Explanatory Note for Non-NHS Bodies

Explanatory Note for non-NHS bodies

Accounting Treatment relating to NHS revenue funded projects

1. What is an NHS revenue funded project? Under NHS revenue funded projects, usually referred to as Design, Build, Finance & Maintain (“DBFM”) schemes, the Health Board pays the private sector partner (i.e. either sub-hubco under the hub programme or the private sector partner under the Non-Profit Distributing (“NPD”) model) for the services it provides, which may include the construction of a new facility.

What does this mean?

• No payment is made until the facility is available and ready for use – no stage payments during construction;

• Payment of an annual Unitary Charge or Service Payment for the life of the project (this is not rent and it is not a lease);

• No service, no payment – deductions apply if, for example, consulting rooms are unavailable due to a burst pipe which is not fixed within a certain timeframe;

• DBFMs generally have a fixed end date – usually 25 years from the completion of the construction;

• Unitary Charge Payment from Service Availability throughout 25 Year life of the contract, a proportion of which increases in line with inflation; and

• Unitary Charge paid on a monthly basis less any deductions levied against the sub- hubco (which is a special purpose vehicle (SPV) set up by hubco for the purposes of ring fencing individual DBFM projects under the hub programme)

2. What does the Unitary Charge include? • Capital expenditure – this includes the capital cost of the building plus associated finance costs with regard to borrowing;

• Sub-hubco costs – costs of administering and running the sub-hubco;

• Lifecycle – replacement costs for major equipment during the life of the project i.e. replacing boilers and lifts etc; and

• Hard facilities management – maintenance costs of the building.

It does not cover rates, energy costs or insurance costs.

of 4 3. Land issues Under the hub programme, the Procuring Authority (“Participant”) retains ownership of the land and anything built by sub-hubco on it, i.e.:

• Sub-hubco does NOT lease the land to the Participant;

• The Participant grants sub-hubco a licence to occupy the land to the extent required to perform the services;

• The Participant will be required to warrant the title to the site; and

• The Participant may grant sub-leases of the facility to other bodies i.e. GP Practices

4. Accounting/ Classification & budgetary treatment of DBFM projects All DBFM schemes need to be considered for both:

1. The accounting implications of the scheme for the procuring authority; and

2. The budgetary implications for the NHS Board and Scottish Government.

Depending on the specific details of each NHS DBFM project, there may be different budgetary treatments with regard to how the NHS Board deals with the Unitary Charge payments in its accounts.

4.1. Accounting Implications The UK now follows the International Financial Reporting Standards (“IFRS”) rather than UK Generally Accepted Accounting Practice (“UK GAAP”) which was previously the case. UK GAAP had a risk based approach to the classification of projects as on or off balance sheet. On the basis that a DBFM project could demonstrate that the majority of the project’s risk was held by the private sector provider the project was classified as off the public sector’s balance sheet.

However, under IFRS, which has a control based approach to asset classification, as the asset will be controlled by the NHS it will almost inevitably be regarded as on the public sector’s balance sheet1;

4.2. Budgetary Implications Scottish Government (“SG”) budgets are classified as either for revenue purposes or for capital purposes. The capital budgets have decreased substantially and the SG have introduced the revenue funded projects as a mechanism to take forward projects where there is insufficient capital cover. All DBFM projects, as revenue funded projects therefore need to meet the requirements of revenue funding. This is a condition of SG support.

From a budgeting perspective, HM Treasury rules state that where a DBFM project is:

1 There needs to be a clear distinction between budgetary treatment and accounting. In an accounting sense these projects will be on balance sheet but in accordance with HMT guidance if they are service concessions under IFRIC12 and pass ESA 95 test they are budgeted for as off balance sheet

of 4 i. assessed as a service concession under the terms of IFRIC12; and

ii. satisfies the test outlined below for risk transfer under ESA95,

it will be classified as revenue and an adjustment will be made to the capital and revenue budgets to reflect the impact of the difference between treatment under IFRS and UK GAAP. In terms of HM Treasury spending controls the Unitary Charge will score against the revenue budget.

For an asset to be classified as a non-government asset under ESA 95, two of the following three risks have to have been transferred to the private sector provider:

• Construction Risk;

• Availability Risk; and/or

• Demand Risk.

If the DBFM project is classified as a “non-government asset” under HM Treasury budget rules this is the best position for the NHS Board. If after applying HM Treasury budget guidance they are classified as a “government asset” the NHS Board will have to:

 allocate the capital budget available in respect of the facility; and

 pay for the Unitary Charge from their revenue budget (note that this does not mean that the NHS is physically paying for the asset twice, more that it scores against both capital and revenue budgets)

It is a condition of the Scottish Government Revenue Support package that the projects are classified as “non-government.”

Therefore, it is important that an NHS Board reviews each project undertaken within the hub initiative and satisfies itself of the appropriate accounting treatment in order to assess its financial impact. The hub DBFM contract has been designed to meet the risk transfer requirements of ESA95 for construction and availability risk. This should be backed up with appropriate professional advice where considered necessary and confirmation from auditors that they are content with the accounting treatment proposed.

5. What about Leases? A finance or operating lease is not expected to be treated as a service concession under IFRIC12 since:

• There would generally not be an integrated provision of construction and services. The public sector would also normally be responsible for internal repairs and insurance; and

• The public sector would not generally control the residual interest in the asset.

of 4 Therefore the assessment of the lease would currently be under IAS17 as to whether it was considered to be a finance lease (on balance sheet) or an operating lease (off balance sheet). The rules associated with IAS17 suggest the following with regard to the structure of any lease if it were to be treated as an operating lease:

• There could no control over the asset at the end of the lease from the public sector (e.g. no right to buy at pricing below the market level);

• The lease term could not be for the major part of the economic life of the building and hence the present value of the minimum lease payments could not make up substantially all of the fair value of the building; and

• No substantial termination amounts due to hubco on cancellation of the remaining life of the lease, if this is a long term lease.

Therefore this may only be suitable for generic buildings that have alternative uses (e.g. offices), for which hubco is prepared to take ongoing void risk and residual value risk. For example if the NHS Board were taking occupancy of a minority part of a building and the hubco were prepared to market the building to other tenants.

In any event a joint exposure draft has been released by the IASB and FASB proposing a change to accounting rules that would also see operating leases being recorded on balance sheet. Although the effective date of a final standard may be some time away, it is sensible to plan projects on this basis of this emerging treatment of leases. In brief for all leases, lessees would record an intangible asset for the right to use the leased asset and a liability for the obligation to make lease payments (including the present value of future obligations).

Therefore this would suggest that a lease (whether a finance lease or operating lease under current accounting rules) is not a viable option for an NHS Board or Local Authority getting funding from the Scottish Government, as this would create a double hit to capital and revenue budgets.

SFT Contacts:

Andrew Bruce: 0131 510 0807

Neil Grice: 07540 123335