INTOSAI Privatisation Working Group (PWG) Technical case study Series 2 – PPP 1. Accounting for PFI/PPP Projects Table of Contents SUMMARY 1. Defining Characteristics of PFI/PPP Deals 5 2. Some Potential Benefits/Dangers of PFI/PPP 6
Technical case study
Series 2 – PPP
1. Accounting for PFI/PPP Projects
1.Defining Characteristics of PFI/PPP Deals5
2.Some Potential Benefits/Dangers of PFI/PPP6
3.The Accounting Issue for the Public Sector7
4. Application of FRS58-9
5.Whose Balance Sheet?10-11
7.Public or Private?16-17
8.International Accounting Standards 18
9.Statistically Based National Accounts 19-20
PFI/PPP is being used internationally to deliver investment in new public sector projects
PFI/PPP has been used to fund major new public investment, including schools, hospitals, prisons and roads.
Introduced back in early the 1990’s, the scheme has become a major element of private sector involvement in the UK’s public services.
Under PFI/PPP, a capital project such as a school is designed, built, financed and managed by a private sector consortium, under a long term contract to provide services. In return, once the development is operational, the contractor is paid a single “unitary” payment in each period, usually relating to availability and performance.
There are advantages and disadvantages of PFI/PPP. This technical case study primarily focuses on the accounting treatment of PFI/PPP projects rather than the merits of PFI/PPP itself.
Accounting for PFI/PPP contracts is often not straightforward in practice
The accounting issue is whether the fixed asset and the associated finance should be counted as on or off the public sector balance sheet.
Analysis of who bears the risks is relevant. The key risks are usually demand risk and residual value risk.
There can be incentives on the public sector to seek off balance treatment even when this is not appropriate.
In the UK this has sometimes resulted in inappropriate and inconsistent treatment. There are examples of an asset and the associated finance being on no-one’s balance sheet.
Is there any guidance for auditors that show how PFI/PPP contracts should be correctly accounted for by the public sector?
Within the UK, the accounting treatment of PFI projects is governed by an Application Note ‘Private Finance Initiative and Similar Contracts’ to the Financial Reporting Standard No. 5 – ‘Reporting the substance of Transactions’. The objective of FRS5 is to ensure that the substance of an entity’s transaction is reported in its financial statements rather than the strict legal form.
Is there any guidance for auditors that show how PFI/PPP contracts should be correctly accounted for by the public sector? (cont)
Should the fixed asset and the associated finance be On or Off Balance Sheet?
Why is the accounting an issue?
Public expenditure and borrowing statistics.
(e.g. in the UK – Maastricht criteria and the ‘Sustainable Investment’ rule)
Departmental cash and capital budgets (‘affordability’)
The danger of deals being constructed to count as “off balance sheet” when this is not appropriate eg the State retains too little control compared to responsibilities.
Introduction to FRS5 – Substance over Form
Application note F – Private Finance Initiative and similar contracts
(a) those where the only remaining elements are payments for the property. These will be akin to a lease and SSAP21 ‘Accounting for leases and hire purchase contracts’ should be applied.
(b) other contracts where the remaining elements include some services. These contracts will fall directly within FRS5 rather than SSAP21.
The factors or risks that might affect balance sheet treatment.
The FRS5 risk analysis looks to establish who will bear the risks (potential variations in profits/losses) associated with the asset.
The principal factors that, depending on the particular circumstances, may be relevant are:
It should be noted that construction risk – who bears the financial implications of cost and time overruns during the
construction period (and related warranty repairs caused by poor building work after the asset has been completed) is not
generally relevant to determining which party has an asset of the property once construction is completed, because such
risk normally has no impact during the property’s operational life.
The following pages elaborate on the above factors.
Application of FRS5
Third Party Revenues
Who determines the nature of the property/Design Risk
Penalties for underperformance or non-availability
Potential changes in relevant costs
Obsolescence, including the effects of changing in technology
Arrangements at the end of the contract and Residual Value Risk
- it will purchase the asset for a substantially fixed or nominal amount at the end of the contract
- the property will be transferred to a new private sector partner, selected by the public sector, for a substantially fixed or nominal amount; or
- payments over the term of the PFI contract are sufficiently large for the private sector not to rely on an uncertain residual value for its return.
- it will retain the asset at the end of the PFI contract; or
- the asset will be transferred to the public sector or another private sector partner at the prevailing market price.
In determining whether each party has as asset, it will not be appropriate to focus on one feature in isolation. Rather, the combined effect of all relevant factors should be considered for a range of reasonably possible scenarios, with greater weight being given to more likelier outcomes.
Can the contract be separated
into asset and service
This flow chart summarises
the decision route that should be
taken in order to assess the balance
sheet treatment between the
public sector and the private sector
After excluding separable service
elements, is the remaining element
only for the asset itself?
Apply accounting treatment
Apply FRS5 – assess who has the benefits and risks
of the property.
Public sector recognises
asset and liability
to pay for it.
Private sector recognises a
Public sector does not
Private sector recognises asset.
- controls or regulates the services the private sector operator provides, and
- has the residual interest in the fixed asset, which is significant
then the fixed asset is deemed to belong on the public sector’s balance sheet.
Public or Private Entity
1.the private partner bears the construction risk, and
2.the private partner bears at least one of either availability or demand risk.
Analysis of risks in PFI
1.Construction risk – covers risk as to who bears the financial implications of cost and time overruns during the construction period
2.Availability risk – (as explained under the FRS5 section)
3.Demand risk – (as explained under the FRS5 section)
Major Office Refurbishment
- Complete refurbishment of existing, architecturally listed, office buildings
-Provision of accommodation services therein over 30 years for 4,300 staff
PFI contract for custodial facility
Maintenance and repair
Medical and health care assistance
Drug tests and treatment programme
This PFI property asset was deemed to be on the public sector balance sheet (a treatment that was symmetrical with the private sector operator’s decision to account for the capital asset as a finance debtor). One factor in the decision was the difficulty in predicting likely demand.
New Build Offices
Flight Simulator and associated training services