3-12-08

PPP Bulletin 1

Purpose

  1. NHS bodies are required to prepare their financial statements on an IFRS basis from the financial year 2009/10. In additionopening balances and comparatives will need to be restated using IFRS.
  1. These bulletins will be published on the Finman website in order to provide an outline of the Department’s latest understanding in relation to IFRS accounting for healthPFI/LIFTprojects in order to support the NHS prepare for the transition to IFRS.
  1. Whilst these bulletins will assist NHS foundation trusts when considering the requirements for restating using IFRS, advice on reporting requirements for NHS foundation trusts will be communicated separately by Monitor and will reflect the FT FReM.

Background

  1. HM Treasury have published guidance ‘Accounting for PPP arrangements, including PFI, under IFRS’in chapter six of the Financial Reporting Manual (FReM) that is availableat The guidance will support the NHS to determine journal entries associated with their PFI schemes in order to restate their 2008/09 opening balances.
  1. The IFRS and PFI/LIFT Position Statement published on the Finman website in October 2008 informed NHS bodies of the work being undertaken by five accounting firms (“advisers”) to provide accounting opinions for a sample of PFI/LIFTschemes for their host NHS bodies. Annexe B to the Position Statement also provided a list of information required to help NHS bodies develop accounting treatment for their PFI/LIFT schemes.
  1. Emerging results will support the Department to develop more detailed accounting guidance for health PFI and NHS LIFT projects in due course that will supersede these bulletins and support the NHS in restating their 2008/09 accounts and account for future periods on an IFRS basis. Whilst we will endeavour to provide as much guidance as possible resulting from this ongoing work, it remains the responsibility of each NHS body to form a view on how to account for its own transactions.

Contents

  1. This first bulletin covers the following topics:
  • High level PFI conclusions;
  • Restatement of the opening balance sheet;
  • Estimating service cost elements by obtaining information from the operator;
  • Initial measurement of PFI assets;
  • Modern equivalent assets;
  • Retained estate;
  • Accounting for Lifecycle; and
  • Lift – update.

High level PFI conclusions

  1. The conclusion reached by advisers reviewing a sample of schemes is that infrastructure assets associated with PFI schemes will fall to be recognised on NHS balance sheets. This is based on the application of IFRIC 12 “Service Concession arrangements”. As PFI contracts are standardised it is expected that there will be very few, if any, exceptions to this rule. Further details on the application of IFRIC 12 can be found in the Financial Reporting Manual (

Restatement of the opening balance sheet

  1. NHS bodies will need to apply the concept of retrospective application when restating their opening balance sheet (1 April 2008) under IFRS. Further guidance on retrospective application is available in IFRS 1’First-time Adoption of International Financial reporting standards’ and in Annex C to ‘Opening Balance Sheet requirements for NHS bodies’ (available in the International Financial Reporting Standards section of Retrospective application will require the NHS to account for health PFI projects as though the IFRS policies had always applied.
  1. In order to restate the opening balance sheet under IFRS NHS organisations will need to:
  • Reverse all previous PFI journal entries applied under UK GAAP;
  • Apply IFRS accounting for health PFI from the commencement of the contract as if IFRS based policies had always applied.
  1. Reversals may include journals relating to:
  • Property and asset transfers from NHS bodies to the project company;
  • All advance/bullet payments;
  • Trust incurred development costs;
  • Residual Interest; and
  • Unitary Payments
  1. IFRS accounting treatment relevant to health PFI projects is detailed in chapter 6 of the Financial Reporting Manual (FReM).

Estimating service cost elements by obtaining information from the operator

  1. Where infrastructure and service elements of a Unitary Payment stream cannot be distinguished(i.e. currently classified as non-separable contracts) these elements will need to be separated using estimation techniques. This is likely to be the case for most PFI infrastructure assets, which are currently accounted for as off-balance sheet.
  1. Initially, the service elements of the Unitary Charge may be estimated at the commencement of the lease by obtaining information from Project Co (“the operator”). This information may also be extracted from the project financial model. Relevant figures include FM costs, SPV operating costs, operator’s margin/IRR and lifecycle costs (where lifecycle costs are deemed to be revenue in nature). The result is the deemed “service charge”.
  1. Where contracts are separable, i.e. the service elements are identifiable,NHS trusts do not need to estimate the “service charge”.

Initial measurement of PFI assets

  1. Once services have been identified/estimated, the remainder of the Unitary Charge relates to the infrastructure assets, and includes both capital and interest costs. At the time the assets come into use, the NHS grantor shall recognise infrastructure assets and liabilities in their statements of financial position at amounts equal to theirfair value.
  1. Fair value is the amount for which the asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.
  1. The majority of advisers, who are providing an opinion on the PFI projects being monitored,advise that construction costs outlined in the Project Co financial model form a sound basis to estimate the fair value for initial recognition. A corresponding liability is recognised at the same time.
  1. Having identified the cash flows associated with the infrastructure assets and the value of these infrastructure assets and offsetting liability it is then possible to determine the interest rate implicit in the arrangement. This is the discount rate that,when applied to the infrastructure cash flows. results in a present value of the minimum lease payments equal tothe fair value of the assets and offsetting liability at initial recognition. Therefore, it is always likely to be practicable to determine the implicit interest rate for PFI projects.
  1. Following initial recognition of assets, they should be treated in the same way as all other assets of their type. This includes component accounting, impairment recognition, depreciation and revaluation policy.

Modern Equivalent Assets (MEA)

  1. Following the initial recognition of PFI propertyassets, they will subsequently need to adhere to the HM Treasury requirement to value property assets on a MEA basis by 1 April 2010. This will require a full revaluation in either 2008/09 or 2009/10.
  1. A formal valuation should be undertaken where possible as at 1 April 2008 so that the opening comparative balances are up-to date, especially for projects that became operational several years ago. A trust’s approach to subsequent valuation of PFI assets will need to be in line with trust policy for all other assets of the same class. Further guidance on the basis of revaluation can be found at

Retained Estate

  1. Existing trust estate that was transferred to Project Co as part of the PFI contract and derecognised under UK GAAP should be disclosed by the NHS under IFRS as though the assets had always remained in trust ownership.

Accounting for Lifecycle

  1. The Unitary Charge includes an element to cover the lifecycle replacement of infrastructure components for lifecycle.The occurrence and value of lifecycle events are not spread uniformly across the life of PFI arrangements. Nor can the actual timing of such events be predicted at the outset. What is known at the outset is the planned lifecycle programme including the planned enhancement/replacement of major components of an asset and the cost contractually committed to the planned activity. Project Co meets these costs through the build up of a lifecycle reserve. The risk that lifecycle costs exceed planned lifecycle costs is a Project Co risk.
  1. The advisers have outlined the following two approaches that can be used to account for lifecycle costs;
  1. It may be adequate to expense lifecycle costs as incurred where the lifecycle costs can be argued to simply reflect the risk of Project Co keeping the assets in the condition contractually required. This is analogous to an insurance service. Differences between carrying asset values and the actual asset base would be recognised in the value of the fixed asset following a revaluation process.
  1. Alternatively, when a lifecycle event takes place that enhances/replaces assets and failure to disclose the enhanced/new assets would materially misstate trust accounts the enhanced/replaced assets associated with the lifecycle event may need to be accounted for discretely/separately.
  1. To account for such lifecycle events a trust would have tobuild up a prepayment reflecting the planned lifecycle cost. This reflects Project Co building up a lifecycle reserve. When the lifecycle event occurs the prepayment would be credited with the value of the lifecycle event and the asset recognised at its fair value and subsequently accounted for in the same way as other assets of its type. The prepayment will be built up reflecting the planned and contractually committed cost of the lifecycle programme such that material variations form this reflecting the Project Co risk are separately identified as reserve balances and/or the prepayment carrying value compared with that planned..
  1. Each year’s prepayment accrued relating to lifecycle is subtracted from that year’s unitary payment and hence the service payment is separated from the infrastructure related payments.
  1. Aside from the additional accounting entries and estimates the latter method would require, there are questions around what happens to the prepayment when planned lifecycle does not occur as scheduled.
  1. In considering the most appropriate method, apart from materiality, NHS bodies should bear in mind the amount of work and estimation involved and the ultimate benefit that would be derived to the reader by his/her enhanced understanding of the accounts. Any approach that is proposed needs to be agreed with external auditors.
  1. Where a lifecycle event is revenue in nature the cost should be expensed as incurred.

Lift Update

  1. Draft guidance, ‘Accounting for NHS LIFT under IFRS’, has been developed by the Department of Health and is currently out for consultation. It is hoped that the guidance can be issued to the NHS in due course once the consultation period has ended.