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

So a question we often get is - CAN WE GET AROUND HAVING AN AUDIT EVEN IF THE LEASE STATES THAT AN AUDIT IS REQUIRED?

The starting point under ICAEW TECH 03/11 is that, where the terms of a lease require or are construed as requiring an audit, an audit should normally be undertaken.

However, there are circumstances where the wording of the lease, or the proportionality of the requirement, may need to be considered more carefully.

Two areas that commonly arise are:

1. Older leases, particularly those drawn up before 1980.

   If the lease is dated before 1980 then an audit is not required. The reason for this is that the lease predates the ISAs (international standards of auditing).* Therefore the meaning of the word “audit” in an older lease may need to be considered in the context of what that term would have meant when the lease was originally drawn up.

2. Where the cost of carrying out an audit appears “disproportionate” to the benefits obtained.

   What is considered disproportionate is a matter of judgement. TECH 03/11 gives the example of a small property where the lessees are all members of the RMC for that property. However, disproportionate cost should not be treated as automatically overriding an audit requirement contained within the lease.

 * The terminology governing annual statements of account, particularly in older leases, may be quite general, and auditing standards and practice have changed fundamentally since the Auditing Practices Committee was established in 1976, leading to the publication of the first Auditing Standards and Guidelines in April 1980 (ISAs). The work effort required by current auditing standards is unlikely to be what was anticipated when older (pre-1980), leases were drawn up.

Therefore the term “audit” in a lease written before 1980 may not necessarily have contemplated the type of formal audit engagement that we understand by that term today.

That does not, however, create a blanket rule that:

“Pre-1980 lease = no audit required.”

Older lease wording needs to be considered carefully in its particular context.

For leases drawn up since 1980, the position is clearer: where the lease requires or is construed as requiring an audit, the starting point should be that an audit is undertaken.

Can we get around having an audit - What if the cost of an audit seems disproportionate?

The circumstances where a “disproportionate” argument can reasonably be raised are likely to be limited.

An example might be a relatively small set of service charge accounts with a single schedule of expenditure, very few complications and a small number of leaseholders who are all members of the RMC.

In those circumstances, the landlord, managing agent or RMC may wish to consider whether an alternative form of examination could be agreed.

However, this is important:

The fact that an audit appears expensive or disproportionate does not, by itself, remove an audit requirement contained within the lease.

The follow on question we often get is…

WHAT IF WE ALL AGREE THAT WE DON’T WANT OUR SERVICE CHARGE ACCOUNTS AUDITED?

Perhaps the RMC directors 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 necessarily a watertight way of overriding the wording of the lease.

Where the lease expressly requires the service charge accounts to be audited, the safest starting point is to comply with that requirement.

If the parties want certainty that the lease no longer requires an audit, it may ultimately be necessary to formally vary the terms of the lease, for example by changing wording such as “audit the accounts” to “certify the accounts” or another appropriate form of examination.

This course of action is not always attractive, as varying a lease can result in significant legal costs to lessees and it may be many years before any saving in audit fees outweighs the cost of varying the lease.

CONCLUSION

Where a lease requires an audit, the safest starting point is always to follow the lease.

There are circumstances where older lease wording may need to be interpreted in its historical context, or where the proportionality of an audit requirement may be considered. However, neither a pre-1980 lease nor the cost of an audit should automatically be treated as a way of disregarding an audit clause.

An audit report on service charge accounts should also not be dismissed without due consideration. Depending on the circumstances, the additional assurance provided by an audit may warrant the additional cost of having one carried out.

Do keep in mind that, whatever type of report is attached to the service charge accounts, the quality of the work will be enhanced where the reporting accountants are experienced and specialise in service charge accounts.

At Qube Accountants, we are here to guide you through these requirements, helping you understand what your lease or transfer document actually requires and the appropriate reporting route for your service charge accounts. If you have any questions or need assistance, please do not hesitate to contact us.

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