Saturday, June 2, 2012

What is provision for reinstatement costs and how to account for it

It's common for an audit client to enter into rental lease agreement to lease the office building, warehouse, etc with the landlord of certain premises for certain period (e.g. 5 years). For operation purpose, the client may renovate the lease premises, such as installing cubicle in the said lease office.

 A landlord might require the our audit client (i.e. the audit tenant) to reinstate the office building upon moving out from the office while the lease has expired. Audit client may have to incur certain costs to reinstate the lease premises to its original state. Hence, a clause will be stated in the agreement to state cleary that the audit client is required to reinstate the lease premise to its original state. [ note: auditor must read the agreement in a cautiour manner to review of the obligations of our audit client].

In this instance, audit client is required to accrue for reinstatement cost. The question is, how to accrue for it, and who much to accrue for it? Audit client is required to obtain a quote from relevant contractor to estimate the reinstatement cost required to reinstate the premise to its original state (after factoring in the inflation in the future years till the end of the lease period). T

he following accounting entries need to be recorded: Dr. Reinstatement Cost (to be recorded in Fixed Asset) Cr. Provision for reinstatement cost (to be recorded in Accrual) The reinstatement csot capitalised as fixed asset need to be depreciated over the lease period. Consequently, it is evident that the reinstatement cost is expensed off on a straight line basis till the end of the lease period.

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