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ACCOUNTING FOR SERVICE CONCESSIONS

ACCOUNTING FOR SERVICE CONCESSIONS. THE UK PRIVATE FINANCE INITIATIVE Peter Morgan. Service concessions – defining characteristics of Private Finance Initiative deals. Contractual arrangements for private sector participation in the development, financing and operation of public infrastructure

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ACCOUNTING FOR SERVICE CONCESSIONS

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  1. ACCOUNTING FOR SERVICE CONCESSIONS THE UK PRIVATE FINANCE INITIATIVE Peter Morgan

  2. Service concessions – defining characteristics of Private Finance Initiative deals • Contractual arrangements for private sector participation in the development, financing and operation of public infrastructure • Public sector purchases services from a private sector contractor that require the contractor to Design, Build, Finance and Operate the relevant infrastructure

  3. PFI – some alternative abbreviations DBFO: Design, Build, Finance and Operate DCMF: Design, Construct, Manage and Finance BOO(T): Build, Own, Operate (Transfer)

  4. PFI schemes – some examples Bridges Schools Tramways Hospitals Roads Prisons

  5. PFI Schemes – some further characteristics • Long term contract to provide a specified level of services • Single (’unitary’) payment made in each period, linked to factors such as availability and performance • Contract will specify arrangements for the property at the end of the contract term • Various operational risks transferred to the contractor

  6. A quick survey of participants • Does your country use PFI style arrangements? • Has the SAI reported on any such arrangements eg their value for money? • Does the public sector record the property asset and the associated liability?

  7. Some potential benefits of PFI • Allocation of those risks to the private sector that it is better at dealing with • Better integration of design, construction and operation • Less prescriptive specifications - more innovation

  8. Some potential dangers of PFI • Contractor’s margin and financing costs outweigh efficiency savings • Inflexible, long-term contracts • Inappropriate risk transfer • Off balance sheet accounting

  9. What is the accounting issue for the Public Sector Should the fixed asset and the associated finance be On or Off Balance Sheet?

  10. Why is the accounting an issue? • Macro considerations – public expenditure and borrowing statistics (e.g. in the UK – Maastricht criteria and the ‘Sustainable Investment’ rule) • Micro considerations - departmental cash and capital budgets (‘affordability’)

  11. The dangers of Off Balance Sheet Accounting • Government liabilities are understated • Payment burdens are shifted onto future generations - will the debt repayment be manageable? • Risks associated with the service provision may be overlooked • Value for Money may be compromised

  12. UK and International Guidance • UK • FRS 5 and HM Treasury Technical Note – a ‘risks and rewards’ approach • IFRS • Draft IFRIC Interpretations 12 - 14 – ‘Control’ • IPSASB working group – clean sheet? • Statistically based National Accounts • SNA / ESA 95 / Eurostat

  13. UK Financial Reporting Standard no 5 ‘Reporting the Substance of Transactions’: Application Note F – ‘PFI and similar contracts’ FRS 5 - “The risks inherent in the benefits provided by an asset determine which entity has the asset” • Is the contract separable into components? • Ignore pure service components and apply FRS 5 risk analysis to remainder, but only taking account of the potential variations in profits/losses that relate to the property • Assess which party bears the majority of any variations in profit/losses relating to the property

  14. Decision route for FRS 5 Application note

  15. FRS 5 analysis – the principal factors • Demand risk • Third party revenues • Design risk • Penalties for underperformance or non-availability • Changes in property related costs • Obsolescence • Residual value risk

  16. FRS 5 – the key risks • “Demand risk is the risk that demand for the property will be greater or less than predicted or expected. Where demand risk is significant, it will normally give the clearest evidence of who should record an asset of the property”. • “Residual value risk is the risk that the actual residual value of the property at the end of the contract will be different from that expected. This risk is more significant the shorter the PFI contract is in relation to the useful economic life of the property. Where it is significant, residual value risk will normally give clear evidence of who should record an asset of the property”.

  17. HM Treasury Technical Note ‘How to account for PFI Transactions’ • “Additional” practical guidance • But viewed by many users as alternative guidance to FRS 5 • Has encouraged use of quantitative technique ‘Monte Carlo’ analysis to assess which party has majority of risk - can be manipulated to give desired result • HM Treasury are being encouraged to withdraw Technical Note

  18. International Financial Reporting Standards • Draft IFRIC interpretations 12 – 14, ‘Service Concession Arrangements’ • For private sector ie the contractors / operators • For assets used to provide services to the public

  19. IFRIC interpretations 12 - 14 • Based on concept of ‘control’ rather than ‘risks and rewards’ • If grantor (public sector body) • controls or regulates the services the operator provides • and has the residual interest which is significant  Property should be on grantor’s balance sheet

  20. IFRIC interpretations 12 - 14 Two possible accounting models for the contractor’s accounts: • If grantor (public sector body) pays – ‘financial asset model’ • If user pays direct – ‘intangible asset model’

  21. Statistically based National Accounts • SNA93 / ESA95 • ESA, broadly follows SNA, and has legal force in UK • Broad framework and principles for National Accounts, including various measures of public debt

  22. Eurostat - Advice on application of ESA95 Guidance on PFI scoring • Not binding • Less restrictive than UK GAAP • Government not required to record PFI debt when contractor has retained construction risk and either supply (availability) or demand risk

  23. PFI scoring for National Accounts debt measures in the UK • Treasury has decided to apply UK GAAP rather than Eurostat guidance • Various National Accounts debt measures that already (or soon will) include an imputed finance lease loan element for on balance sheet PFI • Impact on Maastricht criteria and the ‘Sustainable Investment’ rule)

  24. PFI accounting case study – should the following contracts be on the public sector balance sheet (Yes or No) (1)

  25. PFI accounting case study – should the following contracts be on the public sector balance sheet (Yes or No) (2)

  26. The UK Experience • Controversy • Inconsistency - central government cf. local government and health • Inconsistency – public sector cf. private sector (‘Off – Off Accounting’)

  27. Some UK projects and their accounting (1)

  28. Some UK projects and their accounting (2)

  29. Experiences elsewhere • Is the financial reporting and / or National Accounts reporting of PFI projects / service concession arrangements an issue for your country? (Yes / No). • If so why? (public expenditure constraints, budget constraints, VFM issues?). • If not why not? (service concessions not a major sector, flexible accounting……..?) Or should it be an issue! • Is there accounting (financial reporting) or national accounting (SNA, ESA etc) guidance for service concession arrangements / PFI in your country? (Yes / No) • What further issues may there be for the SAIs – e.g. ensuring liabilities and future commitments are visible and that risks are not overlooked, value for money etc

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