models amortise grant to income, the amortised grant should be disclosed as a contingent liability in the financial statements reflecting the fact that it will be potentially repayable.

34. The SORP Working Party has considered the two methods within FRS 102 and is of the view that the accrual method most appropriately matches the substance of SHG. It is proposed that the accrual model is to be applied to

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SHG by all social landlords that hold their assets at historical cost. This will increase the level of consistency across the sector for the treatment of SHG.

35. For social landlords that hold their assets at valuation the accounting principles set out in FRS 102 on government grant may have a more significant impact. As set out in paragraphs 27 to 30 above FRS 102 requires that grant is recognised as a liability and subsequently recognised as income on either a systematic basis or when performance conditions have been met. Under the current SORP and UK GAAP social landlords that account for their assets at valuation do not explicitly recognise the social housing grant as a creditor on their balance sheet (as those that account at historical cost do by offsetting the grant against the asset cost).

36. If social landlords accounting for their assets at valuation adopt the accrual

model for grant this may result in a significant reduction in net assets as social housing grant would in future be recognised as a creditor (subsequently being amortised to income) however the valuation of the asset itself would not change, being EUV-SH which is a future cash-flow model and therefore excluding the grant. FRS 102 does allow a transitional relief to enable social landlords to freeze the value of their assets as deemed cost as at the transition date. However the SORP Working Party considers that this transitional relief will not be appropriate for social landlords currently holding their assets at valuation.

37. The SORP Working Party has consulted with sector valuation experts and

confirmed that EUV-SH remains the most appropriate valuation method as it represents the fair value of the properties held for a continuing social purpose. The SORP Working Party has also consulted with a number of social landlords that utilise the valuation method to understand the potential impact of the changes in grant accounting on them.

38. The SORP Working Party has considered two options when considering the

treatment of grant for those social landlords that account for their assets at valuation given the impact on net assets as described in paragraph 33 above. These options are:

a) Social landlords that account for their asset at valuation should

adopt the performance model for accounting for grant. The performance model would mean that grant would be recognised as income on completion of the property (when the conditions have been met) and ultimately be reflected in the Revenue Reserve. Social landlords should then assess the housing assets for which the grant was given for impairment. This may result in a corresponding charge to the statement of comprehensive income and ultimately the Revenue Reserve;

b) Social landlords that account for their asset at valuation should use the accrual model for accounting for grant as recommended for those social landlords who hold their assets at historical cost. This

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is on the basis that the impact on net assets as described above is believed to affect only a minority of social landlords significantly.

39. The SORP Working Party’s view is that option a) in paragraph 38 is the most

appropriate model in accounting for grant for those social landlords holding their assets at valuation. This is because this treatment complies with FRS 102 and also accurately reflects the value of the underlying assets.

Consultation Questions

6 For those social landlords accounting for their assets at historical cost, do you agree that the accrual model for government funded SHG is the most appropriate model to apply? If not, please give your reasons why, including: a) how the performance model is a more appropriate treatment of grant; and b) the reasons why allowing a choice between the accrual model or performance model is appropriate and will achieve consistency across the sector.

7 For those social landlords accounting for their assets at valuation, which of the following options do you believe is most appropriate for government funded SHG;

a) the performance model with subsequent review of impairment of the assets for which the SHG was given; or

b) the accrual model being consistent with those social landlords that hold their assets at historical cost, recognising the potential impact on net assets.

Please state your reasons. If none of the options above, please give your alternative and the reasons why this would be more appropriate. In addition indicate whether the impact of the above models would cause you to reconsider carrying property assets at valuation.

40. The SORP Working Party also considered a number of implications of the

accounting for SHG using the accrual model. The key considerations made were: a) how to account for the amortisation of SHG in the statement of comprehensive income; and b) the treatment that should be applied to the amortised SHG and residual deferred income upon disposal of the asset, including subsequent recycling of the grant. These considerations are discussed in the following paragraphs.

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41. As explained in paragraph 30, where the accrual model is applied the grant is classified as deferred income in liabilities. The Working Party considered the model by which the grant should be amortised. Consideration was given to amortising the grant over the life of the structure of the property for which the grant was given only or whether to allow amortisation of the grant to also be applied to components, in effect weighting the amortisation period. It is the view of the SORP Working Party that the grant should be amortised over the useful economic life of the asset’s structure (excepting where grant has been allocated to components in the event of high grant rates and major repairs grant) and recognised as income as the SORP Working Party believes this best matches the economic benefits that accrue from the asset. In particular the SORP Working Party considered that once a component reached the end of its life or was replaced the grant would not be recyclable. Consideration was also given to the ‘linkage’ of grant to land. FRS 102 is silent on this topic other than to refer EU-adopted IFRS as a whole to see if there is guidance that can be used. IAS 20 ‘Accounting for Government Grant and Disclosure of Government Assistance’ considers this area and concludes that grant should not be allocated to land but recognised over the life of the building which sits on the land.

Consultation Question

8 Do you agree that SHG should be amortised over the useful economic life of the asset’s structure only? If not, please give your reasons why and alternative accounting treatment.

42. Upon disposal of the asset there are key considerations that need to be made

with regard to the accounting treatment of SHG and the subsequent recycling of the grant. Under the current SORP, when an asset is disposed any SHG is recycled to the Recycled Capital Grant Fund (RCGF) or Disposals Proceeds Fund (DPF). The funding conditions of SHG in most circumstances require the grant to be reutilised within three years. If the grant is not reutilised within three years of the subsequent year end, it will be required to be repaid to the grant provider (note, different funding conditions may apply to different SHG).

43. The first consideration is at which point the grant is triggered to be transferred to the RCGF. The SORP Working Party considered two alternative treatments: a) At the time of disposal of the asset, transfer the grant to RCGF and recognise a liability. b) At the time of disposal of the asset, disclose a contingent liability. At the time the SHG becomes repayable to the grant provider (for example after three years), recognise a liability.

44. It is the view of the SORP Working Party that the trigger point to recognise the liability and subsequent transfer to RCGF is the non-utilisation of the SHG in the time period allowed, rather than on disposal of the asset. This more closely reflects the definition of a liability under FRS 102. For these reasons, the treatment in 38b) is considered the most appropriate treatment.

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Consultation Question

9 Do you agree that RCGF should not be recognised at the point of disposal of the asset but rather be disclosed as a contingent liability? If not, give your reasons why and alternative accounting treatment.

45. The next consideration made by the SORP Working Party was the recycling of

the SHG. This raises accounting implications of transferring SHG to the RCGF including SHG that has previously been amortised and recognised as income. The SORP Working Party agreed that at the time of disposal of the asset, SHG that had previously been amortised and recognised as income should be debited to the statement of comprehensive income and recognised as an expense. This should continue to be disclosed as a contingent liability. Any SHG classified as deferred income in liabilities should be amortised to income and disclosed as a contingent liability. This is illustrated using the following example:

Asset structure purchase price 01/04/x1: £200,000 (no components element for simplicity) Land element: £ 60,000 Building element: £140,000 SHG for asset purchase: £ 50,000 UEL of asset structure: 100 yrs Asset disposed 31/03/x4 Consideration received: £205,000 31/03/x4: Accounting entries to recognise asset disposal Dr Cash £205,000 Dr Accumulated depreciation £ 4,200 Cr Housing property cost £200,000 Cr Gain on disposal £ 9,200 Recognition of the gain on disposal, accounting for three years deprecation 31/03/x4: Accounting entries to recycle SHG (3 yrs amortised SHG to income) Dr Deferred income liability £48,500 Dr Amortised RCGF £ 1,500 Cr Income £50,000 Transfer of amortised SHG and residual deferred SHG recognised in income. Contingent liability of £50,000 is disclosed in the financial statements.

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Consultation Question 10 Do you agree with the accounting treatment detailed in the

illustrative example of showing amortised and residual SHG as a contingent liability? If not, please give your reasons why and alternative accounting treatment. Provide an illustrative example.

STOCK SWAPS 46. A number of social landlords have or are entering into transactions with other

social landlords to ‘swap stock’, being an agreement to purchase stock from each other in return for non-monetary assets (properties) and often some monetary assets (cash) to equal the value of the transaction to both sides. The current SORP is silent on this topic and there has been some inconsistency of practice in accounting for this type of transaction. Given the increasing number of stock swaps and similar transactions in the sector the SORP Working Party is of the view that the revised SORP should contain some guidance in this area.

47. When considering accounting for stock swaps the SORP Working Party considered two key issues, being a) the purchase price and b) the treatment of associated grant to the assets that have been swapped or disposed of.

48. UK GAAP does not explicitly define purchase price. However, FRS 102 does

contain guidance confirming that where property plant and equipment is acquired in exchange for a non-monetary asset (or in combination of monetary and non-monetary assets) the purchase price should be measured at fair value unless:

a) the exchange lacks commercial substance ;or b) the fair value of the assets received/given up is unable to be reliably measured.

The SORP Working Party’s view is that stock swaps in the sector do have commercial substance and are capable of being measured at fair value, being EUV-SH. This is illustrated in the following example (ignoring depreciation for simplicity):

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RP1 RP2 100 Units 80 Units Cost £8,000,000 Cost £6,000,000 EUV-SH £12,000,000 EUV-SH £10,000,000 The double entry (ignoring grant at this stage) would be: RP 1 Remove Original Units Cr Fixed Asset £8,000,000 Dr Profit/Loss on Disposal £8,000,000 Recognise New Units Dr Fixed Assets £10,000,000 Dr Cash £2,000,000 Cr Profit/Loss on Disposal £12,000,000 Total £20,000,000 £20,000,000 RP 2 Remove Original Units Dr Profit/Loss on Disposal £6,000,000 Cr Fixed Assets £6,000,000 Recognise New Units Dr Fixed Assets £12,000,000 Cr Cash £2,000,000 Cr Profit/Loss on Disposal £10,000,000 Total £18,000,000 £18,000,000

49. There is some inconsistency in practice as to how the grant obligation follows

the swapped assets. It is clear that the grant obligation has been transferred from one social landlord to another however the critical question is whether this obligation should be recognised at the point of the swap or at the point of any subsequent disposal? SSAP 4 (in UK GAAP) and FRS 102 deal with government grants. The SORP Working Party’s view is that both SSAP 4 and Section 24 of FRS 102 apply in a stock swap scenario as the receiving social landlord has received government grant in substance even though it has not directly received the grant from a government source. This is illustrated in the following example (ignoring depreciation and amortisation of grant for simplicity):

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RP1 RP2 100 Units 80 Units Cost £8,000,000 Cost £6,000,000 Grant £3,200,000 Grant £2,400,000 NBV £4,800,000 NBV £3,600,000 EUV-SH £12,000,000 EUV-SH £10,000,000 RP 1 Remove Original Units Cr Fixed Asset £8,000,000 Dr Grant £3,200,000 Dr Profit/Loss on Disposal £4,800,000 Total £8,000,000 £8,000,000 Recognise New Units Dr Fixed Assets £10,000,000 Dr Cash £2,000,000 Cr Grant £2,400,000 Cr Profit/Loss on Disposal £9,600,000 Total £12,000,000 £12,000,000 RP 2 Remove Original Units Dr Profit/Loss on Disposal £3,600,000 Dr Grant £2,400,000 Cr Fixed Assets £6,000,000 Total £6,000,000 £6,000,000 Recognise New Units Dr Fixed Assets £12,000,000 Cr Cash £2,000,000 Cr Grant £3,200,000 Cr Profit/Loss on Disposal £6,800,000 Total £12,000,000 £12,000,000

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50. An alternative view is one in legal form the grant attached to the assets that are swapped has not come from a government source and as such should not be accounted for under SSAP 4 or Section 24 but rather FRS 12 and Section 21 of FRS 102 concerning the recognition of provisions and contingent liabilities. Under this view, a transfer of economic benefits is not probable as at the date of the swap and so recognition would not be appropriate.

Consultation Questions

11 Do you agree that the fair value of the purchase price when considering stock swaps should be the EUV-SH of the properties that are acquired? If not, please give your reasons why and alternative accounting treatment?

12 Do you agree that the government grant linked to the assets swapped between social landlords should be recognised as an obligation by the receiving social landlord If not, please give your reasons why and alternative accounting treatment. For example, do you agree with the alternative view expressed in paragraph 50?

13 Do you have a view on the wider implications of the treatment proposed by the SORP Working Party in paragraph 49, for example on the treatment of grant in consortium and/or inter-company transactions?

AGREEMENTS TO IMPROVE EXISTING PROPERTIES

51. A number of social landlords have entered into agreements to improve existing properties, primarily with local authorities, and in doing have recognised the net effect of these agreements in their financial statements.

52. FRS 102 does not specifically consider this type of contractual relationship

however it does consider core principles of revenue recognition and considering the underlying substance of the transactions. FRS 102 is clear that an entity cannot offset assets and liabilities, or income and expenditure, unless specifically required to by FRS 102, for example some financial instruments and tax assets and liabilities.

53. The SORP Working Party considers that the requirements in FRS 102 are clear

and that social landlords should recognise agreements to improve existing properties gross, that is both the prepayment by the social landlord and the payment in advance by the local authority.

54. The SORP Working Party proposes that the SORP should be amended to

reflect the requirements of FRS 102 to reflect that agreements to improve existing properties should be recognised on a gross basis.

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Consultation Questions

14 Are you of the view that guidance over the treatment of agreements to improve existing properties should be amended in the SORP to comply with FRS 102 and ensure that agreements to improve existing properties are recognised on a gross basis?

15 If yes, do you agree with the proposed amendments in relation to agreements to improve existing properties? If not, why not and what alternatives do you support (with reasons)?

FINANCIAL INSTRUMENTS

55. Social landlords will need to categorise their financial instruments between basic and other. Basic financial instruments are to be accounted for in accordance with Section 11 and other financial instruments are to be accounted for in accordance with section 12.

56. The FRC intends to consult on future changes to the accounted of financial instruments following the adoption IFRS 9 ‘Financial Instruments’. The Working Party will respond to these changes when they are published but is of the view that it is important for social landlords to understand the requirements of sections 11 and 12 of FRS 102 in the intervening period.

57. The SORP does not intend to repeat Section 11 or Section 12 however the SORP will provide a technical note showing worked examples of how to account for typical financial instruments in the social housing sector. Examples proposed will be similar to those shown below:

Fair value of intercompany loan Association A has two subsidiaries, B and C. B decides to lend to its fellow subsidiary, Association C, £5m interest free for a period of 5 years. Under current UK GAAP this ordinarily would not cause any problems as the asset and liability would be recorded respectively by B and C at £5m. However, under FRS 102 the asset and liability would be recorded at the net present value of future payments. Let us suppose that the market rate for interest on a loan of this kind is 5%. Over five years, this would result in a discount of just under 28% being applied to the one payment required, that of repaying the £5m loan advance, and an initial asset and liability being recognised of approximately £3.9m (£5m discounted by 28%).

As a consequence, B would record a loss of £1.1m at the point it signed the loan contract with its subsidiary and C would record a profit of the same amount.

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Fair value of bank loan Association D has a bullet repayment loan of £100m with 20 years remaining, paying an overall interest cost of three month LIBOR plus 50 basis points. It now needs further funds to continue with its development programme and agrees with the same bank to refinance to £200m (bullet repayment) for 30 years. Market rates are now much higher than LIBOR plus 50 basis points and consequently the new rate for the new instrument is LIBOR plus 100 basis points. The market rate for such instruments is assessed as being 120 basis points. On the assumption that the Association judged that the terms were significantly different from the original loan (by virtue of the period, rate and amounts changing substantially, Association D will derecognise the existing loan and record the new loan initially at the net present value of future payments discounted by the current market rate (i.e. LIBOR plus 120 basis points). Since the rate it is paying is lower than the market rate, this will result in the net present value being lower than the amounts advanced and therefore again will be recorded in the income and expenditure account. In this case, the gain is approximately £1m.

58. Social landlords will need to assess the applicability of Section 11 and Section 12 to their portfolio of financial instruments.

Consultation Questions

16 Do you agree that the SORP should not repeat Section 11 or Section 12 in relation to financial instruments, but rather clearly reference to FRS 102 and provide a technical note? If not please explain your reasons.

17 The technical note to the SORP is intended to provide worked examples of how to account for common financial instruments that social landlords have. What are the common financial instruments social landlords have which should be included in the technical note?

TRANSITIONAL ARRANGEMENTS

59. In accordance with FRS 102, social landlords will be required to restate their balance sheets (statement of financial position) for the beginning and end of the comparative period. FRS 102 will be effective for accounting periods beginning on or after 1 January 2015. Therefore for a social landlord with a 31 March year end the first year of mandatory adoption will be the year ending 31 March 2016. The social landlord will need to restate both its comparative statement of financial position as at 31 March 2015 and its opening statement of financial position as at 1 April 2014.

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60. The transition to FRS 102 and revised SORP will result in a number of changes to social landlords financial statements. These changes include the following:

Key changes to accounting policies.

Other changes to accounting policies.

Changes to terminology to be used.

Changes to the presentation and disclosure of financial statements.

61. The SORP Working Party has discussed a number of the significant changes to accounting policy in this ITC. It is proposed that other changes required as a result of the transition to FRS 102 and adoption of the revised SORP will be addressed in a ‘transitional’ section of the revised SORP.

Consultation Questions

18 Do you agree with the key changes to accounting policies considered in this ITC? If not, what other key changes do you believe should be considered separately by the SORP Working Party?

19 Do you agree that other changes to accounting policies, changes to terminology and changes to the presentation and disclosures are best addressed in a ‘transitional’ section of the revised SORP? If not, please give your reasons why and alternative suggestions.

62. There are a number of exemptions provided in FRS 102 when adopting FRS 102 for the first time. The exemptions are detailed in paragraph 35.10. The SORP Working Party does not propose to provide specific guidance on these exemptions.

Consultation Question

20 Are there any exemptions in paragraph 35.10 of FRS 102 that you believe should not be available to social landlords? If so, please give your reasons why and alternative treatment.

NARRATIVE REPORTING 63. The current SORP requires an Operating Financial Review (OFR) be prepared

for social landlords with more than 5,000 homes in management at the balance sheet date. FRS 102 does not stipulate any requirements for narrative reporting. The SORP Working Party is of the view that narrative reporting is an important element of social landlord’s annual report and financial statements to inform the users of the financial statements.

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Consultation Questions

21 Do you agree that there is value in narrative reporting as part of the financial statements beyond the requirements of statute, for example the Companies Act?

22 Do you agree that all social landlords with more than 5,000

homes in management should prepare an OFR? If not, please provide an alternative threshold or state the reasons why you believe an OFR should not be required.

64. The information currently required to be included in an OFR is that which is

required by under section 416 of the Companies Act 2006. However, the Industrial and Providence Societies Act 1965 does not require any narrative reporting. Consequently the current OFR disclosure requirements however may not be relevant for all social landlords.

65. It is proposed that the reporting requirements of an OFR be revised to allow social landlords to report with greater transparency regarding the performance of their association whilst ensuring consistency and comparability across the social housing sector.

Consultation Question

23 Do you agree with the current reporting requirements of an OFR, including the required headings that are to be included in an OFR? If not, provide those headings that you believe should be required.

ADOPTION DATE

66. FRS 102 allows early adoption following the publication of relevant SORPS. The SORP Working Party plans to publish the new SORP based on FRS 102 in March 2014 following a full exposure draft in Autumn 2013. This timescale allows the early adoption of the SORP for social landlords preparing financial statements for the year ended 31 March 2015.

Consultation Question

24 Given the timescales outlined in paragraph 66 above do you plan to early adopt the new SORP based on FRS 102 for the year ended 31 March 2015. If yes, please state your reasons.

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Appendix 1 Housing Properties

Housing properties – initial recognition

The intended use for each housing property (or class of housing properties) should be

determined to identify whether they should be treated as property, plant and equipment or

as an investment property. In determining the intended the use for the housing property

the following principle should be considered:

i) is the asset held to earn rentals or for capital appreciation or both rather

than for:

a) use in the production or supply of goods or services of for

administrative purposes; or

b) sale in the ordinary course of business; and

ii) is the asset held for social benefit?

Properties (or class of properties) that are held to earn rentals or capital appreciation, or

both, should be treated as investment properties and accounted for in accordance with

Section 16 of FRS 102. Such properties would normally include properties held for

market rent, shared equity properties, commercial properties and student accommodation.

Land banks which have no agreed development plans should also be treated as investment

properties.

Properties that are used in the production or supply of goods or services or for

administrative purposes, or are held for social benefit, should be treated as property, plant

and equipment and accounted for in accordance with Section 17 of FRS 102. Such

properties would normally include general needs, shared ownership, affordable rent,

intermediate rent, rent to buy, almshouses, key worker accommodation and care homes.

However, it is important that each social landlord considers the use of its housing

properties in the context of its own objectives. Similar or the same class of housing

properties may be held for different purposes by different social landlords.

Property, plant and equipment – cost and valuation

In line with Section 17of FRS 102 housing properties should be analysed by class of

properties appropriate to the social landlord (for example general needs, supported

housing, shared ownership and other properties) in the notes to the accounts. Completed

schemes and properties under construction should, if material, be separately disclosed by

class of property.

Properties developed for outright sale and properties developed for sale to other bodies

should be treated as current assets. Those properties included as current assets should be

shown at the lower of cost and net realisable value, calculated on a scheme by scheme

basis.

Social landlords should include their housing properties in the Statement of Financial

Position at either:

(a) historical cost less depreciation; or

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(b) valuation, being the current value at the balance sheet date.

If properties are included at historical cost, the depreciated cost should be shown on the

face of the balance sheet.

Where social landlords include their properties at valuation, the appropriate basis of

valuation should normally be the existing use value for social housing (EUV-SH), as

defined in X, with the addition of directly attributable acquisition costs where material.

For social landlords the Royal Institution of Chartered Surveyors has defined EUV-SH in

its Valuation Standards.

Paragraph x above indicates that the SORP is neutral regarding showing housing

properties at historical cost or valuation. Where housing properties are included at

valuation they are valued at the lower of replacement cost and recoverable amount. In the

social housing context, replacement cost might be defined as the cost of an identical

development today. Recoverable amount is defined as the higher of net realisable value

and value in use. The value in use is defined as the discounted present value of the cash

flows expected from continuing use and ultimate sale by the present owner.

The net realisable value is equivalent to the market value (MV) taking into account the

legal restrictions on disposal of tenanted property and the requirements to recycle or repay

grant. Any disposal of housing properties owned by a registered social housing provider

requires the consent of the appropriate regulatory body. Under normal circumstances

consent would only be granted to dispose of tenanted properties if the disposal was to

another social landlord. The value of tenanted properties is therefore normally limited to

EUV-SH. Any which are intended to be sold should be subject to an impairment test and

held in property, plant and equipment until sold. Such properties should be valued on the

basis of MV with expected directly attributable selling costs deducted where material.

Paragraph x above recommends the use of EUV-SH valuations as this basis reflects the

discounted net income stream from the housing properties in their existing use by the

current social landlord and thus has a strong relationship to the capacity of the social

landlord to continue to service its debts on a cash flow basis. Valuations are subject to a

degree of sensitivity as small changes to the key assumptions made in the valuation model

can have significant effects on the valuation figure.

If housing properties of a particular class, such as general needs or shared ownership, are

included at valuation, the policy should apply to all of the properties included in that

class. Unless there is an indication of impairment, valuations need not be calculated on

individual properties to identify possible impairments contained within the valuation as a

whole. There are unlikely to be material gains and losses on individual properties within a

class of asset valuation, but where this is the case, material gains and losses on individual

properties should not be aggregated.

The valuation methodology is normally based on projections of future net income

streams. Although the rental income can be broken down to an individual property level,

assumptions for management and maintenance costs are made for the portfolio of

properties within the class.

Where properties are included in the balance sheet at a valuation, a full valuation exercise

should be undertaken at least once every five years and an interim valuation in year 3.

Interim valuations in years 1, 2 and 4 should be carried out where it is likely that there has

been a material change in value. Alternatively, a rolling programme may be used whereby

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each year full valuations are performed on a proportion of the stock and interim reviews

are performed on the remainder where it is likely that there has been a material change in

value. Every property which is included at valuation should be subject to a full valuation

at least once during the five-year period. A full valuation is conducted by either a

qualified external valuer, or a qualified internal valuer, provided that the latter valuation

has been subject to review by a qualified external valuer. An interim valuation should be

performed by either an external valuer or internally with the advice of a qualified valuer

who may be a member of staff. Internal valuations require sufficient evidence on the state

of the market for properties of that type and location.

Where properties are included at valuation the following disclosures should be made for

each class of properties included at valuation as required by FRS 102:

(a) the effective date of the revaluation;

(b) whether an independent valuer was involved;

(c) the methods and significant assumptions applied in estimating the items’ fair values;

and

(d) for each revalued class of property, plant and equipment, the carrying amount that

would have been recognised had the assets been carried under the cost model.

Where housing properties are revalued and the valuation exceeds the carrying value (net

of depreciation), the difference should be credited to the revaluation reserve and reported

in Statement of Changes in Equity, except where it reverses a previous impairment that

was recognised in the Statement of Comprehensive Income.

When housing properties carried at valuation are disposed of, any amounts in the

revaluation reserve relating to those properties should be transferred to retained earnings.