How to Read Public Accounts
Public sector spending in the UK is considerably higher than in many other countries. In order to monitor the ways in which this money is spent, it is necessary to know how budgets are constructed and where the main areas of financial jiggery pokery might be found. The ways in which spending is controlled and categorised are key factors in this regard.
The majority of public sector organisations will:
• Set both annual and three-year budgets.
• Make a distinction between revenue and capital spending.
• Separate out cash transactions.
One of the first steps in interpreting budgets in the public sector is to determine whether they are going up or down, in real terms, compared to previous years. While increases in overall spending may be trumpeted by politicians, it is the current expenditure which reflects the consumption for the current year and excludes other considerations that might account for a boost in spending (such as capital/investment spending). You might also wish to compare the organisation you are studying with an equivalent in the field, which is known as benchmarking.
Within central government, current (or resource/revenue) expenditure further breaks down into: Resource Departmental Expenditure Limits (known as rDEL) – this is set by individual departments, often over several years, and reflects the planned expenditure, therefore is not a guaranteed figure. Resource Annually Managed Expenditure (known as rAME) – this is set on an annual basis and is volatile as it is ‘demand-led’ and depends on council tax spending, social security benefits and debt interest repayments.
Compound Annual Growth Rate (CAGR) is the real amount by which budgets are increasing after inflation. This takes account of debt interest, which massively reduces current spending levels.
Distinction between Revenue and Capital Spending One of the main ways of controlling how public money is spent relies on the somewhat malleable distinction between revenue and capital spending.
Revenue spending (also known as resource/current spending) is derived, in theory, from tax revenue hence its name. Revenue spending reflects immediate consumption, for example wages, benefits, heating and food for hospitals and schools.
Capital spending (also known as investment) is officially defined as something that costs more than £5,000 and lasts more than one year, which includes buildings and other long-life equipment. A more pragmatic definition is that, if you can see it from the road, it has probably come from capital spending. Because of their investment potential, capital projects may be financed through borrowing. This means that capital spending is a useful area in which to attract borrowing to meet the deficit between revenue and expenditure. In times of crisis, capital spending is the first area to be cut because it is less immediate and often less evident than cuts to revenue spending. So, for example, buildings can suffer some lack of maintenance more subtly than frontline resources can be lost.
Controlling Capital Spending In order to understand how creative accounting may be undertaken between revenue and capital accounts, it is necessary to consider the following: • Capital budgets are ring-fenced, with borrowing limits in place for each public sector organisation. • Capital is intended to stay as capital and there are rules against funding revenue spending with the proceeds from asset sales (so, for example, a school cannot sell its buildings to pay for its teachers and books). • Capital charges are payable, as a tax to the Treasury, on any assets sold, which acts as a disincentive to owning/selling property.
Of course, creative accountants have found ways around all of these controls:
Creativity around Capital Spending Limits Capital budgets may be manipulated in the following ways:
1. Revenue to Capital Transfers Public Finance Initiatives (PFIs) are rather like public sector hire purchase agreements, allowing payment for an asset to be spread over an extended period. Significantly, for a public sector organisation entering into partnership with a private body, PFI permits capital assets to be paid for with revenue. Invented to keep government debt levels (and hence interest rates) down, this has recently been the main government-endorsed way of conducting spending away from the balance sheet (the statement of financial position for any organisation). Of the 628 PFI deals entered into by February 2010, 532 of them have been conducted away from the balance sheet in deals worth £57bn; by 2060, the cost of these deals to the public purse will be £267bn. The accounting system has recently been reformed to avoid off-balance-sheet transactions, which will have an impact on the public sector.
2. Capital to Revenue Transfers If the revenue budget has been overspent, attempts may be made to raid the capital budget. One of the main ways in which capital can enter into the revenue account is if an asset is sold, whereby any profit is permitted to be transferred over to the revenue account.
3. Property Valuations According to law: • The proceeds from capital sales are only intended to fund new capital projects. • There are rules governing property valuations (through which the ‘book value’ of a property is determined), involving a district auditor applying a defined methodology. • Only ‘profit’ above and beyond the book value may be used to fund revenue costs. Perhaps inevitably, this has led to the manipulation of valuations. So, for example, hospital managers might have their properties valued while prices are plummeting, only to sell them during a boom time, in order to transfer profits over to revenue spending. Valuations will normally be conducted at regular intervals, with a revaluation being undertaken if owners have an intention to sell. As an investigative researcher, you should look for evidence of the valuation period changing.
4. Capitalisation/decapitalisation Organisations will go to great lengths to balance their books. Definitions of spending may be varied to suit accounting purposes, which has seen whole categories of items fluctuating between revenue and capital from one year to the next, according to which account needed bolstering. In the past, there have been attempts to pay staff responsible for capital projects from the capital budget, thereby alleviating revenue spending. Similarly, the definition of equipment as consumables (revenue) or fixed assets (capital) is by no means clear. By changing the budget from which money is drawn, the whole accounting position is changed. Look at the Notes to the Accounts for details of any redefinitions.
Cash and Funny Money As in the examples given above, in the fluctuating distinctions between revenue and capital spending, there is also a lack of clarity around the budget lines ‘cash’, ‘near cash’ and ‘non-cash’. When government allocates funding to organisations, it is in the form of an I.O.U. and the organisation has to claim the cash value from the Treasury, but sometimes this will not be backed up by tax revenue. The discrepancy between cash that is promised and that which actually materialises creates more opportunities for creative accounting. Bear in mind that cash is different from resource spending.
Accruals or Resource Accounting is where resources are reported as having been spent at the point at which they have been consumed so, for example, a gas bill received in April, detailing the gas used in March, will be reported as having been spent in March. In hospitals, look out for prepayment or partially completed spells.
There are several ways to be creative with funny money:
1. Depreciation Whenever a building is bought, its lifespan will be estimated and a charge will be made against capital assets, which represents a fraction of the cost of the building over the course of its useful life. So, for example, if a building costs £300,000 and is estimated to last 30 years, a charge of £10,000 could be made to the capital account every year. This is a non cash charge; spending it creates cash whereby organisations charge themselves depreciation and set this aside to fund future capital. This raises questions about the asset’s useful life and its actual value, the latter of which is expected to conform to the Treasury’s Modern Equivalent Asset Value (MEAV). The government sets values for depreciation – look for any changes of definition in the Notes to the Accounts. Note that depreciation can only be factored into budgets if the asset appears on the balance sheet, which means that it is generally not chargeable on PFI projects. This will create an issue for those organisations bringing PFI projects onto their balance sheets.
2. Impairments If the value of an asset, as shown in the balance sheet, exceeds its actual value if it was sold, then the amount shown on the balance sheet needs to be reduced accordingly. A non-cash charge is made to the revaluation reserve and the income and expenditure account, through a process known as impairment. This is subject to manipulation, for example where a loss is recorded after an asset has been re-valued, which again makes it important to look at valuation timings. Impairment is a useful way of ‘hiding’ money in the accounts, setting aside cash in case it is taken away in the future.
3. Provisions Provisions account for costs which may be forthcoming but which are by no means certain, for example an employment tribunal, contract litigation or unused staff holidays. This is known as ‘strengthening the balance sheet’, which is code for hiding money. In its 2009-10 budget, the NHS included £16.6bn of provisions, only £1.5bn of which had actually been spent. If investigating in this area, ask yourself how likely it is that the eventuality being budgeted for will actually happen.
There are many other avenues for exploration when investigating public sector organisations, not least by following where the money is being spent and how it is weighted in different geographical areas, which will almost always be politically motivated. As the coalition government embarks on its radical programme of cuts, the public sector will be dramatically affected. This provides plenty of scope for looking at the strategies public sector organisations deploy to balance their books. You will also be able to engage in some pre-emptive work, for example by comparing the provisions made by particular quangos for mass redundancy to the actual picture it would be facing if it was wound up.
Based on a presentation by Sally Gainsbury and Noel Plumridge
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- On 30 November 2006, the International Financial Reporting Interpretations Committee (IFRIC) issued an Interpretation, called IFRIC 12 Service Concession Arrangements, which addresses how service concession operators (private bodies contracted to provide a public service) should apply existing International Financial Reporting Standards (IFRSs) to account for the obligations they undertake and rights they receive in service concession arrangements. See http://www.ifrs.org/Current+Projects/IFRIC+Projects/ IFRIC+12+Service+Concession+Arrangements/IFRIC+12+Service+Concession+Arrangements.htm