Accounting for Service Concessions
North Lanarkshire Council · 23 February 2023
Back to Council — 23 February 2023 and its agenda
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North Lanarkshire Council Report Council Does this report require to be approved? ☒ Yes ☐ No Ref EK/KS/RM Date 23/02/23 Accounting for Service Concessions From Elaine Kemp, Chief Officer for Finance E-mail kempe@northlan.gov.uk Telephone 07939 280 601 Executive Summary The report seeks approval to implement a change in accounting for all existing service concession agreements following the publication of new statutory guidance published in September 2022; Local government finance circular 10/2022 – accounting for service concession arrangements, leases and similar arrangements. This provides a statutory override to the requirements of the accounting code in respect of the Council’s existing service concessions (PPP schools) only. The proposed option must be adopted no later than financial year 2023/24 and the guidance stipulates that Council approval is required to make the change to accounting practice. The report aims to provide more details on the key principles of the statutory guidance and detailed financial implications, including potential associated costs that may require to be managed, subject to future decisions on use of the one-off retrospective saving. It is important to note there is no change to the unitary charge cash payment to school contractors over the contract period. This proposed change applies only to the accounting treatment in respect of the repayment of debt in the Council’s revenue account. The change in accounting treatment will see a reduction in annual accounting charges for service concession arrangements in the short to medium term, due to spreading them over the remaining useful life of the assets rather than the shorter contract life which is currently applicable. Thus, results in a short to medium term financial benefit for the Council. However, a further consequence of such action is that charges will be incurred beyond the contract period, which the Council will have to manage. Based on the analysis shown in Appendix 1, an annual financial saving of £4 million is estimated to be prudent and sustainable over the short to medium term. This has been reflected as a base budget adjustment to reduce the Council’s budget gap in 2023/24, in the Revenue Budget 2023/24 to 2025/26 and Council Tax 2023/24 Report, also included on this agenda. It should also be noted there is a potential £44.8 million one-off benefit arising from the retrospective application of the change in accounting. Consideration will be given to the use of this one-off benefit as part of future Medium Term Financial plans and budget strategies, following an update of the existing PPP affordability model over the longer term, to ensure a robust and affordable budget strategy is in place to meet the PPP accounting charges beyond the contract period.
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1. Background 1.1 Council will be aware that the Scottish Government introduced a number of potential fiscal flexibilities to local authorities aimed at assisting Councils to manage the financial impact of COVID. The Council’s Treasury Management Strategy, reported to Finance & Resources Committee on 10 March 2022 provided a high-level summary of these flexibilities, and advised specifically of the flexibility in relation to accounting for service concessions, commonly known as public private partnerships (PPP) arrangements. 1.2 Currently, a statutory intervention is in place in respect of service concession arrangements in Scotland, which was introduced in 2010 to address a financial impact when service concession assets, mostly schools, were first recognised on a local authority’s balance sheet. The current statutory arrangements require the repayment of the liability to be charged to the revenue account over the contract period. This is contrary to standard accounting practice which requires an asset to be depreciated over its useful life. 1.3 In the interests of ensuring a consistent approach going forward, Scottish Government has introduced statutory reforms to support standard accounting practice for all leases and service concession arrangements. The Scottish Government suggested this would generate a saving for Councils, as the cost is spread over the useful life of the asset, which is generally greater than the contract period. As previously advised, initial modelling indicated the Council would accrue a prudent one-off revenue benefit of approximately £17.7m, if retrospection application was permitted, as well as recurring Use of the one-off retrospective benefit will most likely require additional borrowing, incurring interest costs, which could be material. As a result, full consideration of all future forecast loan charge costs compared with budgetary provision is required to determine the affordability of any proposals to use the one-off benefit. In addition, future changes in respect of implementing the new accounting standard, IFRS16, which is currently planned to be adopted by the Council in 2024/2025, are also anticipated to give a financial benefit in respect of costs of service concession arrangements only. This will also be given due consideration as part of future budgetary strategies, as indicated above. Recommendations It is recommended that Council: (1) Approves the implementation of the change in accounting for all existing service concession arrangements (2) Acknowledges the reduction in annual accounting costs of service concessions over the short to medium term and that this has been reflected in the 2023/24 to 2025/26 budget report to this Council meeting (3) Acknowledges the one-off benefit generated in applying the accounting change retrospectively and notes that use of this benefit will be approved as part of future budget strategies, subject to an affordability review (4) Recognises that it is anticipated that further financial benefit may be generated following the implementation of IFRS16 in 2024/25 The Plan for North Lanarkshire Priority Improve North Lanarkshire's resource base Ambition statement (25) Ensure intelligent use of data and information to support fully evidence based decision making and future planning
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annual savings. This was subject to receipt and analysis of the awaited statutory guidance. 1.4 In September 2022 the Scottish Government published new statutory guidance; Local government finance circular 10/2022 – accounting for service concession arrangements, leases and similar arrangements. The statutory guidance provides a statutory override to the requirements of the Code of Practice for Local Authority Accounting in accounting for infrastructure assets. This essentially provides the details of the options available in accounting for PPP arrangements. 1.5 Officers have reviewed the guidance and have taken specialist independent advice to review and critically appraise the options available, and to model and verify the financial implications of such options. It should be noted that the option proposed needs to be applied to all existing service concession arrangements and must be adopted no later than financial year 2023/24. The guidance also stipulates that any change to accounting for such arrangements, requires full Council approval. 1.6 This report aims to provide more details on the key principles of the statutory guidance and detailed financial implications, including potential associated costs that require to be managed, subject to future decisions on any use of the one-off retrospective saving. 1.7 It should also be noted that CIPFA/LASAAC published the 2022/23 edition of its Code of Practice on Local Authority Accounting in the United Kingdom (the Code) in August 2022. This sets out the accounting for service concession arrangements under the new IFRS 16 Leases accounting standard, which the Council currently plans to adopt in 2024/25 financial year. Implementing the new standard is expected to generate a further financial benefit in respect of accounting for service concession arrangements, which will be further clarified in future budgetary strategies. 2. Report 2.1 In June 2005, the Council entered a 31 year public private partnership (PPP) agreement for the provision and maintenance of a number of purpose built school and community buildings, which ends in March 2037. A Design, Build, Finance, Maintain (DBFM), arrangement was agreed in 2016/17 for the replacement of Greenfaulds High School, with a second DBFM contract following for Cumbernauld Academy, both with a contract period of 25 years, ending in 2040/41. The useful life of these assets is estimated at 50 years. 2.2 Under such arrangements the Council is liable for annual contractual payments for the provision of schools, over the life of the contract. These unitary charge payments, cover the cost of operations, life cycle replacement, repayment of capital, interest on the outstanding liability, as well as inflationary uplifts (as determined by the individual contract). Essentially the unitary charge is a payment for services, repayment of debt and interest costs payable. The assets revert to the Council’s ownership at the end of the contract. 2.3 Whilst the assets are not legally owned by the Council, accounting practice requires the assets to be recognised on the balance sheet, along with the long-term liability to pay for the asset over the contract life. The element of the unitary charge payment which represents the repayment of debt, writes down the long-term liability in the balance sheet, such that the debt outstanding will be nil by the end of the contract when the assets revert to Council ownership.
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2.4 The Local Government Finance circular 10/2022 replaces the 2010 version, which covered service concession arrangements, and now permits the authority to apply an alternative accounting treatment for all service concession arrangements entered prior to April 2022. This can only be applied in 2022/2023 or 2023/2024. There are 3 options outlined in the circular that Councils can consider for service concession arrangements: • Option 1; Apply the accounting code with no statutory adjustments • Option 2; Continuation of existing statutory accounting arrangements as set out in 2010 • Option 3; Apply the new flexibility that aligns the statutory adjustments to the asset life, with a choice of retrospective or prospective application. If this option is applied there is a further choice on how to reprofile the principal elements, either using an equal instalment of principal (EIP) methodology or an annuity method 2.5 It is important to note that the unitary charge cash payment will remain unchanged and continue to be paid to the contractor over the contract period. This proposed change applies only to the accounting treatment in respect of the repayment of debt for these assets in the Council’s revenue account. 2.6 Option 3 outlined in 2.4 above better reflects the benefit/ use of the asset over its life, therefore, it is prudent to account for the repayment of the debt over the longer period, represented by the asset life. For example, the period over which the Council’s original schools’ contract would be accounted for, would increase to 50 years from the 31 years contract life. This option will result in an annual reduction in the accounting charge to the revenue account, which will mean that charges will be incurred beyond the period currently planned. Note the Council also has the option to apply the accounting change retrospectively and recalculate the revised charge which would have been incurred to date, had charges been originally spread over asset life since the start of the contract, resulting in a retrospective one-off benefit/ overpayment. 2.7 It is important to note that applying this flexibility does not generate an overall saving, it just extends the period over which payments are made, such that the total charges to the revenue account are unchanged over the life of the assets. 2.8 These are not cash releasing savings, as we continue to pay the contractors as planned, but they reduce the charges to the general revenue account, thus increasing the General Fund Reserve by reversing part of the charge that has already been made, which sits in an unusable reserve (Capital Adjustment Account). Changes to Accounting for Existing Service Concessions 2.9 The remainder of this report assumes the Council will adopt option 3, noted in 2.4 above, from 2023/24 onwards, which enables debt repayments to be paid over the life of the asset. Option 3 also requires the Council to determine its preferred repayment method i.e. annuity method or the equal instalments of principal (EIP) method. 2.10 The report advises on the financial implications using the annuity basis as opposed to the EIP method, which is deemed to be the most prudent repayment option as it reflects the consumption of assets over their useful lives, and the time value of money. It recognises that assets are not consumed equally throughout their lives, as maintenance costs tend to increase in later years. With the annuity method lower charges are incurred in the early years and higher charges in later years. The use of the annuity method is also in line with the methodology currently applied to service
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concession arrangements by the Council, and mirrors the current methodology for loans fund charges, in respect of Council assets, funded from borrowing. 2.11 There are a number of variables within the financial modelling undertaken, which require a number of assumptions to be made. Therefore, some sensitivity analysis has also been carried out to give some assurances over the robustness of the estimated financial implications reported. Financial Implications of Applying the Change 2.12 As a result of the change in accounting from 2023/24, it is estimated there will be an annual reduction in statutory charges to the revenue fund of £4.0 million. Therefore a £4.0 million annual saving is assumed as part of the Revenue Budget 2023/24 to 2025/26 and Council Tax 2023/24 report, to this Council. However, by extending the repayment period the Council will have to ensure there is budgetary provision to pay for the accounting charges beyond the current contract lives, when it had previously been assumed such costs would drop off. 2.13 In addition, by applying this change in accounting retrospectively, there will be a one- off gain to the Council, albeit not cash backed. The clarification of application now provided in the guidance indicates an estimated one-off increase in useable reserves of £44.8 million. This represents the overpayment, to 31 March 2023, based on spreading the costs over the asset life and not the contract period. 2.14 However, as indicated earlier in this report, this change in accounting does not represent an overall saving over the life of the asset. The total charges to the general fund revenue over the asset lives remain unchanged, which means the Council will have to ensure there is adequate budgetary provision in the future to meet all costs. Therefore, whilst this increase in the reserves balance may be used to support the Council’s revenue budget strategy going forward, consideration must also be given to ensuring any proposal is prudent, affordable, and sustainable. 2.15 It is currently envisaged that a combination of the future unitary charge budget (uplifted for inflation, less the Scottish Government funding, which will cease at the end of the contract lives), along with provision as part of robust future Medium Term Financial Plans, and perhaps earmarking some of the one-off benefit of £44.8 million, will ensure there is adequate funding to meet future service concession charges. More detailed modelling is required before any decisions around alternative use of these one-off funds can be made, as well as determining the costs and affordability aspects, of such use. Use of Retrospective Benefit & Associated Costs 2.16 As indicated in 2.8 above these benefits are not cash savings, they are accounting savings. Therefore, if the Council wishes to consider using these savings to support future budget strategies, and ultimately incur additional expenditure, then cash resources will most likely need to be borrowed, which will result in increased interest costs. The scale of the interest costs will be determined by any decisions taken to use the retrospective benefit. However, it is important to note these costs are not a consequence of the change in the accounting practice. 2.17 The amount borrowed and interest rates applicable at the time will determine the cost incurred. By way of illustration, three different scenarios have been modelled, which result in material interest costs ranging between £169 million and £178 million. Even after adjusting for the time value of money these costs are material.
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2.18 It is important to note there are already several factors putting pressure on the loan charges budget including: previously approved loan debt re-profiling savings, which were acknowledged at the time need to be repaid; hikes in interest rates (cost of borrowing); implications of any decision to exercise the loan debt holiday flexibility available to the Council in 2022/23. As a result, full consideration of all future loan charge costs compared with budgetary provision is required to determine the affordability of any additional borrowing from using the retrospective benefit. 3. Measures of success 3.1 Successful implementation of the accounting change, delivery of the annual saving and prudent provision of budgetary requirements to meet the future PPP costs and the cost of any decision to use the one-off benefit. 4. Supporting documentation 4.1 Appendix 1: Repayment Profiles of Service Concession Arrangements Elaine Kemp Chief Officer (Finance)
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5. Impacts ( http://connect/report-template-guidance ) 5.1 Public Sector Equality Duty and Fairer Scotland Duty Does the report contain information that has an impact as a result of the Public Sector Equality Duty and/or Fairer Scotland Duty? Yes ☐ No ☒ If Yes, please provide a brief summary of the impact? If Yes, has an assessment been carried out and published on the council’s website? https://www.northlanarkshire.gov.uk/your-community/equalities/equality- and-fairer-scotland-duty-impact-assessments Yes ☐ No ☐ 5.2 Financial impact Does the report contain any financial impacts? Yes ☒ No ☐ If Yes, have all relevant financial impacts have been discussed and agreed with Finance? Yes ☒ No ☐ If Yes, please provide a brief summary of the impact? Details are contained within the report 5.3 HR policy impact Does the report contain any HR policy or procedure impacts? Yes ☐ No ☒ If Yes, have all relevant HR impacts have been discussed and agreed with People Resources? Yes ☐ No ☐ If Yes, please provide a brief summary of the impact? 5.4 Legal impact Does the report contain any legal impacts (such as general legal matters, statutory considerations (including employment law considerations), or new legislation)? Yes ☐ No ☒ If Yes, have all relevant legal impacts have been discussed and agreed with Legal and Democratic? Yes ☐ No ☐ If Yes, please provide a brief summary of the impact? 5.5 Data protection impact Does the report / project / practice contain or involve the processing of personal data? Yes ☐ No ☒ If Yes, is the processing of this personal data likely to result in a high risk to the data subject? Yes ☐ No ☐ If Yes, has a Data Protection Impact Assessment (DPIA) been carried out and e- mailed to dataprotection@northlan.gov.uk Yes ☐ No ☐ 5.6 Technology / Digital impact Does the report contain information that has an impact on either technology, digital transformation, service redesign / business change processes, data management, or connectivity / broadband / Wi-Fi? Yes ☐ No ☒
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If Yes, please provide a brief summary of the impact? Where the impact identifies a requirement for significant technology change, has an assessment been carried out (or is scheduled to be carried out) by the Enterprise Architecture Governance Group (EAGG)? Yes ☐ No ☐ 5.7 Environmental / Carbon impact Does the report / project / practice contain information that has an impact on any environmental or carbon matters? Yes ☐ No ☒ If Yes, please provide a brief summary of the impact? 5.8 Communications impact Does the report contain any information that has an impact on the council’s communications activities? Yes ☐ No ☒ If Yes, please provide a brief summary of the impact? 5.9 Risk impact Is there a risk impact? Yes ☐ No ☒ If Yes, please provide a brief summary of the key risks and potential impacts, highlighting where the risk(s) are assessed and recorded (e.g. Corporate or Service or Project Risk Registers), and how they are managed? 5.10 Armed Forces Covenant Duty Does the report require to take due regard of the Armed Forces Covenant Duty (i.e. does it relate to healthcare, housing, or education services for in-Service or ex- Service personnel, or their families, or widow(er)s)? Yes ☐ No ☒ If Yes, please provide a brief summary of the provision which has been made to ensure there has been appropriate consideration of the particular needs of the Armed Forces community to make sure that they do not face disadvantage compared to other citizens in the provision of public services.
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Appendix 1 Repayment Profiles of Service Concession Arrangements Year Current Revised Current Revised Current Revised Current Revised Annual Cumulative £m £m £m £m £m £m £m £m £m £m Pre 23/24 60.133 21.851 5.069 1.028 3.105 0.596 68.307 23.475 44.832 44.832 23/24 4.877 1.851 0.947 0.204 0.949 0.218 6.772 2.273 4.499 49.331 24/25 5.714 1.932 0.996 0.214 0.994 0.228 7.704 2.375 5.329 54.660 25/26 5.456 2.017 1.047 0.225 1.042 0.239 7.545 2.482 5.063 59.723 26/27 6.537 2.106 1.101 0.237 1.091 0.251 8.730 2.593 6.137 65.860 27/28 6.469 2.198 1.158 0.249 1.144 0.263 8.771 2.710 6.061 71.921 28/29 6.942 2.295 1.218 0.262 1.198 0.275 9.358 2.832 6.526 78.447 29/30 6.555 2.396 1.281 0.276 1.255 0.288 9.092 2.960 6.132 84.579 30/31 6.973 2.501 1.347 0.290 1.315 0.302 9.636 3.093 6.543 91.121 31/32 6.025 2.611 1.417 0.305 1.378 0.317 8.820 3.232 5.588 96.709 32/33 7.117 2.725 1.490 0.321 1.444 0.332 10.051 3.378 6.674 103.383 33/34 6.676 2.845 1.568 0.337 1.513 0.348 9.756 3.530 6.226 109.609 34/35 8.295 2.970 1.649 0.355 1.585 0.364 11.528 3.689 7.840 117.449 35/36 7.953 3.100 1.734 0.373 1.661 0.381 11.347 3.855 7.492 124.941 36/37 8.074 3.237 1.824 0.392 1.740 0.400 11.637 4.029 7.609 132.550 37/38 0.000 3.379 1.918 0.412 1.823 0.419 3.741 4.210 (0.469) 132.081 38/39 0.000 3.527 2.017 0.434 1.910 0.439 3.927 4.400 (0.473) 131.608 39/40 0.000 3.682 2.121 0.456 2.001 0.460 4.123 4.598 (0.475) 131.133 40/41 0.000 3.844 2.231 0.480 2.097 0.482 4.328 4.805 (0.477) 130.655 41/42 0.000 4.013 1.158 0.505 2.197 0.505 3.355 5.022 (1.667) 128.989 42/43 0.000 4.189 0.000 0.531 2.302 0.529 2.302 5.248 (2.947) 126.042 43/44 0.000 4.373 0.000 0.558 2.412 0.554 2.412 5.485 (3.073) 122.969 44/45 0.000 4.565 0.000 0.587 0.754 0.580 0.754 5.732 (4.979) 117.990 45/46 0.000 4.765 0.000 0.617 0.000 0.608 0.000 5.991 (5.991) 111.999 46/47 0.000 4.975 0.000 0.649 0.000 0.637 0.000 6.261 (6.261) 105.738 47/48 0.000 5.193 0.000 0.683 0.000 0.668 0.000 6.544 (6.544) 99.194 48/49 0.000 5.421 0.000 0.718 0.000 0.700 0.000 6.839 (6.839) 92.355 49/50 0.000 5.659 0.000 0.755 0.000 0.733 0.000 7.148 (7.148) 85.208 50/51 0.000 5.908 0.000 0.794 0.000 0.768 0.000 7.470 (7.470) 77.737 51/52 0.000 6.167 0.000 0.836 0.000 0.805 0.000 7.807 (7.807) 69.930 52/53 0.000 6.438 0.000 0.879 0.000 0.843 0.000 8.160 (8.160) 61.770 53/54 0.000 6.721 0.000 0.924 0.000 0.883 0.000 8.528 (8.528) 53.242 54/55 0.000 7.016 0.000 0.972 0.000 0.925 0.000 8.913 (8.913) 44.329 55/56 0.000 7.324 0.000 1.022 0.000 0.970 0.000 9.316 (9.316) 35.013 56/57 0.000 0.000 0.000 1.075 0.000 1.016 0.000 2.091 (2.091) 32.922 57/58 0.000 0.000 0.000 1.131 0.000 1.064 0.000 2.195 (2.195) 30.727 58/59 0.000 0.000 0.000 1.189 0.000 1.115 0.000 2.304 (2.304) 28.422 59/60 0.000 0.000 0.000 1.251 0.000 1.168 0.000 2.419 (2.419) 26.003 60/61 0.000 0.000 0.000 1.315 0.000 1.224 0.000 2.540 (2.540) 23.463 61/62 0.000 0.000 0.000 1.383 0.000 1.283 0.000 2.666 (2.666) 20.797 62/63 0.000 0.000 0.000 1.455 0.000 1.344 0.000 2.799 (2.799) 17.998 63/64 0.000 0.000 0.000 1.530 0.000 1.408 0.000 2.938 (2.938) 15.060 64/65 0.000 0.000 0.000 1.609 0.000 1.475 0.000 3.085 (3.085) 11.975 65/66 0.000 0.000 0.000 1.693 0.000 1.546 0.000 3.238 (3.238) 8.737 66/67 0.000 0.000 0.000 1.780 0.000 1.620 0.000 3.400 (3.400) 5.337 67/68 0.000 0.000 0.000 0.000 0.000 1.697 0.000 1.697 (1.697) 3.641 68/69 0.000 0.000 0.000 0.000 0.000 1.778 0.000 1.778 (1.778) 1.863 69/70 0.000 0.000 0.000 0.000 0.000 1.863 0.000 1.863 (1.863) (0.000) Totals 153.794 153.794 33.292 33.292 36.909 36.909 223.995 223.995 (0.000) SC21 Greenfaulds Cumbernauld Total Total Benefit