Appendix 3: NDA Budgeting Shortfall
2007-08: Lessons Learned Report Summary
NDA BUDGETING SHORTFALL 2007-08 LESSONS LEARNED
REPORT SUMMARY
Introduction
1. The 2008 Spring Supplementary Estimate for BERR
asked for an additional £400 million to be made available
to the Nuclear Decommissioning Authority (NDA) for the financial
year 2007-08. Of this total, £256 million of near cash was
raised from the Department's End Year Flexibility (EYF), £97
million was claimed from the Reserve and £47 million of capital
was allocated from unspent funds elsewhere in the Department.
2. When the Reserve claim was made, BERR's Permanent
Secretary asked his Head of Internal Audit, in co-operation with
the NDA and Treasury (HMT), to examine the circumstances that
led to the need for a reserve claim with a view to learning lessons
for the future. This is the report of that work.
Background
3. In November 2007 at a meeting between BERR and
NDA officials it came to light that the budgeting treatment for
certain commercial income streams which, at that stage, was assumed
to include Waste Substitution Income (WSI), was likely to be different
from the budgeting treatment assumed for 2007-08 and in the CSR07
settlement.
4. Both the 2007-08 forecast for commercial income
and CSR settlement, were based on WSI being recognised when the
cash was expected to be received allowing for end-year accruals.
In November 2007, during the latter stages of WSI contract negotiation,
it was agreed that WSI would be contracted as a variation to original
reprocessing service agreements rather than being subject to a
separate agreement. In January 2008, the UK GAAP accounting treatment
of WSI that would follow as a consequence of this agreement was
still under discussion. At that time, on the basis of work completed,
advice from the NDA's accounting advisors, Deloitte, was that
the revenue from WSI should be taken as part of the long term
work in progress accounting and spread over the life of the relevant
contracts. Under HMT's budgeting rules, HMT determines the budgeting
treatment of income which usually follows the UK GAAP accounting
treatment. Consequently, in the absence at that time of more specific
information for the relevant contracts, it was presumed likely
that only a proportion of the WSI would be recognised as income
in 2007-08. Therefore, the Department took the prudent course
of requesting a Supplementary Estimate to address what was considered
to be the likely budgetary shortfall.
5. By the middle of March, NDA had further developed
their review of the WSI income and the relevant contracts to the
point that an alternative accounting treatment was proposed. Their
view was that it was correct application of UKGAAP and Government
accounting rules (under the Government's Financial Reporting Manual
- FReM) to take the invoiced amount in full to income in the month
in which the invoices were raised. This would lead the NDA to
record income of £438m for the contracts in the 2007-08 financial
year meaning that the additional funding granted in the Spring
Supplementary Estimate would not be required and therefore that
the Reserve claim could be repaid. On 21st April 2008 the NAO
confirmed that this proposed accounting treatment was reasonable.
Findings and lessons learned
6. In May 2005, a revenue derogation was granted
by HMT which allowed revenue from certain long-term contracts
for which the accounting treatment was uncertain to be scored
in full to the Departmental Expenditure Limit (DEL) at the point
of invoice. The derogation was for one year only to allow time
for the correct accounting treatment to be determined.
7. At a meeting in February 2006 between the NDA
and HMT, the NDA understood verbal agreement to have been given
to the extension of the revenue derogation beyond 2005-06. This
was a misunderstanding, the most likely cause of which is set
out in paragraph 18 of the main report.
8. When accounting policies were agreed for the 2005-06
audit, subsequent years' budgets were not revisited and re-profiled
to match the accounting treatment. In 2006-07 the immaterial difference
between the cash receipts and accruals treatment meant that this
discrepancy went unnoticed.
9. Although the derogation was wrongly assumed by
NDA to be in operation after 2005-06, it was not applied to WSI.
The uncertainty over the budgeting treatment of WSI arose from
the fact that in November 2007, during the latter stages of the
WSI contract negotiation, it was agreed that WSI would be contracted
as a variation to original reprocessing service agreements rather
than being subject to a separate agreement. This raised uncertainty
over the accounting, and hence budgeting treatment of WSI, which
Deloitte were then engaged to advise on.
10. At the time of the Spring Supplementary Estimate,
on the basis of work completed, the advice from the NDA's accounting
advisors, Deloitte, was that the revenue from WSI should be taken
as part of the long term work in progress accounting and spread
over the life of the relevant contracts. In the absence at that
time of more specific information for the relevant contracts,
it was presumed likely that only a proportion of the WSI would
be recognised as income in 2007-08. Therefore, the Department
took the prudent course of requesting a Supplementary Estimate
to address what was considered to be the likely budgetary shortfall.
11. BERR, NDA and HMT have considered what lessons
can be learned from the chain of events that led up to the need
for a Spring Supplementary Estimate. The Lessons Learned section
of the main report includes agreed actions under the following
headings: Corporate Memory; Strengthening of the NDA finance team;
Clarity of financial reporting; Maintenance of formal records;
and the NDA funding mechanism, as well as acknowledgement of action
taken in November 2007 to strengthen BERR's governance of the
NDA.
DETAILED REPORT
12. When the NDA was created in 2005-06, specific
treatments for the reporting of income and expenditure against
the Departmental Expenditure Limit (DEL) were agreed in a letter
from HMT to DTI dated 26th May 2005.
13. This letter sought to align the NDA's DEL budget
with its cash requirements by excluding potentially significant
and unpredictable non-cash items from BERR DEL and allowing them
to be classified in BERR Annually Managed Expenditure (AME). These
included:
- New provisions and changes
to existing provisions (i.e. the nuclear
liability);
- and charges for the cost of capital and depreciation.
14. This derogation from standard budgeting treatment
was set out in DTI's SR2004 settlement of July 2004 and was subsequently
rolled over into the CSR07 period and the continuation of these
derogations is explicitly stated in the CSR07 settlement letter
from HMT to BERR of 8th October 2007.
15. However, the May 2005 letter addressed to DTI
also agreed exceptional treatment in 2005-06 for certain revenue
flows where the accounting treatment was uncertain and the accruals
profile was likely to differ significantly from the cash profile
assumed in SR2004. Flows covered by these revenue derogations
were in relation to Thorp and Magnox reprocessing income, Mox
income and related long term work in progress costs.
16. For these items, revenue could be scored in full
to DEL when the cash was received, allowing for end-year accruals.
Any difference between this figure and the accounting treatment
under FReM (and therefore UK GAAP) was to score as AME. This derogation
was not reflected in DTI's SR2004 settlement letter of July 2004
and was, according to the May 2005 letter, applicable only to
the 2005-06 financial year.
17. The revenue derogation was granted in May 2005
in recognition that the accounting policies for certain long term
contracts had not been agreed and therefore NDA were unable to
prepare 2005-06 budgets using the same basis as the accounting.
A delay in agreeing the treatment of £3.3bn of deferred income
on BNFL's balance sheet, led to all three years of SR2004 being
profiled on the basis of the derogation.
18. At a meeting in February 2006 between the NDA
and HMT, the NDA understood verbal agreement to have been given
to the extension of the revenue derogation beyond 2005-06. No
minutes of this meeting can be found. In the absence of a written
record of the meeting this misunderstanding is most likely explained
by a reference to the roll forward of the SR2004 derogations mistakenly
being taken to also include the time limited revenue derogation
set out in the HMT's letter to DTI on 26th May 2005.
19. When accounting policies were agreed for the
2005-06 audit, the accounting treatment of income from long-term
contracts was to recognise income according to the stage reached
in the contract by reference to the value of work done. Under
HMT's budgeting guidance, the budgeting treatment of income usually
follows the accounting treatment. However, budgets for 2006-07
and subsequent years were not re-profiled to reflect the agreed
accounting policy but instead remained on the basis of the derogation.
20. This oversight was not picked up in 2006-07 because
in that year there was an immaterial difference in accounting
terms between the income figure recognised on the basis of FReM
and the cash received (allowing for end-year accruals). It was
less than £10m and 1% of total income for the year of £1,250m.
At no time did NDA apply the derogation to WSI.
21. The timing of income from waste substitution
was first flagged by the NDA in April 2006 as part of discussions
on the 2007-08 budget and CSR07 submission. At that time it was
anticipated that WSI would be subject to a separate agreement
rather than a variation to existing reprocessing, waste management
and decommissioning contracts. On the basis of this assumption,
NDA informed BERR that if WSI were to be included, it would be
included on the basis that it was recognised when invoiced and
receivable. BERR therefore confirmed to HMT that WSI would be
recognisable in both budgets and accounts.
22. In their initial bid for 2007-08 funding and
CSR07 bid NDA did not include WSI revenues and instead requested
additional Grant-in Aid funding to fill the shortfall that would
materialise if WSI were not received. As BERR/HMT assumed the
accounting/budgetary treatment was set/agreed the issue that dominated
discussions was that of the timing of the WSI (i.e. when the income
could be recognised) and the subsequent impact on the 2007-08
budget. Following discussions with BERR and HMT over the likely
timing and accounting recognition trigger (not treatment) of WSI,
the Permanent Secretary of BERR wrote to the NDA chairman in February
2007 confirming that for budgeting purposes, NDA should assume
that the WSI will be earned in 2007-08. This letter was sent to
acknowledge that the evidence available at that time was that
WSI would accrue in 2007-08, and to record that in the event that
it did not, DTI would provide NDA with additional Grant in Aid.
However, the letter was also seen by the NDA as a correct and
reasonable instruction that confirmed their understanding of the
budgeting treatment.
23. In November 2007, during the latter stages of
WSI contract negotiation, it was agreed that WSI would be contracted
as a variation to original reprocessing service agreements rather
than being subject to a separate agreement. NDA engaged Deloitte
to consider the accounting consequences of this decision. The
NDA were aware of the possibility that the accounting treatment
could be different to the budgeting treatment assumed in CSR07
and the 2007-08 budget, but did not regard this as problematic
because of their understanding that the revenue derogation had
been extended, and therefore of the possibility that it could
be applied to WSI.
24. BERR became aware of the continued reliance on
the derogation by NDA during discussions with them in early November
2007. This was then raised by BERR in a meeting with HMT on 14th
November. At a further meeting between HMT and BERR on 29th November
it was established that there was no agreement to roll forward
the derogation beyond the end of 2005-06 and therefore no possibility
of it applying to WSI.
25. On 15th January 2008 a meeting was held between
NDA, BERR, HMT and Deloitte, at which an accounting treatment
paper drafted by Deloitte was discussed. Deloitte's advice at
this meeting was that WSI was a contract variation and should
be taken as part of the long term work in progress accounting
and spread over the life of the relevant original contracts. Although
other accounting treatments were discussed, at this time, on the
basis of preliminary work done, these were not seen as viable
options. Under HMT's budgeting rules, HMT determines the budgeting
treatment of income which usually follows the accounting treatment.
Consequently, in the absence at that time of specific contract
information for the relevant contracts, it was presumed likely
that only a proportion of the WSI would be recognised as income
for 2007-08. With the likelihood that the majority of the WSI
revenue was to be excluded from income, there was a need for additional
funding for the expenditure that was to have been funded by this
income. Although BERR were aware that NDA had further work to
do before reaching a definitive judgement on accounting treatment,
the Department took the prudent course of requesting a Supplementary
Estimate to address the likely budgetary shortfall.
26. At the time of the preparation of briefing for
the Select Committee hearing on 4th March 2008, NDA's work reviewing
the extremely large and complex long term contracts, which included
the WSI contracts, had progressed to a point where alternative
accounting treatments were thought possible. It was therefore
reported to the hearing that this work was still in progress and
had yet to conclude.
27. By the middle of March, the review of the contracts
had progressed to the point that an alternative accounting treatment
was proposed by the NDA. At the NDA audit committee on 19th March
2008 the committee endorsed a paper setting out the NDA's alternative
accounting, and therefore budgeting, treatment for WSI. The proposed
treatment was to take the invoiced amount in full to income when
the service was delivered. This would lead the NDA to record income
of £438m for the contracts in the 2007-08 financial year.
The paper noted that the above treatment had been fully disclosed
to the NAO for consideration via NDA's interim accounts. However,
it is the Office for National Statistics (ONS) acting as an independent
agency that determines the treatment of income in the National
Accounts and confirmation is still awaited that WSI may be treated
as income.
28. On 21st April 2008 the NAO submitted their final
paper setting out their opinion on the proposed accounting treatment
of WSI. This set out that the NAO considers that NDA's proposed
treatment to recognise all of the WSI in 2007-08 was reasonable.
This is still subject to final sign-off of the accounts by the
CA&G. Therefore with the accounting treatment agreed the budgeting
treatment usually, subject to confirmation by ONS, follows suit.
29. In correspondence throughout 2006 and 2007, there
was incorrect and inconsistent use of the term 'near cash' budgeting
treatment when used in relation to the NDA. There was a misconception
that the term meant that income associated with long-term contracts
would be recognised on a cash receipts or receivable basis. This
led to confusion between NDA, BERR and HMT as when NDA stated
they were budgeting on a 'near cash' basis, for example in their
CSR07 submission, BERR and HMT would have understood this to mean
income was being treated in accordance with the accounting treatment
required by the FReM and UK GAAP (as per Treasury's budgeting
guidance) whereas NDA were actually saying income was being treated
on a cash received or receivable basis (i.e. allowing for year
end accruals).
LESSONS LEARNED
30. BERR, NDA and HMT have considered what lessons
can be learned from the chain of events that led up to the need
for a Spring Supplementary Estimate. The actions that have been
agreed are described in the next section of this report.
Corporate Memory
31. The time limit on the revenue derogation granted
in May 2005 was overlooked by BERR and HMT. Had there been some
form of prompt in place near the time of its expiry, either within
BERR or HMT, then the erroneous application of the derogation
by NDA into 2006-07 would most likely have been picked-up.
32. The Finance Directorate in BERR (FRM) has committed
to establish and maintain a log of key budgeting and accounting
issues and judgements. This will include all material departures
from standard government accounting and budgeting treatment which
have been agreed, such as budget derogations agreed with HMT and
accounting treatment agreed with the NAO for highly material,
complex or subjective areas where significant debate and/or consultation
has been undertaken to agree the appropriate treatment.
33. This log will be subject to regular review jointly
with the HMT, NAO and other relevant third parties, such as the
NDA, to ensure these departures from standard treatment are still
appropriate. Timing of the review will coincide with the Spending
Review, budget/Estimates preparation and the review of accounting
policies by FRM during the resource accounts preparation period.
Strengthening of NDA finance team
34. The NDA recruited a finance team with a high
degree of commercial expertise and experience. However, government
accounting and budgeting rules are complex and differ in some
material ways from those that apply in the commercial world. The
NDA has acted to acquire training for its finance staff from the
National School of Government. When this is completed the NDA
will assess whether any further action is required to equip the
team with the requisite level of government accounting and budgeting
knowledge. This assessment is to be discussed with BERR.
Clarity of financial reporting
35. NDA's budgets are complex with many individual
elements that are prone to fluctuation and over which the NDA
has varying degrees of direct control. In order that all parties
can maintain a complete understanding of the numbers, NDA and
BERR have undertaken to consider jointly how the reporting of
financial information to BERR can be done with greater transparency,
for example, by showing the movement of individual budget elements
even when the net movement may be immaterial, and being clear
as to which elements are expected to move over time and why.
36. The underlying accounting records and processes
in the Nuclear Estate are wholly and exclusively based on commercial
accounting, and do not have embedded within them government accounting
or budgetary controls which have to be overlaid by the NDA. The
NDA will undertake an assessment of how the government accounting
framework is applied to budgetary control, the results of which
will be considered along side the assessment of the skills of
their finance team.
Maintenance of formal records
37. The meeting in February 2006 at which NDA understood
HMT to have given verbal agreement to the extension of the revenue
derogation was significant. There is no formal record of that
meeting, nor was there subsequently any correspondence that confirmed
what those present believed to have been agreed. To minimise the
risk of misunderstandings in the future, all parties have acknowledged
the importance of agreeing a written record of all material decisions
and future actions.
NDA funding mechanism
38. The NDA is funded by Government funding and from
commercial income. The commercial income is volatile and over
time will decline as sites progressively close and move into the
decommissioning phase. The grant-in-aid portion of the NDA's income
already represents a very sizeable proportion of BERR's annual
budget - 42% of the original total DEL for the 2007-08 financial
year.
39. Although the accounting treatment of WSI has
now been agreed on a basis other than was assumed at the time
of the Supplementary Estimate, the fact that the funding gap anticipated
was met in part by using all of BERR's end year flexibility, illustrates
the extent to which the Department is vulnerable to movements
in the NDA's budget caused in large degree by the reliance on
volatile commercial income.
40. Government has agreed that it will consider whether
there are changes that could be made to the NDA funding model
to better enable its funding to be managed effectively while maintaining
the right incentives and controls. It has been agreed that these
options will be considered by HMT in advance of the next spending
review
Governance of the NDA
41. In November 2007 it was agreed that the level
of resource devoted within BERR to sponsorship of the NDA should
be increased and that responsibility should transfer from the
Department's Energy Group to the Shareholder Executive. This change
was made in order to provide a level of finance and governance
expertise commensurate with the inherent risks posed by the NDA's
business. The NDA team within Shareholder Executive has a balance
of commercial and government accounting and budgeting experience
which will be kept under review to ensure that the correct skills
set is maintained. There will continue to be regular communications
between NDA, Shareholder Executive, HMT and BERR.
BERR Internal Audit
June 2008
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