An Overview by David Hewett FCA FIRPM, Chief Executive of the Association of Residential Managing Agents (ARMA)

Summary

Many resident management companies (RMCos) account for service charge monies collected from lessees as part of their annual accounts for Companies House.

This practice is not correct. Service charge monies are held in trust by the Company and should not be accounted for as if they were company assets to be included in the Company's statement of accounts for Companies House purposes.

In addition the Government will soon be introducing a requirement for all RMCos to produce annual statements of account of service charges. The statement will have to contain certain prescribed contents and will not satisfy the requirements for company accounts as set out in Company Law.

These statements of service charge accounts will also have to be checked and a report made upon them by an independent accountant. This accountant's report will be in addition to any report by an accountant or auditor on the Company's accounts.

It is possible for most RMCos to produce dormant or near dormant accounts (after excluding service charge income and expenditure) which do not require audit or other formal, external review, thus saving costs when the Government’s requirement for a separate service charge statement of account is introduced.

ARMA suggests its members and others may wish to await the final details of the new requirements before changing the method of annual accounting for RMCos to avoid making two changes to accounting formats in as many years.

CURRENT LEGAL REQUIREMENTS FOR RMCos AND SERVICE CHARGE MONIES

Many RMCos have always assumed that service charge monies collected by them from lessees is the RMCo's money and should be accounted for within the Companies Act form of accounts.

The current legislation relating to service charge monies paid by lessees is primarily S.42 of the Landlord & Tenant Act 1987 (the holding of funds) and S.21 of the Landlord & Tenant Act 1985 as amended by (S.41 and Schedule 2) the Landlord & Tenant Act 1987 (the provision of a summary of relevant costs of service charge expenditure). S.42 requires that any service charge monies collected from lessees must be held 'on trust'; the law has created statutory trusts if the relevant leases do not create express ones.

With regard to the provision of regular statements of account for service charges, S.21 gives any lessee or recognised residents' associations the right to request a summary of relevant costs incurred during the last accounting year. Where the summary is for a block of more than four dwellings this summary must be certified by an independent accountant, who is a registered auditor, as a fair summary.

It should be noted that there is at present no statutory requirement for landlords or RMCos to automatically provide annual statements of account of service charges or for these to be certified or audited by an independent accountant (but see below); however, it is regarded as best practice and many leases require a statement in some form and either certification or audit. If the leases for your block do require a statement of service charge accounts and you only produce a set of the RMCo's accounts you may well find there are problems. There have been several Tribunal cases where RMCos have been unable to recover service charges because of failure to produce accounts of service charge expenditure according to the requirements of the leases.

ACCOUNTING FOR RMCos – CURRENT BEST PRACTICE

It has already been established that service charge monies are trust funds because that is a statutory requirement under S42; these monies are therefore held by the company for the benefit of the lessees. If they are trust funds they are not company funds.

It is ARMA's clear view that under present law it is wrong to assume that service charge monies are company's monies and to account for them as such in the annual financial statements prepared in accordance with the Companies Act 1985.

Given that service charges are trust funds, they must be ring-fenced. ARMA therefore requires its members to arrange for service charge monies to be held in a clearly designated trust or client account that is separate from any other account in the member's name. Even if the person entitled to collect service charges is a RMCo (whether the freeholder or not) or Right to Manage Company these funds must not at any time be held in the company's own bank account. Correct practice is to maintain a
separate account with ‘trust or client ‘ in the name operated by the company or by the agent on its behalf; ensuring the bank recognises the status.

THE FUTURE

The Commonhold and Leasehold Reform Act (CLRA) 2002 contains two sections that specifically relate to the holding of and accounting for lessees' monies, namely:-

• S.152 Regular statements of account.

• S.156 Service charge contributions to be held in a separate designated account.

There is still no clear indication as to when the sections will be amended and commenced. At best guess commencement could be 1.4.10, hopefully with a sensible lead-in period.

ACCOUNTING FOR RMCos - IMPLICATIONS FOR THE FUTURE

Whatever the arguments about separation of company and service charge accounting under current law, when the new legislation is introduced it will be made even clearer that what is required is separation. This is what is likely to be the case:

• A separate designated bank account solely for service charges will required unless strict conditions can be met. Any monies belonging to the RMCo e.g. ground rents should not be left in that account.

• An annual statement of account for service charges will have to be issued to all leaseholders of the scheme within 6 months of the end of the financial year. The service charges format will not meet the Companies Act requirements for the RMCo's accounts, and the Companies Act format does not meet the requirements of service charges legislation.

• This annual statement will have to be accompanied by a report by an independent accountant with a prescribed content. This report is not an audit and neither is it a review of the RMCo's activities. (There are proposed exemptions for small schemes with less than £5000 per annum expenditure on services or 4 or less units.)

• The leaseholders of the RMCo will have to pay for the independent accountant's report on service charges. They will also have to produce accounts for Companies House with or without an accountant's report. It makes sense for all this to be done at the same time albeit within 6 months rather than the 9 months currently allowed by Companies House.

• There will be savings that could accrue to an RMCo from the changes. In the case of RMCos with no income e.g. ground rents, rents etc, if the service charges are taken out of the RMCo's accounts then it may be possible to produce simplified dormant accounts.

• Where an RMCo has some other income in addition to service charges, then a decision on whether an audit of the company is necessary will have to be considered. The current exemptions from audit cover all RMCos if they chose to be exempt.

• When service charge and company accounts are separated then you will need to consider how certain company costs may be recoverable. Careful reading of lease clauses on insurance may allow the inclusion of D & O insurance. Clauses allowing all costs relating to the good management of a scheme may allow Companies House filing fees to be recovered.

A R M A fully supports these changes. They will lead to greater transparency of accounting for lessees, introduce greater protection for service charge monies and clarify at last the difference between company and service charge monies.

Formed in 1991, ARMA is the only body in England and Wales to focus exclusively on matters relating to the block or estate management of long leasehold residential property. With over 200 corporate members managing in excess of 800,000 units in more than 32,000 blocks of flats or estates (at least 60% of which are lessee-controlled properties), the Association’s founding principal aims are to represent its members and the interests of lessees, resident management companies and investor freeholders.

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