In recent weeks a number of members have raised a possible accounting issue over the treatment of rental income and the impact on distributions.
Authorised funds and some other funds in accordance with their fund documents are required to distribute all their income. Widespread rent holidays and rent deferrals will have a much greater impact on available cash than on accounting income where the effect will be spread. Funds may have a requirement to distribute but have insufficient cash.
We held a virtual meeting of accountants, fund managers, auditors, lawyers and others on 23rd June. After much discussion, we reached the following consensus.
The regulatory requirement for an authorised fund under COLL is that all net income must be distributed on an annual basis. Although judgement can be exercised on the amount distributed in interim distributions during the year, any undistributed net income for the year will need to be distributed in the final distribution. The net income for the year to be reflected in the annual statutory accounts will therefore be key. The IMA SORP defines the net income for the year and this forms the starting point in COLL for calculating the amount to be distributed. For funds that do not account under the SORP, the provisions of the fund documents will determine how much flexibility there is determining the amount to be distributed. Although we discussed the possibility of FCA and HMRC waivers in respect of the distribution requirement, we concluded that this is unlikely to be a realistic route to follow.
The recognition of rental income over the life of the lease is also not an area in which there is much flexibility. As was pointed out on the call, if leases are being extended as a result of negotiation of deferrals, rent holidays etc the income may be spread over a longer period. However, at present the terms may not yet have been agreed / documented so income recognition is likely to be based on the current lease terms.
In view of this, there are likely to be many cases where rental income is being recognised currently although no cash is received or indeed receivable currently if a deferral has been agreed. As the rental is recognised as income, there will be a corresponding debtor.
It is in assessing the recoverability of the debtor that judgement can be exercised. The IMA SORP requires a provision to be made where the receipt of rent is doubtful. Provisions for bad debts will need to be agreed with the auditors. In most cases, this is likely to require an analysis debtor by debtor as previous collection history is unlikely to be a reliable guide. Where there are pools of tenants with similar characteristics, it may be possible to determine bad debt provisions based on pools. The provision for bad debts will reduce the net income and the distribution. Whilst it is likely to be straight forward to establish the need to make a provision, determining the level of provision will be a difficult judgement. An inadequate provision will result in an excess distribution. Equally it would not be “treating customers fairly” to make an excessively large provision to depress NAV and deter redemptions. Obviously this will be less of an issue when funds are suspended but the expectation is that valuation uncertainty and fund suspensions will be lifted before rents return to normal.
If you wish to comment on the following you can do so through the AREF Member online forum where this discussion has been posted.