Dilapidation provisions are the liabilities to put back a property at the end of the lease into the same condition it was when you commenced the lease.
Therefore, any change in the condition of a property during the lease my creates a liability. This is one area that companies often fail to account for correctly.
If it is probable that you will need to pay dilapidation and you can reliably estimate the cost – you should provide.
If it is probable that you will need to pay dilapidation but you cannot reliably estimate the cost – you should not provide, but you should disclose.
If it is possible that you would need to pay dilapidation and the likelihood of this is not remote - you should not provide, but you should disclose.
If it is possible that you would need to pay dilapidation and the likelihood of this is remote - you should do nothing.
The most common failings are:
Getting the above wrong; or
Calculating the dilapidation on a straight line basis; or
Not considering a break clause.
Calculating dilapidation provision:
The easiest way of explaining the calculation needed is by providing an example:
A lease is taken on in 2020 on a 10 year lease. The property requires £125k to install some fixtures and fittings. The probability is that there will be £75k dilapidation liability to pay in 10 years’ time.
The double entry initially is: DR Fixed Assets £125,000CR Creditors £125,000 DR Fixed Asset £46,043CR Provision £46,043 Being the net present value of £75k assuming a rate of interest of 5%.
Future Value | Annual Interest Rate | Number of Years | Present Value |
75000 | 0.05 | 10 | =+C2/(1+C3)^C4 |
Future Value | Annual Interest Rate | Number of Years | Present Value |
£75000 | 5% | 10 | £46,043 |
After one year the double entry is: DR Depreciation expense £17,104CR Accumulated depreciation £17,104DR Interest (P&L) £2,302CR Provision £2,302
Being the net present value of the effective interest (£75,000-£46,044=£28,957)
WACC | Total Interest | Years | Discount Factor | Present Value |
0.05 | 28957 | 1 | =+(1+$C1)^C3 | =+C4/M4*C2 |
2 | =+ (1+$C1)^D3 | =+$C$2/D4 | ||
3 | =+(1+$C1)^E3 | =+$C$2/E4 | ||
4 | =+(1+$C1)^F3 | =+$C$2/F4 | ||
5 | =+(1+$C1)^G3 | =+$C$2/G4 | ||
6 | =+(1+$C1)^H3 | =+$C$2/H4 | ||
7 | =+(1+$C1)^I3 | =+$C$2/I4 | ||
8 | =+(1+$C1)^J3 | =+$C$2/J4 | ||
9 | =+(1+$C1)^K3 | =+$C$2/K4 | ||
10 | =+(1+$C1)^L3 | =+$C$2/L4 |
Total Discount Factor | Total Present Value | |||
=SUM(C4:L4) | =SUM(C5:L5) |
WACC | Total Interest | Years | Discount Factor | Present Value |
0.05 | 28957 | 1 | 1.05 | £2,302 |
2 | 1.10 | £26,265 | ||
3 | 1.16 | £25,014 | ||
4 | 1.22 | £23,823 | ||
5 | 1.28 | £22,689 | ||
6 | 1.34 | £21,608 | ||
7 | 1.41 | £20,579 | ||
8 | 1.48 | £19,599 | ||
9 | 1.55 | £18,666 | ||
10 | 1.63 | £17,777 |
Total Discount Factor | Total Present Value | |||
13.21 | £198,322 |
Issues that require further consideration:
Lease that has a break clause
Agreement to pay the landlord a fixed sum
Agreement to waive the dilapidations costs since the tenant extends the lease
Auditors would require the necessary evidence and workings to be able to become comfortable that the treatment has been performed correctly.