Why commercial service charge accounting is under the spotlight

Under the spotlight
Under the spotlight

The UK total commercial service charge market costs UK plc an estimated £5.9 billion per annum. The management and administration of commercial service charges is not subject to any overriding statutory legislation (unlike the residential market). Guidance has been published such as The Royal Institute of Chartered Surveyors (RICS) Code of Practice on Service Charges. And last year recommendations, initiated by the British Property Federation, were issued in a Technical Release by the ICAEW (Institute of Chartered Accountants for England and Wales) this became mandatory in April this year for its members.

Our research into the financial implications of the management of commercial service charges has established that limitations in accounting sign off within service charge financial statements restricts transparency and may ultimately hinder the delivery of “value for money”.

We advise both landlords and occupiers on these issues ad we recently published a discussion paper highlighting the current limitations of service charge financial reporting. The paper assesses the industry and determines whether current guidelines for surveyors and accountants are adequate to give tenants a full and transparent view of their service charges and whether they are being appropriately levied within the terms of the lease and service contracts.
The discussion paper reviewed financial reporting requirements for the commercial service charge market. We considered the commercial viability of developing a “banding” system for service charge liabilities. This could mean buildings with high service charge costs would require a fuller, more detailed financial sign-off, audit or certification process.

Discussion Paper findings:
The total number of office buildings in England and Wales is around 356,000 (Valuation Office Agency), these account for c. 1.1 bn. sq. ft. of commercial office space.
Core data analysed in the paper accounted for buildings greater than 100,000 sq. ft. As indicated by the most recent Estates Gazette data, the total number of multi-let office buildings within this bracket in England and Wales is c. 600.

Having identified that 600 buildings account for c. 12% of total office space and c. 18% of the total service charge bill if managing agents and landlords engaged in enhanced audit sign-offs by accountants in conjunction with other property professionals for buildings of this size, they would be able to significantly mitigate risks and disputed service charge costs within the industry.

In previous research commissioned with Dr Andrew Holt of Kingston University the prevalence of businesses paying unnecessary costs due to improper governance of service charges was investigated.

Some of the critical points he observed were:
• inconsistencies in the level of service charge review and cost certification
• misleading use of the word “audit” within reconciliation statements prepared by accountants
• accountants not reporting on issues to allow tenants to gain an assurance of the appropriateness of costs, correct apportionment, and recoverability of service charge costs
• lack of proper management of incoming and outgoing cash flows by the landlord/managing parties
Without legislation occupiers could find themselves challenged to ensure their service charges are fully transparent, effectively managed, charged and signed off appropriately. We have made recommendations to the industry after undertaking assessment of the administrative cost of implementation of more robust reporting systems against the risks of non-compliance.

Our findings showed that if buildings of more than 100,000 sq. ft. of office space were subject to tighter reporting then tenants would be in a better position to justify the administrative costs associated with undertaking a stricter review of properties.

We recommend the following elements should be reviewed in the annual or bi-annual service charge evaluation:
• lease provisions
• material transactions against invoices
• invoices against contracts
• invoices against leases
• opening and closing accruals
• sinking funds and utilities deposits
• preparation of a balance sheet

To read more the following documents can be downloaded:

Discussion Paper
ICAEW Technical Release
RICS Code of Practice Service Charges

David Barrass - Managing Director Property Solutions

David graduated with an honours degree in Chemical Engineering at Newcastle University. Following a period as a Process Engineer in textiles production with Courtaulds, David joined Esso Petroleum as an Energy Conservation Engineer at their Fawley Refinery near Southampton. He then took up a variety of consulting and management positions within the Company including Head of UK Petrol Pricing, investment appraisal and Secretary to the Board of both the Upstream and Downstream activities. David left Esso in 1986 and then set up a serviced office business which was subsequently developed to 20 locations throughout the UK. David is co-founder and Director of Property Solutions.