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Annual certification of service charge costs

16 Jan 2018

How should service charge (SC) costs be certified to provide assurance and transparency to both owners and occupiers alike? 

Dr Andrew Holt, Professor of Accounting at MSU Denver (formerly of Kingston University) has, in conjunction with Property Solutions, undertaken research that investigates the service charge provisions within the commercial leases for 90 multi-let office premises.

This important research has been undertaken to obtain factual information about the level of detail and clarity within typical lease provisions, in support of proposals to strengthen the impact of the RICS Code by upgrading its status to a professional statement for RICS members.

An initial discussion paper about the findings and implications from this research was published by PSL in August 2017, and the final paper from this research piece of academic research will be released in early 2018. Over the next few months we will be releasing select findings from the research to highlight the current state of commercial lease provisions for service charges.

This present article addresses the following research question:  

Do commercial office leases require annual SC costs to be “certified”, and if so, what certification process must be followed?

 The 3rd edition of the RICS Code states, in the Core Principle number 7, that:

Certified accounts of expenditure are to represent a true and accurate record of expenditure incurred. Those certifying service charge accounts should recognize that they have a duty of care to both owners and occupiers to act with professional care, diligence, integrity and objectivity.

85 out of the 90 leases (94.4%) analysed required some form of certification for the annual service charge costs. However, even where certification is required by the lease, certification provisions vary widely in terms of their wording and specificity.  Generalised statements such as the one below leaves the occupier uncertain as to the time frame within which the certificate will be issued, as well as who will certify these costs.

As soon as practicable after an Account Date the Landlord shall submit to the tenant an Account Statement for the account period ending on that account date.

As the requirements set out in a lease are contractually binding on both parties, it is important that leases include transparent and clear procedures as to how the service charges are to be accounted for and reported upon at year end. The RICS Code sets out best practice but states categorically that the lease has the final word:

Managers should ensure that annual statements of service charge expenditure are issued strictly in accordance with the procedures and requirements as set down under the terms of the lease.

Therefore, the wordings of these provisions in the leases should be explicit, otherwise, it can jeopardize the owner’s ability to recover the costs as well as reduce the tenant’s satisfaction with the whole process.

The 85 leases that have some provisions are further analysed in light of three questions which are important to service charge certification provision.

What is the timeframe to produce these certificates?

28 of the 85 leases provided a specific time frame within which certificates should be produced, and this time period ranged from 28 days to 9 months. The term “as soon as practicable after the end of each service charge period” was widely used, and although this term establishes an obligation to actually issue a certificate, it does not provide a timeframe for its issuance.

Core principle number 24 highlights the time within which the service charge costs should be issued.

Detailed statements of actual expenditure, together with accounting policies and explanatory text, will be issued within four months of the service charge year-end.

Only 12 leases required certificates to be issued within four months after the service charge year end. A good illustrative example statemen from these 12 leases is as follows:

There shall be served upon the Tenant by the Landlord or the Landlord’s Surveyor a certificate (“the Certificate”) (within such three-month period) signed by each accountant certifying the accuracy of the contents thereof.

Who should certify the costs?

45 of the 90 leases specified the credentials of the individual who should certify the certificate. Either the landlord’s surveyor or an accountant were responsible for validating the service charge accounts prepared by the landlord. It is recommended best practice as per the RICS that the annual statements should be reviewed by an independent accountant.

A ‘best practice’ statement from one of the leases analysed is given below, which clearly states who should sign off the certificate, which enhances the credibility of the certificate.

“..the Landlord as soon as convenient after each computing date prepare an account and upon the account being certified by the Accountant the same shall be conclusive evidence for the purposes hereof of all matters of fact referred to in the account save for manifest error.”

The property managers producing these certificates have control over who signs/authorises these accounting documents, and must ensure that this is an appropriately senior individual. Appropriate certification is crucial, as certification provides occupiers with comfort and certainty that the accounts are “a true and accurate record of expenditure”, and as a result, it is vital that the costs are certified by an appropriately knowledgeable and qualified individual.

Are there any specific “audit” requirements?

When the lease explicitly requires an audit to be carried out, this should be undertaken. It adds to the credibility of the certificate; however, it may not offer the best value for money. Therefore, this remains a question as to whether the leases should include an audit requirement where an independent accountants report would be adequate.

Only 6 leases required that service charge certificates should be audited.

The lease analysis highlights the need for greater uniformity and specificity within the provisions for the certification of certificates, especially in terms of the timeframe allowed for producing the annual reconciliation certificate. Furthermore, while the RICS Code does not yet stipulate that a balance sheet be included as part of the certificate, several office landlords now provide one in order to provide more transparent accounting information.

In summary, although an accountant’s independent validation of the annual service charge costs is welcomed, it does not necessarily ensure that the included costs are charged in compliance with the terms of the lease. As a result, further independent scrutiny of costs may be needed to assure the occupier that all service charge costs are actually fair and recoverable.