FRS11 and local government

 

Local authority accounts are impenetrable to most council tax payers. This is a shame as the council tax payers are also the voters and therefore responsible for judging the local authorities. Arguably most council tax payers aren’t happy with numbers or accounts and therefore any type of accounting system would be impenetrable. But local authority accounts are impenetrable to most council tax payers who are qualified accountants.

 Local government accounts are directed by a Statement of Recommended Practice. This document attempts to interpret accounting standards fore local authorities in the light of their many statutory requirements.

The first (and arguably most significant of these) is the minimum revenue provision. Back in the midst of time (Ok 1987 ish), local authority councillors (it was said) found a way to make themselves more popular with voters. They would undertake large capital projects (for example build a leisure centre) but not pay for them. How was this achieved? Well they would borrow the money on an interest only basis making no provision to repay the capital. In 25 years time when the loan was due for renewal the Councillors would be long gone and paying for it would be somebody else’s problem.

 It was therefore decided (in the 1989 Local Government and Housing Act) that local authorities should put aside an amount each year to repay debt. It wasn’t necessary for them to actually repay debt each year as this may not be efficient treasury management practice; but each year the council tax should include a charge for debt. This charge was to be approximately 4% of outstanding debt and was known as the minimum revenue provision. The Councillors could then be held accountable for their spending.

 This sounds fairly logically; as a householder you would want to put aside money to repay any outstanding debts. However in the corporate world we are all ready charging depreciation (to represent the consumption of the asset).

 Local government want to comply with accounting standards, they really do…but they also like the minimum revenue provision. What to do?

 Well, first they charge depreciation (and any extra consumption of economic benefit) to the service that uses the asset. If for example education has a mini-bus for school trips; then the depreciation on that mini-bus will be charged to education. They then go on to calculate any surplus or deficit that the authority has made. Then they reverse out the depreciation (and impairment) and replace it with the Minimum Revenue Provision (MRP).

 This is extremely complicated; so complicated local authorities have to produce a statement that nobody else produces and in turn makes there accounts less understandable.

 What are the alternatives? We could just charge the MRP instead of depreciation- the problem here is that we are not showing the cost of assets used we only show the cost of those that are debt financed. We could just charge depreciation, this would make the accounts consistent with other organisations and would show the cost of assets used. It would mean charging the council tax payer a non-cash based charge but as that would represent the cost of the assets used it would make sense. We could always get around this by calculating the council tax on the cash requirement.

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.

There are things we need to know

Today this article appeared in the Guardian

http://www.guardian.co.uk/politics/2008/oct/09/economy.alistairdarling1

It tells us that the major deal to refinance the banks was secured over a curry- it even tells us what was ordered.

This isn’t what we need to know! What we need to know is- what type of shares does the government have in the banks- preference shares were widely touted. earlier in the week the Guardian descriped preference shares as ‘taking preference over other shares’. This is sort of true…preference shares (usually) have a fixed rate of divided -this is a charge against pofit before ordinary dividens are paid out; if the company goes bankrupt preference share holders get their money before ordinary share holders. However this reduced risk has a price; preference share holders are not  owners of the company- they do not have voting rights on the board, they don’t get higher dividens if the company is doing well.

However some reports have suggested that the government will have some seats on the board. If government does have seats on the board then government (the people) own a high proportion of the countries capital. This capital is used to finance businesses- in buying the means of production. The state owns the means of production- is there not a debate here that is much bigger than curry?

Anyone read Marx reccently- the growth of capitalism- to cover the whole word based on a principle of expansion- will collapse as the inherent contradictions do not allow for eternal expansion…its been a while but I think a reread may be in order….