Written evidence submitted by the Chartered
Institute of Public Finance and Accountancy
CIPFA, the Chartered Institute of Public Finance
and Accountancy, is the professional body for people in public
finance. Our 14,000 members work throughout the public services,
in national audit agencies, in major accountancy firms, and in
other bodies where public money needs to be effectively and efficiently
managed.
As the world's only professional accountancy body
to specialise in public services, CIPFA's portfolio of qualifications
are the foundation for a career in public finance. They include
the benchmark professional qualification for public sector accountants
as well as a postgraduate diploma for people already working in
leadership positions. They are taught by our in-house CIPFA Education
and Training Centre as well as other places of learning around
the world.
We also champion high performance in public services,
translating our experience and insight into clear advice and practical
services. They include information and guidance, courses and conferences,
property and asset management solutions, consultancy and interim
people for a range of public sector clients.
Globally, CIPFA shows the way in public finance by
standing up for sound public financial management and good governance.
We work with donors, partner governments, accountancy bodies and
the public sector around the world to advance public finance and
support better public services.
EXECUTIVE SUMMARY
The Chartered Institute of Public Finance and Accountancy
(CIPFA) welcomes the opportunity to provide evidence to the Select
Committee on the Private Finance Initiative. CIPFA is one of the
leading professional accountancy bodies in the UK and the only
one which specialises in the public services. It is responsible
for the education and training of professional accountants and
for their regulation through the setting and monitoring of professional
standards.
CIPFA has a key role in local authority accounting.
We are responsible for the Code of Practice on Local Authority
Accounting in the United Kingdom, which represents professional
best practice in this area and which local authorities are required
to follow under the 2003 Local Government Act. This is reinforced
for CIPFA members through the Statement of Professional Practice
with which all members are required to comply. In developing the
Code of Practice, CIPFA works closely with HM Treasury and the
other relevant authorities to ensure that financial reporting
across the public sector is as consistent as possible.
CIPFA believes that the main emphasis of the enquiry
should be around ensuring that the optimum procurement method
is selected for each capital project, and that the accounting
and budgeting requirements do not provide incentives for one form
of procurement over another. The key conclusions from our submission
are:
— PFI
deals have a strong focus on the Outline Business Case and the
Value for Money Test; but their long duration may make them less
flexible.
— It
is probable that there would have been fewer PFI projects if the
debt had more usually been scored on-balance sheet.
— The
control approach adopted in IFRIC 12 and which is being developed
for the public sector by the IPSASB is the appropriate basis on
which to account for PFI arrangements in financial statements.
— The
UK Government should seek to influence the development of requirements
for economic and statistical reporting, so that balance sheets
in the UK and other government National Accounts show PFI debt
as assessed under the "control approach".
— Only
those risks which the private sector are best placed to manage
should be transferred.
— Business
cases should consider all methods of making available the assets
required to meet service needs, including the use of partnerships
with the private sector; value for money should be paramount.
CIPFA is happy to offer the Select Committee whatever
assistance it is able in the consideration of the Private Finance
Initiative.
INTRODUCTION
1. The UK has used PFI arrangements since 1992.
The first schemes were in central government, with other parts
of the public sector adopting PFI arrangements at a later date.
What are the strengths and weaknesses of different
public procurement methods?
2. A strength of PFI has been the strong focus
placed on the Outline Business Case and the Value for Money Test.
CIPFA's Prudential Code for Capital supports strong asset management
of which the Business Case is a part. In considering capital projects,
however procured, public bodies need to apply rigorous cost benefit
analysis and ensure all projects are sustainable and affordable.
3. A potential weakness of PFI is the long duration
of the contracts, such that there may be less flexibility to adapt
the arrangements to changing circumstances.
If PFI debt had been on-balance sheet rather than
off-balance sheet would PFI projects have been used as much? How
should PFI deals be accounted for?
4. When PFI arrangements were first introduced,
the accounting issues had not been addressed in accounting standards.
Accounting treatments were developed initially by analogy with
leases. The risk and rewards approach that underpinned leasing
standards was adapted for PFI deals, and similar approaches are
used in the requirements for statistical and economic reporting
(eg under the European System of National and Regional Accounts,
referred to as ESA 95). ESA 95 requirements are used for National
Accounts which inform HM Treasury's economic planning process.
5. In September 1998 the Accounting Standards
Board issued an amendment to Financial Reporting Standard 5 (FRS
5) "Reporting the Substance of Transactions" in the
form of Application Note F "Private Finance Initiative and
similar contracts".
6. Application Note F set out the accounting
requirements for PFI schemes. Assets and liabilities were treated
as on-balance sheet or off-balance sheet based on an assessment
of the relative balance of risks and rewards. Under Application
Note F, retention by the public sector of demand risk and residual
value risk was regarded as generally decisive.
7. In 1999, the Treasury Taskforce issued Technical
Note No. 1 "How to Account for PFI Transactions". This
was intended to be an interpretation of Application Note F, but
in practice acquired the position of a competitor standard, allowing
for a wider spectrum of risks to be considered[83].
As a result, risks and rewards were not assessed on a consistent
basis across the whole of the public sector.
8. The risk and rewards approach in Application
Note F (and Technical Note No 1) was similar to that used
in ESA 95, and became the effective basis on which the funding
and approval of projects was decided.
9. The use of PFI deals to keep debt off-balance
sheet appears to have been viewed positively by both the previous
Conservative and Labour governments. This is best shown by considering
the funding arrangements for local government, where central government
funding for PFI deals was typically only available where the scheme
was off-balance sheet. PFI funding was in addition to schemes
funded through more traditional procurement methods. This provided
local government with an incentive to enter into PFI deals that
were off-balance sheet. The incentive for local government related
to the additional funding rather than the off-balance sheet treatment
per se. However, during much of this time HM Treasury sought to
manage the PSBR within certain limits and it is unlikely that
as much funding would have been made available had more PFI schemes
been on-balance sheet. CIPFA would therefore conclude that it
is probable that there would have been fewer PFI projects if the
debt had been on-balance sheet. This conclusion is based on the
effect on the PSBR, and does not reflect whether or not the schemes
provided value for money; this is a separate consideration.
10. In 2006 the International Financial Reporting
Interpretations Committee (IFRIC) of the International Accounting
Standards Board (IASB) issued Interpretation No 12 (IFRIC 12),
"Service Concession Arrangements". Under the accounting
requirements set out in IFRIC 12, which covers most UK PFI deals,
assets are treated as off-balance sheet for the private sector
operator where the public sector has control of the assets. IFRIC
12 does not cover the public sector accounting, but the clear
implication is that the assets (and related liabilities) should
be on-balance sheet for the public sector. Since 2009-10, this
has been the approach taken in the Financial Reporting Manual
(FReM) issued by HM Treasury, the Code of Practice on Local Authority
Accounting in the United Kingdom issued by CIPFA/LASAAC and the
similar manuals in the health service (issued by the Department
of Health and Monitor).
11. It should be noted that the references above
to the UK public sector having adopted the control approach refer
to the accounting within an entity's financial statements produced
under the FReM (and equivalent guidance in other parts of the
public sector). The treatment of PFI deals in the National Accounts
produced under ESA 95 continues to be based on a risk and rewards
basis.
12. There is currently no international standard
that covers the public sector accounting for PFI schemes, although
the International Public Sector Accounting Standards Board (IPSASB)
is currently developing such as standard. A Consultation Paper
was issued in 2008, and this was followed by an Exposure Draft
in 2010. CIPFA continues to work with the IPSASB to develop this
standard.
13. The proposed IPSASB standard adopts the control
approach of IFRIC 12; the proposed standard is intended to provide
a "mirror approach" to IFRIC 12, such that an asset
will either be on the private sector balance sheet or the public
sector balance sheet.
14. The control approach is seen as less subjective
than the risk and reward approach, and is more likely to result
in assets (and related liabilities) being on-balance sheet for
the public sector. CIPFA strongly supports this approach.
15. The control approach considers which party
has ultimate control of the assets, rather than day to day control.
This is consistent with the definition of an asset in both IFRS
and IPSAS as "resources controlled by an entity as a result
of past events…".
16. Concentrating on who has ultimate control
of the asset provides a solid basis for recognising assets and,
where appropriate, related liabilities. This approach is also
likely to be less susceptible to attempts to structure deals in
such as way as to provide a desired accounting outcome.
17. This emphasis on control also helps to align
the balance sheet with accountability for services. The public
sector will enter into PFI deals to meet service delivery objectives
through the construction, renovation, or improved operation of
the underlying property. The public sector will generally remain
ultimately accountable for the delivery of the service provided
through the property, and is therefore accountable for the operation
of the property, even though its operation is being undertaken
by the operator. Because of this, and because of the general public
perception that the service being provided through a PFI arrangement
is a public service, political risk associated with the delivery
of services through the underlying property remains with the public
sector, notwithstanding the fact that some service delivery risk
may fall to the operator.
18. For these reasons, CIPFA believes that the
control approach adopted in IFRIC 12 and which is being developed
for the public sector by the IPSASB is the appropriate basis on
which to account for PFI arrangements. This approach, which the
UK public sector has followed since 2009/10, provides for a more
consistent treatment than the risk and rewards approach previously
followed, particularly given the potential conflict between Application
Note F and Technical Note No. 1. This improvement in accounting
should also help to reduce, if not eliminate, the number of occasions
on which an asset appears on neither the public sector nor private
sector balance sheet.
19. As the UK budgeting framework is based on
the National Accounts (and therefore ESA 95), budgets and financial
statements are inconsistent in relation to PFI deals. Whilst these
differing treatment remain in place, there remains the possibility
that PFI deals may be structured to achieve an off-balance sheet
treatment within National Accounts (and therefore within the budget),
notwithstanding the fact that the deal will be on-balance sheet
within the financial statements of the entity and within the Whole
of Government Accounts.
20. It should be noted that accounting standards
and standards for economic and statistical reporting such as ESA
95 need to reflect a balance between the conceptual and the pragmatic
approaches. Because of the vulnerability of the risk and rewards
approach to structuring, and the greater possibility of assets
appearing on neither the private sector nor the public sector
balance sheet, CIPFA believes that the control approach would
be more appropriate for economic and statistical reporting.
21. As CIPFA considers that the control approach
to PFI arrangements provides better accounting, we would recommend
that the UK Government seek to influence the development of requirements
for economic and statistical reporting, so that balance sheets
in the UK and other government National Accounts show PFI debt
as assessed under the "control approach". This would
not only help ensure that National Accounts better avoid the risks
of structuring, and the risk that assets do not appear anywhere
in National Accounts, but would also remove the disconnect between
budgets and financial statements.
How far can risk really be transferred from the
public to the private sector? Are there particular kinds of risk
which are particularly appropriate for transfer through PFI deals,
or particular projects which are suited for PFI?
22. As the public sector will ultimately remain
accountable for the delivery of services, it is inevitable that
some risks, including a degree of delivery risk, will remain with
the public sector.
23. Whilst almost any level of risk can be transferred
from the public to the private sector, the real issue is at what
level is risk transfer cost-effective and appropriate. Only those
risks which the private sector are best placed to manage should
be transferred as the private sector will price in to contracts
significant premiums for risks that it cannot directly manage.
An example of risks that may attract an undue premium would include
environmental risks and under occupancy (except where there is
the potential to replace public sector with private sector use).
24. Adoption of the control approach to balance
sheet classification should encourage a different view to be taken
of risk transfer and bring a focus on the transfer of costs that
the private sector is best placed to manage, such as construction,
maintenance and third party income risks. With the current determination
there may be a danger that risks are transferred to support a
balance sheet treatment.
In what circumstances are PFI deals suitable for
delivery of services?
25. The key to the identification of circumstances
where PFI deals are suitable for the delivery of services is effective
Capital Strategy and Asset Management Planning processes. These
should be focussed on meeting service needs rather than the acquisition
of capital assets. Where a future service need is identified the
business case should consider all methods of making available
the assets required to meet service needs, including the use of
partnerships with the private sector.
26. Value for money should be paramount in arriving
at a decision as to the appropriate manner in which to deliver
the service and related assets. Robust option appraisal methodologies
should be used to ensure that each option is assessed on a level
playing field. PFI deals will be a suitable method of delivering
services where it can be demonstrated that such a scheme can deliver
the best value for money over the life of the contract, taking
into account the possible need for flexibility regarding changing
circumstances.
CONCLUSION
27. PFI deals have been useful in delivering
assets and services that otherwise might not have been available
to the public. PFI deals still have a role to play in delivering
assets, but value for money is paramount, and a level playing
field is required when assessing differing procurement options.
28. Previous accounting and budgeting arrangements
may have obscured the level of future commitments being taken
on by the public sector. In the current economic climate, it is
important that such deals are as transparent as possible, and
this is best achieved by using the control approach for financial
statements, National Accounts and budgets.
April 2011
83 Heald, D A and G Georgiou (2010) "Accounting
for Public-Private Partnerships in a converging world", in
Hodge, G, C Greve and A Boardman (eds), International Handbook
on Public-Private Partnerships, Cheltenham, Edward Elgar,
pp 237-261. Back
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