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There can be few words in a lease that cause more confusion and angst than the term “audit”. Lessees and directors of Residents’ Management Companies usually approach this matter with the following question, “I know the lease says that we need an audit of our service charge accounts but we don’t really need an audit, do we?”

What does an “audit” of service charge accounts mean?

In the run up to the release in 2011 of best practice guidance for service charge accounts, TECH03/11, the Institute of Chartered Accountants in England and Wales (ICAEW) sought a legal opinion on whether the term “audit”, when used in the context of a property lease, meant an audit in accordance with International Standards of Auditing (ISA) or whether the term meant something different.

The work effort required to carry out an audit in accordance with the ISAs is significant and the procedures and guidance contained in the ISAs is primarily aimed to cover the audit of relatively large organisations. For example, the criteria for a company requiring a statutory audit at the present time includes any two of the following (generally for 2 consecutive years),

1. Turnover of more than £10,200,000
2. More than 50 employees
3. Net assets on the Balance Sheet of more than £5,100,000.

How can these criteria possibly apply to service charge accounts? However, legal counsel’s opinion was along the lines of, “an audit is an audit is an audit”. If the lease states that an audit of the service charge accounts is required then that means that an audit should be carried out in accordance with International Auditing Standards.

TECH03/11 gets around the complications by requiring service charge audits to be carried out in accordance with International Standard on Auditing 800 (ISA800) – Special considerations – Audits of Financial Statements prepared in accordance with Special Purpose Frameworks.

ISA800 only covers the special considerations arising from the application of ISAs to special purpose accounts such as service charge accounts. This avoids some of the significant requirements placed on auditors when carrying out their audit work.

Can we get around having an audit even if the lease states that an audit is required?

TECH03/11 gives two circumstances when it is possible to avoid an audit even when the lease states that an audit is required.

1. If the lease is dated before 1980 then an audit is not required. The reason for this is that the lease predates the ISAs.
2. If the costs to carry out an audit are “disproportionate” to the benefits obtained. What is disproportionate is a matter of judgement although TECH03/11 does give the example of a small property where the lessees are all members of the RMC for that property.

What if we all agree that we don’t want an audit?

The circumstances when the “disproportionate” argument can be justified would seem to be limited. For example, a relatively small set of service charge accounts with a single schedule of expenditure and few complications.

Another typical approach is for RMC directors to claim that they have agreed and minuted in their board minutes that they wish to dispense with an audit. Even if all the lessees unanimously agree to this course of action it is still not a watertight option and depending on the number of lessees it can be difficult to get all lessees to agree in writing to dispense with an audit.

The only sure way for RMC directors to avoid criticism at some stage in the future is to follow the lease and so the only way around the issue is to vary the terms of the lease and to change the term “audit the accounts” to “certify the accounts” or something similar. This course of action is not always popular as varying a lease can result in a significant cost to lessees and it may be many years before the savings in audit fees outweigh the legal costs of varying the lease.

Conclusion

An audit report on service charge accounts should not be dismissed without due consideration. We have come across many circumstances where the additional assurance provided by an audit warrants the additional cost of an audit being carried out.

Whatever report is attached to service charge accounts it follows that the quality of the work will be enhanced if the reporting accountants are experienced and specialise in service charge accounts.

 

For advice, information or simply a quick chat about your service charge needs, please get in touch using our contact form

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