Archived decisions

HAMPSHIRE COUNTY COUNCIL

Decision Report

1. Introduction

1.1. This report outlines the changes in local authority accounting as a result of the move to adopt International Financial Reporting Standards (IFRS) across the public sector. Though the changes don't come into effect fully in Local Government until the publication of 2010/11's accounts, there is a lengthy lead in period required for some of the changes and implementation planning is now underway. The purpose of this report is to highlight some of the main potential implications for the financial statements which will be in future presented to the Committee.

2. Background

2.1. The County Council is required to produce its accounts in line with published guidance. This has taken the form of the Statement of Recommended Practice (SORP), developed by the Chartered Institute of Public Finance and Accountancy (CIPFA) and issued each year. Over recent years the SORP has promoted accounting practices which are more in line with the private sector than previously. This has been based on standards issued by the UK Accounting Standards Board along with other regulations and legislation which are collectively known as UK Generally Accepted Accounting Practice (UKGAAP). This process of harmonization with UKGAAP has been encouraged by the Government's objective of producing Whole of Government accounts (WGA), including the consolidation of local authority accounts, which requires the adoption of common accounting practices across the public sector. The first full set of Whole of Government accounts are due to be produced in 2009/10

2.2. In recent years there has been a move in accounting towards developing international standards which merge the practices of different nations. A significant driver for this project has been the globalisation of business. To this end, an International Accounting Standards Board was established in 2001 which has overseen this project. Compliance with International Standards became a requirement for UK businesses from January 2005.

2.3. It had originally been planned to introduce IFRS accounting for the whole of the public sector shortly after the private sector change. However, delays in interpreting standards so that they are relevant to the public sector environment have led to delays in their application. The Government's original intention announced in the 2007 budget was to implement IFRS across the public sector in 2008/09, but implementation in Central Government has now been deferred until 2009/10 and in local government until 2010/11.

2.4. CIPFA has now issued a draft Code of Practice for local authority accounting in line with IFRS requirements which applies to the year 2010/11. This will be the replacement for the previous SORP and will be issued annually. The consultation on this draft document ended on 11 September 2009.

3. Implications

3.1. Though a Code of Practice based on IFRS does not come into effect until 2010/11, a number of the recent changes to UK accounting standards implemented in Local Government have been based upon IFRS. Some early changes to accounting for Private Finance Initiative (PFI) and other similar contracts are being introduced in 2009/10 to match the Government's implementation timetable. Thus there are already some indications of the likely impact of IFRS implementation.

3.2. Format of the statements - are not subject to fundamental change but there will be an additional requirement to present the main income and expenditure statement both on the basis of a standard classification of services and in accordance with the internal management structure of the local authority. The latter will not necessarily be particularly understandable to internal stakeholders as the definition of income and expenditure in the income and expenditure statement differs from the one that operates in the regulations relating to the setting of council tax, which forms the basis of the County Council's decision-making and reporting to members.

3.3. PFI and similar contracts - one of the main changes resulting from IFRS relates to the treatment of PFI and related contracts in local authority accounts. This change comes into effect from 2009/10's accounts. Previously it was necessary in order to receive grant support from Central Government to be able to demonstrate that the risks and rewards associated with the contract lay primarily with the contactor so that the local authority could justify accounting for the contract as a service provision contract. This meant that the value of the asset and the corresponding liability to make future payments to the contractor did not have to be included in the local authority balance sheet. IFRS introduces a different test based on control of the asset, which is likely to result in most local authority PFI contracts being reflected in local authority balance sheets - including the Street Lighting PFI contract which the County Council is just about to enter into.

3.4. It had been seen assumed that the change to the balance sheet treatment of PFI contracts under IFRS would have implications for Government fiscal policy as it would have resulted in a similar accounting treatment in the majority of cases for projects whether funded by means of PFI or conventionally procured and financed by borrowing. However the Treasury has recently confirmed that there will be a dual approach to PFI, based on IFRS for accounting purposes but using different criteria (akin to the previous risk and reward approach) to govern budgeting within Central Government and form the basis on which National Accounts are prepared and on which fiscal policy and international debt comparisons are based. PFI will continue therefore to provide a means of funding public sector capital investment without the same impact on published public sector debt levels as conventional finance.

3.5. In addition to the Street Lighting PFI contract, the treatment of other similar contracts will need to be reviewed. This could have an impact on the treatment of the Waste management contract with Veolia, where it may be appropriate to recognise that the reversion of the infrastructure to the local authorities at the end of the contract, will generate an asset for the local authorities. Therefore part of the fixed fee payment to Veolia should be regarded as a capital payment for the asset rather than simply a cost of providing the current service.

3.6. Leases - IFRS will also affect the classification of leases between operational leases ( akin to a hire arrangement) and finance leases (treated as an indirect form of borrowing). The value of finance leased assets and the liability to make future payments to the lessor are included in the lessee's balance sheet. Currently the County Council has no finance leases recorded in its balance sheet, but the requirement in IFRS to consider land and building elements of a property lease separately, could result in the classification of some building leases as finance leases. A review of the County Council's leases will be required to establish whether in practice any changes to the classification of leases is required.

3.7. The overall effect of the changes in IFRS to the treatment of PFI , related contracts and leases is likely to be to increase the value of assets and liabilities recorded in the County Council's balance sheet. It will also increase the proportion of the County Council's assets for which there are matching long-term liabilities. None of these changes will necessarily have any impact on decision-making or on council tax levels.

3.8. Primacy of the balance sheet and disclosure requirements - a general feature of IFRS is that its primary focus is on ensuring that the assets and liabilities recorded in the balance sheet are valued on a meaningful basis. The implication of recording assets and liabilities at fair value rather than cost is that the numbers recorded in the income and expenditure account may be more volatile. This is likely to accentuate the distinction between the accounting required for IFRS and that which the Government has determined by regulation should apply for council tax setting, which is designed to limit volatility in council tax levels from year to year while still requiring local authorities to set balanced budgets. Where assets and liabilities are not recorded at fair value in the statements , IFRS typically requires disclosure in the notes to the accounts of fair values if they differ materially from cost. The introduction of the new IFRS based accounting standard relating to financial instruments in 2007/08 increased the length of the notes to the accounts relating to financial instruments from about 2 pages to 5 pages. The length of the Statement of Accounts submitted to this Committee in future is therefore likely to increase.

3.9. Employee benefits - the issues covered by accounting standards in the UK have tended to be largely determined by their relevance to UK companies. With the introduction of IFRS the focus is more on relevance to the accounts of US companies. While there is no current UK standard dealing with accrued leave entitlement, this is apparently of much greater relevance in the USA because of the arrangements which some companies make for paid sickness which enable entitlement to be carried forward. There is therefore an IFRS relating to employee benefits which requires the cost of accrued leave entitlement to be accounted for in the period in which it is earned. The County Council will have to determine whether the current arrangements for the carry forward of leave result in any material accrual of leave entitlement. There will be a material impact in relation to teachers because the academic and financial years are not coterminous and the teacher's contract entitles a teacher to be paid in April largely on the basis of service prior to 31 March. The Government are expected to introduce regulations which will result in the accrual of teachers' leave being disregarded for budgetary purposes.

3.10. Pension Fund accounts - the accounts of the Hampshire Pension Fund will also be affected by IFRS. One potential change arising from IFRS will be a requirement to disclose within the Pension Fund accounts the actuarially assessed surplus or deficit of the fund. At present the disclosure is only required in the accounts of the various employers, of that employer's share of the surplus/ deficit.

4. Consultation

4.1. The consultation on the draft IFRS Code of Practice is primarily a technical consultation designed to establish whether there is any challenge, from audit or practitioner consultees, to the interpretation of IFRS adopted by the draft code. Where IFRS has been interpreted in the public sector context, the interpretation in the draft Code of Practice generally follows that proposed by the Government in its own accounts. As local authority accounts will be consolidated within WGA from 2009/10, a consistency of accounting practice will reduce the extent of reworking required of local authorities by WGA.

4.2. The other key aspect of the consultation is to establish the extent to which local authority budgets and council tax levels are potentially affected by the changes in IFRS, so that Government can determine whether to introduce regulations that will allow the impact of IFRS to be disregarded within the General Fund, which local authorities are required to balance in setting their budgets and council tax. The Government has indicated that it will be prepared to regulate where the implementation of IFRS is likely to have a material impact on council tax. From the County Council's perspective , the main area in which there is certain to be an impact is in relation to the accrual of leave for teachers and this has been highlighted in the County Council's response to the consultation.

5. Implementation

5.1. Though the first set of IFRS compliant accounts do not have to be produced until June 2011, any changes to accounting systems and processes ideally should be introduced from 1 April 2010. The IFRS transitional arrangements also require not only the opening 2010/11 balance sheet to be restated on an IFRS basis but also the opening balance sheet for the preceding year, 1 April 2009. Though it is envisaged that any significant budgetary impacts will be avoided by changes in regulations, the position needs to be clarified before the budget for 2010/11 is set.

5.2. The IFRS implementation plan therefore requires a significant level of preparatory work to be undertaken over the remainder of 2009/10. This includes the restatement of the 1 April 2009 balance sheet, the production of a skeleton set of IFRS accounting statements and discussion of the initial conclusions on which these are based with the Audit Commission. A further progress report will be submitted to the Audit Committee at the end of the financial year.

6. Recommendation

6.1. That the implications of implementing IFRS be noted and a further progress report be submitted at the end of 2009/10.

CORPORATE OR LEGAL INFORMATION:

Links to the Corporate Strategy

IMPACT ASSESSMENTS:

1. Equalities Impact Assessment:

1.1 Equality objectives are not considered to be adversely affected by the proposals within this report.

2. Impact on Crime and Disorder:

2.1. The proposals in this report are not considered to have any direct impact on the prevention of crime

3. Climate Change:

a) How does what is being proposed impact on our carbon footprint / energy consumption?

* no specific proposals

b) How does what is being proposed consider the need to adapt to climate change, and be resilient to its longer term impacts?

* no specific proposals affecting adaptation to climate change