Service Charge Accounts: what are the legal requirements

Managing small blocks of flats can be a challenging task, especially for financial matters. Understanding the difference between service charge accounts and company accounts is crucial for blocks of flats large and small. Here, we explore the differences and shed light on their functions, and key differences. Read on to get an understanding of how these accounts operate, the insights will enable you to manage your property's finances more efficiently.
Service Charge Accounts: what are the legal requirements
Service charge accounts are financial statements that record the income and expenditure associated with the maintenance, repair, and management of a property. Service charge accounts for residential properties are governed by the Landlord and Tenant Acts. They reflect service charges collected from the leasehold property owners to cover shared expenses. The key elements of service charge accounts are:

Income:  what income shows in the service charge accounts?

The service charge collected from the residents forms the primary source of income for service charge accounts. This amount is determined based on the service charge budgeted which represents expected expenses and is collected from the leaseholders as owners of each apartment in the block. Other sources of income could be interest charged on arrears and debt chase and legal costs of recovering service charges recovered from owners. Also, you might find the proceeds of an insurance claim.

The income due (paid or owed) will show on the income and expenditure account. Income not yet paid, e.g. service charge debts expenditure is shown on the balance sheet as debtors in the assets section. The reason service charge accounts have an income and expenditure account rather than a profit-and-loss account is that service charges are not for profit. Whatever is not spent is credited back to owners by a balancing charge, and if more is spent/incurred than budgeted the shortfall is collected from owners by a balancing charge. The balancing charge effectively equalises the service charge funds - thereby making the service charge not for profit.

Expenditure: what expenditure shows in the service charge accounts?

Service charge accounts track all expenses incurred for the maintenance and management of the property. These expenses may include insurance premiums, repairs, cleaning services, gardening, communal utilities, management fees, and any other relevant costs. What is important is to ensure that only expenditure permitted specifically in the lease or that is provided for by a sweeper clause is included. Anything else will not be deemed, if challenged in a Tribunal, as recoverable service charges.

One example of this that many blocks get wrong is the costs of running an RTM or right to manage a company such as the fees of the accountants to produce the RTM Company accounts, directors and officers insurance for the company officers, and the fees of the company secretary if any will never be recoverable as service charges in the service charges accounts. The reason is that the RTM was not conceived when the lease was drawn so its company administration and accounting costs will not have been written into the lease as recoverable service charge expenditure.

Expenditure incurred (paid or due) will show on the income and expenditure account. Unpaid expenditures (invoices not yet paid or due) will show on the balance sheet as creditors in the liabilities section.

Reserve Funds or Sinking Funds: 

Service charge accounts may also include a reserve fund or sinking fund. These are monies set aside for future major repairs or renovations. A good lease will allow the competent landlord (the person who collects the service charge) to collect a reserve fund, the aim being to accumulate funds gradually, thereby reducing the financial burden on leaseholders when significant works are required. The reserve fund demanded will show on the income and expenditure account. Reserve funds due and not paid will show as an asset on the balance sheet. The total cumulative reserves held are shown at the bottom of the balance sheet.

How to set a service charge budget

Service charge accounts involve the preparation of an annual budget that outlines projected income and expected costs for the property. This budget serves as a guideline for collecting service charges and managing expenses throughout the year. The year-end service charge accounts will demonstrate how effective or accurate the service charge budget set was.

What law governs service charge accounts

It is important to remember that service charges accounts are governed by landlord and tenant legislation whereas company accounts are governed by company law. Service charge accounts have to be presented to the service charge payers. Delays in doing so can be fatal, particularly if a deficit has been incurred - delays in presenting the service charge accounts may render such deficit unrecoverable.
Company Accounts for blocks of flats
Company accounts, on the other hand, refer to the financial statements of the company responsible for managing the property, they should not include service charges. In self-managed blocks of flats, a private limited company is usually set up to handle administrative tasks, maintenance, and financial matters. The key aspects of company accounts are:

What are the key aspects of company accounts?

1. Shareholders:

The leaseholders of the flats are typically shareholders of the company or at least those who participated in the freehold purchase or right to manage. Each leasehold property owner holds a share that represents their ownership interest in the company. The company's structure and decision-making processes are defined by its articles of association.
2. Share Capital:

Shareholders may be required to make an initial investment or pay a nominal amount to acquire their shares. This share capital forms the basis of company accounts and represents the financial value assigned to each shareholder's ownership interest.
3. Directors' Responsibilities:

The company's directors, who are usually elected from among the residents, have legal responsibilities for managing the company's affairs. This includes ensuring accurate financial records, compliance with relevant regulations, and making informed financial decisions.
4. Annual Accounts:

The company accounts comprise the annual financial statements, including the profit-and-loss account, balance sheet, and cash flow statement. These accounts provide an overview of the company's financial performance, assets, liabilities, and cash flows during a specific period. They have to be filed at Companies House.

Differences between Service Charge Accounts and Company Accounts 

While service charge accounts focus on the income and expenditure related to property maintenance, company accounts provide a broader perspective on the company's financial standing. The key differences between the two can be summarised as follows:

• - Service charge accounts are specific to the property and track shared expenses and income related to the maintenance and management of the property, while company accounts encompass the overall financial activities of the company responsible for managing the property.
• - Service charge accounts primarily serve the purpose of transparently managing the funds collected from residents to cover shared expenses. They focus on the day-to-day financial operations of the property.
• - Company accounts, on the other hand, provide a comprehensive view of the company's financial health, including its assets, liabilities, and profitability. They are essential for assessing the overall financial viability and long-term sustainability of the company.

In conclusion, understanding the difference between service charge accounts and company accounts is crucial for self-managed small blocks of flats. Service charge accounts focus on tracking income and expenditure related to the maintenance and management of the property, while company accounts provide a broader view of the company's financial position. By grasping the functions and distinctions between these accounts, property owners can better manage their finances, ensure transparency, and make informed decisions. Seeking professional advice and maintaining accurate financial records are vital to successfully navigate the financial complexities of self-managed small blocks of flats.