Dilapidations

It is often the case that a property lease includes the requirement for the property to be returned to the landlord in the same state as when the lease was taken out. Any changes to the original condition of the property will therefore create a liability to reinstate the property back to that original condition (a present obligation as a result of past event). As the economic outflow is probable and assuming a reliable estimate for the reinstatement works can be obtained, a dilapidations provision (NOT an accrual) should be recognised.

It is NOT APPROPRIATE to recognise the dilapidations provision on a straight line basis (i.e. build up a provision by charging £7,500 to the profit and loss account every year for 10 years), as the obligating event giving rise to the liability does not occur on a straight line basis; the obligating event is the point of which the alterations were made (i.e. at the start of the lease).

Confusion can also be caused by “repairing” requirements set out in leases. Consider the following scenarios:

• The lease requires all existing carpets to be replaced at the end of the lease. Even though the damage (or wear and tear) of the carpets may well occur over the period of the lease, the actual obligating event is the signing of the lease – the tenant has agreed to replace the carpets, and assuming a reliable estimate can be obtained, the cost of this work will be recognised “up front” as an asset, following the example above.
• The lease requires the carpets be in the same condition at the end of the lease as they were when taking out the lease (there is no specific requirement for full replacement). As damage occurs to the carpets (e.g. there is a spill that can’t be cleaned or there is a tear), the cost of replacing this should be accounted for at the point the damage occurred. If it became clear after year 6 that the carpet would need to be replaced at the end of the lease due to the damage, it would be appropriate at this point to recognise a provision for the cost of replacing the carpet, discounted over the remaining term of the lease.

What happens if the landlord decides to keep the changes (i.e. there is no payment)?

• If it is the case that the landlord simply takes the property back at the end of the lease term and no reinstatement works are required (maybe because the landlord likes the works that were carried out), the provision would simply be written off back to profit or loss.
• If the lease term is extended and the landlord agrees to waive the requirement for reinstatement works to be undertaken at the end of the re-negotiated lease period, the release of the dilapidations provision should be treated as a lease incentive.