The business premises is a 3 year lease and there is a contract states that they can buy the premises any time in the next 3 years for a set amount that cannot go up or down.
They have spent a lot of money on 'doing up' the premises (around 25k)
I am having trouble deciding what to call this expenditure.
I think it is capital expenditure and the premises is an asset - but as the building is leased is this correct?
Thanks in advance for any help - I've tried researching this on the hmrc website but cannot find anything remotely helpful
The HMRC site is the wrong place to look. This is an accounting problem, not (immediately) a tax one so you should be looking to the accounting standards for guidance.
First of all is it an asset?
Always remember that the basic definition of an asset is a resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity.
Its leased. There may be an option to buy but thats all it is, an option. It is not owned by your client.
Next, about that lease. Does it fail substance over form testing in that its more like a finance lease where the risk and reward of ownership lies with your client rather than the leasing company?
Thats a very important consideration. The option to do something in the future (which may never actually come to pass) is not a statement of the conditions as they exist now.
I do not believe that the premises are an asset of your client but lets just for a moment assume that substance over form shows that I'm wrong in that.
There are only ever three reasons where subsequent expenditure on an asset may be capitalised.
Remember the mnemonic ERR. (just think ERR on the side of caution).
E - Enhances economic benefits (worth more than it was previously (the carrying amount, not just what you would pay for it in its previous condition))
R - Restores previously consumed economic benefits (Such as replacing the lining of a kiln)
R - Replace a seperately depreciated component of the asset. (i.e. an aircraft engine replaced more often than the fusilage)
Simply spending money on the premises does not make them worth more than their carrying value (just look at adding a conservatory to a house) and it does not meet either of the other criteria so to my mind the expenditure should be expensed rather than capitalised.
Of course, there's probably an awful lot more to the scenario and my view may be different if I had all of the facts. But for now I would say that its revenue rather than capital expenditure.
So, in short. I'm not seeing it as an asset and I'm not seeing the expenditure as being capital in nature. But, I would be happy for someone to debate the point (This is right up Bill (Wella's) street).
Talk later,
Shaun.
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Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
That makes sense - it just seems a lot of money to spend to not capitalise.
Basically it is almost all money spent on building materials - so I'm unsure what expense to call this. It can't possibly be repairs and renewals so what would you suggest I should call this expense? Should I set up an expense account called 'start up costs' although that sounds a bit too general.
Thanks for your help again - I have so many new clients and am doing quite a bit that I have never done before...it's a bit scary!
Wearing my management accountants hat, I'd want to see the costs separate from repairs and renewals, so I knew what was the one-off startup cost, and what was ongoing maintenance. But if Shaun is right I'd have thought it should go in the same area of the accounts. I think I'd set up a new account called something like "Initial Repairs and Improvements", and give it an account code next to "Repairs and Renewals". Assuming you're not doing the year end accounts and tax, it's then all in one place for the accountant to deal with, and move around if necessary.
On the other hand, I might treat it as a prepayment to be spread over the expected life of the work, if it's significant, (rather like depreciation) in the management accounts, if the client wants such things, to give a more accurate comparison of costs, but not in the financial accounts.
I think that we need a bit more information as to what exactly the expenditure was.
The client has leased premises that they have spent £25k on but what exactly was that £25k spent on?
What physically do they have to show for their efforts? Are these cosmetic changes in a similar manner to a display in a shop window? Is the expenditure on changes that are permanent or can they be removed... Indeed is it in the lease that they must be removed on vacation which opens up a whole new can of worms over provisions. Its possible that there is some allowable capital expenditure in there but we need much more detail.
Conversely, depending on what exactly the expenditure is the fact that the client has spent their money enhancing an asset that does not belong to them may mean that its regarded as capital in nature but have no capital allowances available to it in which case it would go through the companies books as a balance sheet item (something like improvements to landlords assets) and be amortised over the remainder of the lease but for tax purposes would be treated like depreciation and added back.
As I say, please post more infoto see if there are elements that can either be treated as revenue expenditure or treated as an enhancement, restoration or replacement for capitalisation purposes.
Also, let us know whether the clients were using the property in the same trade before they made the improvements or whether the improvements were made as soon as they moved in.
Kind regards,
Shaun.
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Shaun
Responses are not meant as a substitute for professional advice. Answers are intended as outline only the advice of a qualified professional with access to all relevant information should be sought before acting on any response given.
