Financial Reporting Standards and the Public Sector

In the UK we have something that is known as Generally Accepted Accounting Practice. This is things that all accountants do (or should do) and is largely defined by accounting standards. Accounting standards are published by the Accounting Standards board which is a part of the Financial Reporting Council. They exist so that we know what generally accepted practice is.

 The reason we have generally accepted practice is to make published accounts meaningful. We treat like items in similar ways so that we can understand accounts produced by different organisations. Accounting standards aren’t overly prescriptive but where we have made a significant judgement this should be disclosed so readers of accounts know what happened.

 The Accounting Standards board sets accounting standards with the private sector in mind and recognises that accounting for the public sector is a matter for government. Significant differences exist (for example in funding streams) and therefore slightly different accounting treatments are required in places.

 Therefore in the public sector accounting standards are applied not directly but via some sector specific instructions. So in central government and the NHS standards are applied via manuals published by the treasury. They choose which accounting standards to adopt and how. In local government, higher education and charities practice is guided by a series of Statements of Recommended Practice published by the appropriate body (e.g for universities the SORP is published by the funding council).

 The government also sets targets for the public sector and specific parts of the public sector. The governments desire to set and meet targets leads to some strange anomalies.

 One of the fundamental accounting concepts is accruals (or matching). According to this concept income should be recognised in the period that it is earnt and expenditure should be matched to the income it generates. Therefore if we buy a big asset that will last more than one year we charge the cost of the asset against income over the life of the asset (so for example if we bought a mini-bus for £10k and expected to use it in the business over 10 years we would charge £1k for each year we owned the mini-bus). This is called depreciation.

 FRS11 (accounting standards are called either FRSs or SSAPs) deals with impairments. An impairment is the reduction in value of an assets.  One type of impairment is the consumption of economic benefit. The consumption of economic benefit occurs when we’ve used are asset up more quickly than we expected; we’ve consumed it. So, if we take the example of the mini-bus, we buy this mini-bus but we drive it like crazy fools and give all our friends lifts. After 5 years we take a look at our mini-bus and say ‘uh-oh that’s not going to last another 5 years- I’d give it another 2’. We have therefore not charged enough against income for our mini-bus. FRS11 Impairments of Fixed Assets and Goodwill tells us that we should charge the extra depreciation against income. Now.

 NHS Trusts have statutory targets, in theory the finance director and chief executive can be sent to prison for failing to meet these targets- in practice they are more likely to be given a stiff talking too or possibly lose their jobs. One of these targets is to break-even, if the NHS Trust suffers an impairment it makes it tricky for them to break-even. The government felt that the NHS Trusts shouldn’t fail to break even because of a change in accounting policy and introduced the funds flow arrangements

 

Department of Health

Primary Care Trust

NHS Trust

 

The NHS trust will recognise the impairment in their accounts. They will then apply to the PCT for funding. The PCT will give the Trust cash to cover the cost of the impairment; which creates a cost for the PCT. The PCT will then apply to the DofH for funding to cover this cost. The DofH will give them the cash. This creates a cost for the DofH and they will ask the NHS Trust to repay this through a repayment of capital in the next year.

 This is insane, it’s complicated and inconsistent. But what else could we do? Well there are 3 choices- firstly we could change the target. This is what happens if an impairment occurs in a PCT; rather than having a funds flow arrangement some bod at the DofH simply changes the target. Secondly, we could make the Trust bare the cost of the asset (after all they have consumed the economic benefit) or thirdly we could just not adopt that accounting standard.

 Making NHS Trusts bare the cost of the assets they have used would be my favourite. The real reason NHS Trusts are failing to meet their break even targets at the moment is because they were pushed to use PFI arrangements to finance necessary building works and are now having to service those contracts.

 The government was very keen on PFI because of another target. The sustainable investment rule which stated that all other things being equal public sector net debt should be less than 40% of GDP. PFI projects were kept off the balance sheet and therefore didn’t contribute towards debt.

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