whc (2006) 068 welsh health circular - nhs wales2006)068.pdfwhc (2006) 068 parc cathays caerdydd...

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WHC (2006) 068

Parc Cathays Caerdydd CF10 3NQ

Cathays Park

Cardiff CF10 3NQ

Issue Date: 2 nd October 2006

Status: Select Status Title: CAPITAL ACCOUNTING MANUAL

For Action by: Directors of Finance LHBs

Action required See paragraph(s) :

For Information to: Wales Audit Office and attached core distribution list

Sender: Mr Kevin Jones Financial Controller, Department of Health & Social, Care Resources Directorate

National Assembly contact(s) : Mr John Evans, Mrs Jackie Salmon Department of Health & Social Care, Resources Directorate

Enclosure(s): Copy Of Capital Accounting Manual

Tel: 029 20825111 GTN: 1208

Llinell union/Direct line: 029 20 Ffacs/Fax: 029 20 Minicom: 029 20823280

http://howis.wales.nhs.uk/whcirculars.cfm

WELSH HEALTH CIRCULAR

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Distribution List Chief Executives NHS Trusts Chief Executives Local Health Boards HR Directors NHS Trusts HR Directors Business Services Centre Director NHS Confederation in Wales Chief Officer Association of Welsh Community Health Councils Director Welsh Local Government Association Dean University of Wales, Bangor Chief Executive Commission for Racial Equality Chief Executive Centre for Health Leadership Secretary British Dental Association in Wales Postgraduate Dean University of Wales College of Medicine Director information services University of Wales College of Medicine Secretary British Medical Association (Wales) Regional Head of Health UNISON Board Secretary Royal College of Nursing (Wales) Welsh Council Representative British Dietetic Association Wales Secretary British Orthoptic Society Wales Secretary AMICUS MSF Regional Secretary The GMB Regional Secretary Transport & General Workers Union Chair Community Pharmacy Wales Chair Royal College of General Practitioners General Secretary Wales TUC Assistant Director Chartered Society of Physiotherapists Officer for Wales Society of Radiographers IR Officer Society of Chiropodists and Podiatrists Regional Secretary Union of Construction Allied Trades and Technicians Board Secretary for Wales Royal College of Midwives Officer for Wales AMICUS Electrical & Engineering Staff Association Regional Secretary AMICUS Amalgamated Electrical and Engineering Union Welsh Executive Royal Pharmaceutical Society of Great Britain Information Officer Wales Council for Voluntary Action National Member for Wales AMICUS - Guild of Health Care Pharmacists Business manager Institute of Health Care Management Welsh Division Chief Executive Association of Optometrists Librarian British College of Optometrists Director General Audit Commission (Wales) Director Business Service Centre Patch Managers Business Service Centres across Wales (6 copies each) Secretariat Statutory Committees Regional Directors NHS Wales Regional Offices Chief Executive Health Commission Wales (Specialist Services) Chief Executive Health Professions Wales Librarian National Public Health Service Chief Executive Welsh Language Board / Bwrdd yr Iaith Gymraeg Librarian Health Promotion Library Chief Executive Healthcare Inspectorate Wales

Also: Information Officer Audit Commission Bristol Information Officer National Audit Office Cardiff Information Officer Audit Commission in Wales Information Officer PricewaterhouseCoopers Information Officer Deloitte & Touche Information Officer KPMG

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Dear Colleague,

CAPITAL ACCOUNTING MANUAL Summary 1. This circular issues the new revised Capital Accounting Manual for NHS bodies in Wales

(which replaces the Capital Charges and Trust Equivalent Manual 1993/94.) The manual brings together guidance issued under previous Welsh Health Circulars (WHC) and is intended to complement the respective NHS Trust and Local Health Board Manual for Accounts which are issued by Department of Health and Social Care, Resources Directorate each year.

2. This manual is consistent with Financial Reporting Standards 10, 11 and 15 which have

been issued by the Accounting Standards Board since the first version of the manual was published in 1993-94.

3. Amendments to the manual to enable it to comply with new Treasury requirements or

accounting standard changes will be issued to NHS Wales as replacement pages via a WHC.

4. I am very grateful to the members of the Welsh NHS Trust Capital sub-group whose work

and expertise has been invaluable in completing this new manual.

5. I am issuing a PDF version of the hard copy of the manual with this circular. Should anyone require a paper copy please contact the Resources Directorate.

Kevin Jones Financial Controller Department of Health and Social Care Resources Directorate

National Assembly for Wales

1 NHS Wales Capital Accounting Manual –September 2006

NHS Wales Capital Accounting Manual



NHS WALES CAPITAL ACCOUNTING MANUAL ____________________________________1

1 INTRODUCTION_______________________________________________________________4 Purpose of the Manual __________________________________________________________4

2 THE CAPITALISATION AND VALUATION OF FIXED ASSETS______________________________5 Introduction ___________________________________________________________________5 General principles and definitions _________________________________________________5 Tangible fixed assets ____________________________________________________________5 Grouped assets ________________________________________________________________6 Intangible fixed assets - capitalisation _____________________________________________12 Deferred assets in PFI schemes___________________________________________________14 Measurement and valuation _____________________________________________________14 Valuations, review and impairments _______________________________________________17 Indexation ___________________________________________________________________20 Surplus assets and disposals _____________________________________________________21 Impairments__________________________________________________________________23 Presentation and disclosure - examples ____________________________________________30 Annex 1 - Definitions ___________________________________________________________32

3 DEPRECIATION AND ASSET LIVES ________________________________________________34 Introduction __________________________________________________________________34 Depreciation policy for NHS bodies _______________________________________________34 Chargeable period_____________________________________________________________36 Other considerations ___________________________________________________________37

4 LEASES____________________________________________________________________41 Introduction __________________________________________________________________41 Definitions ___________________________________________________________________42 Determining the lease type - the 90% test ___________________________________________43 Determining the Lease Type – Other Factors ________________________________________44 Property leases _______________________________________________________________44 Accounting for finance leases – lessees_____________________________________________45 Operating Leases______________________________________________________________49 Leases and the External Financing Limit ___________________________________________50 Accounting for leases – lessors ___________________________________________________50 Hire purchase contracts ________________________________________________________51 Future developments ___________________________________________________________51 Accounting entries _____________________________________________________________51

5 CAPITAL CHARGES ___________________________________________________________54 Introduction __________________________________________________________________54 Cost of capital charge – calculation of relevant net assets _____________________________55

6 CAPITAL RESOURCE BUDGETING ________________________________________________57 Introduction __________________________________________________________________57 External Financing and Capital Resource Budgeting for NHS trusts ______________________59

7 DONATED ASSETS____________________________________________________________62 Introduction __________________________________________________________________62 Accounting for donated assets____________________________________________________62 Accounting entries for donated assets ______________________________________________64

8 PRIVATE FINANCE INITIATIVE __________________________________________________66 Introduction __________________________________________________________________66 FRS 5 and SSAP21 ____________________________________________________________66 PFI Accounting _______________________________________________________________67 Required accounting ___________________________________________________________69

9 ASSET REGISTERS____________________________________________________________73 Introduction __________________________________________________________________73 Buildings ____________________________________________________________________75 External Works _______________________________________________________________77 Assets Under Construction ______________________________________________________78 Second – hand Assets___________________________________________________________80 Enhancements Altering Value ____________________________________________________81 Modern Equivalent Asset________________________________________________________82



Surplus Assets ________________________________________________________________83 Educational Use Assets _________________________________________________________84

10 REFERENCES______________________________________________________________85 11 USEFUL WEB ADDRESSES ___________________________________________________86 12 LIST OF ABBREVIATIONS USED IN THE FINANCE MANUAL ____________________________87



1 Introduction

Purpose of the Manual

1.1 This edition of the Capital Accounting Manual (CAM) brings together guidance issued under the previous Health Authority, and NHS trust Circulars and is intended to complement the respective Manuals for Accounts, bringing together relevant capital related issues into one volume. It is applicable to all LHB’s and NHS trusts and replaces the Capital Charges and Trust Equivalent Manual – 1993/94.

1.2 This Manual therefore refers to all NHS bodies in Wales except where a treatment is specific to a certain type of entity. Similarly, term “revenue account” is used generically in place of ‘I&E account’ or ‘Operating Cost Statement’ (OCS).

1.3 Where differences in treatments exist between bodies, for example because of the NHS trust finance regime, then these will be highlighted in the text by boxes.

1.4 It is expected that this Manual will be, in the main, used by staff who are relatively conversant with accounting principles and are familiar with one of the Manuals for Accounts. The CAM will be of less value to staff operationally involved in maintaining asset registers, where locally produced procedure notes will be more appropriate.

1.5 The CAM interprets standard accounting practice for its application in the NHS context. In the rare event NHS bodies propose to set aside guidance in the CAM in order to present a “true and fair” view of their transactions, organisations must inform NAW contacts so that any further implications can be followed through with the Assembly’s central finance department, as departures from NAW’s set policies could result in qualifications of Accounts. The NAW should also be informed of any issues that may affect national policy, or require liaison with the Valuation Office Service, HM Treasury, or the Wales Audit Office.

1.6 Private Finance Initiative (PFI) transactions should also be accounted for in a manner consistent with the CAM and MFAs. Chapter 8 outlines the key issues and accounting treatments around PFI.

1.7 This Manual should be applied by all bodies unless specific exemptions apply as set out in the text.



2 The Capitalisation and Valuation of Fixed Assets

Introduction

2.1 FRS 15, Tangible Fixed Assets, has been applicable to the NHS from the 1999-2000 financial year. In the NHS, particular issues around valuation include:

• The fact that much of the NHS estate consists of specialised healthcare assets for which no true market exists

• The use of a current-cost basis of valuation, together with a capital charges system, which UK Generally Accepted Accounting Practice (UK GAAP) sometimes does not comprehensively address

• The existence of assets in the form of streams of future income or cost reduction, generated in the course of PFI schemes

• The importance of the finance/operating lease distinction because of the operation of Treasury controls over external financing and the implications of on and off-balance sheet items in capital charging.

2.2 A separate chapter, Chapter 4, deals with leases specifically.

General principles and definitions

2.3 FRS 5, Reporting the Substance of Transactions, defines assets as “rights or other access to future economic benefits controlled by an entity as a result of past transactions or events”. For NHS bodies “future economic benefits” relate to the contribution of assets in some way to the provision of services or other outputs.

2.4 Ownership of assets tends to confer access to the economic benefits, but circumstances exist where access to benefits is obtained without legal ownership (as in finance leases) and so in any consideration of the recognition of an asset the concept of “substance over form” must be adopted. Both FRS 5 and SSAP 21, Accounting for Leases and Hire Purchase Contracts, are therefore relevant.

Tangible fixed assets

2.5 FRS 15 defines these as:

“assets that have physical substance and are held for use in the production or supply of goods or services, for rental to others, or for administrative purpose on a continuing basis in the reporting entity’s activities”

2.6 A tangible fixed asset will always have a life in excess of one year.



Capitalisation threshold of fixed assets - de minimus limits

2.7 The HM Treasury Financial Reporting Manual (FReM) leaves discretion for individual government Departments to set their own capitalisation thresholds, having regard to practicality, flexibility, consistency and asset grouping considerations. The NAW has adopted a £5,000 capitalisation threshold for individual assets, although assets of lesser value should be capitalised if they form part of a group, with a group value in excess of £5,000, as defined below. The £5,000 figure includes VAT where this is not recoverable.

Grouped assets

2.8 "Grouped assets" are a collection of assets which individually may be valued at less than £5,000 but which together form a single collective asset because the items fulfil all the following criteria:

• the items are functionally interdependent

• the items are acquired at about the same date and are planned for disposal at about the same date

• the items are under single managerial control, and

• each individual asset thus grouped has a value of over £250, however this deminimus value does not apply in dealing with the initial equipping of hospitals. See para 2.16

IT assets

2.9 IT hardware may be considered interdependent if it is attached to a network, the fact that it may be capable of stand-alone use notwithstanding. The effect of this will be that effectively all IT equipment purchases, where the final three criteria above apply, will be capitalised. The effect of such a change may well not be material, given the rate of depreciation that would have been applied to prior-period purchases.

Interdependency

2.10 The distinction between assets that are in some way dependent on each other for their effective and efficient operation, and those that are “stand-alone” items can be a fine one. Where items are used within a system (eg trays of sterile instruments are designed to be used with a specific sterilisation system), those items are likely to be considered interdependent even though they also have a value in “stand alone” use.

Tangible fixed assets - expenditure to be capitalised

2.11 FRS 15 clarifies which costs can and cannot be capitalised on acquiring or constructing an asset. It says:

“A tangible fixed asset should initially be measured at its cost. Costs, but only those costs, that are directly attributable to bringing the asset into working condition for



its intended use should be included in its measurement.”

Attributable costs

2.12 Under FRS 15 “directly attributable costs” include:

• labour costs of own employees (e.g. site workers, in-house architects and surveyors) arising directly from the construction or acquisition of the specific asset. The costs of an NHS body’s capital projects department may only be allocated to individual capital schemes where it can be demonstrated that these costs relate to the production of a capital asset (and not its management or maintenance), and that the basis of apportionment is reasonable, and

• the incremental costs to the entity that would have been avoided only if the tangible fixed asset had not been constructed or acquired. These include:

◊ acquisition costs such as stamp duty, import duty and non-refundable purchase tax

◊ the cost of site preparation and clearance

◊ initial delivery and handling costs

◊ installation costs, and

◊ professional fees (such as legal, architects’ and engineers’ fees).

Non-attributable costs

2.13 The standard specifically says that the following are not directly attributable costs and so should be charged directly to the revenue, rather than capitalised:

• administration and other general overhead costs

• employee costs not related to the specific asset (such as site selection activities)

• operating losses that occur because a revenue activity has been suspended during the construction of a tangible fixed asset

• any costs relating to an off-balance sheet PFI scheme

• abnormal costs e.g. costs relating to:

◊ design errors

◊ industrial disputes

◊ idle capacity

◊ wasted materials, labour or other resources, and

◊ production delays.

2.14 Non-attributable costs should not be capitalised at any point and so should be charged to the revenue account. NHS bodies should be aware that controls on



capital to revenue virement are not permissible so proposals to fund non-attributable costs from capital funds must be discussed be avoided.

Interest

2.15 FRS 15 permits capitalisation of finance costs at the entity’s option. However, as a matter of policy, interest or finance costs may not be capitalised in the NHS.

Initial equipping and setting-up costs of new building

2.16 Assets which are capital in nature but which are individually valued at less than £5,000 may be capitalised (at NHS bodies discretion) as collective (or “grouped”) assets where they are acquired as part of the setting-up of a new building. In this context, the enhancement or refurbishment of a ward or unit should be treated in the same way as "new build", provided that the work would be considered as capitalisable “subsequent expenditure” in FRS 15 terms (see para 2.23 below). It may therefore be appropriate to capitalise the purchase of new furniture in a new build or refurbishment exercise, wherever practical/possible and based on the principle of materiality.

2.17 UITF Abstract 24 addresses the capitalisation of start-up costs associated with a start-up or commissioning period. It is mainly concerned with items that would be revenue expenses in normal circumstances (as opposed to those items that are capital in nature but treated as revenue because of their value). The UITF consensus is that costs that would be revenue expenditure in normal operations must be continued to be treated as such, and that any abnormal costs incurred simply by virtue of the start-up process also do not give rise to any asset.

2.18 This does not affect the practice of capitalising setting up costs in the NHS because the items so capitalised are capital in nature, but usually are taken to the revenue account only by virtue of their low value. The UITF Abstract refers to expenditure that is revenue in all circumstances, no matter what the value (e.g. training expenses, losses in trading, advertising and so on).



Demolition costs

2.19 Costs incurred in demolishing or rearranging existing assets should be capitalised where this is necessary to allow a new asset to be built. Where no new asset is to be created, these costs must be taken as revenue expenditure.

Staff training costs

2.20 As the nature of the investment is in staff rather then fixed assets directly, such expenditure should always be treated as a revenue expense.

Subsequent expenditure

“Subsequent expenditure to ensure that the tangible fixed asset maintains its previously assessed standard of performance should be recognised in the profit and loss account as it is incurred.” – FRS 15

2.21 Therefore, repairs and maintenance expenditure cannot be capitalised and

should be charged to the revenue account.

2.22 FRS 15 permits capitalisation of subsequent expenditure when:

• That expenditure provides an enhancement of the economic benefits of the tangible fixed asset in excess of its previously assessed standard of performance. (Therefore, this includes an element of betterment which leads to an improvement in service).

• A component of an asset that has been treated separately for depreciation purposes is replaced or restored, or

• Subsequent expenditure relates to a major inspection or overhaul that restores the economic benefits that have already been consumed and reflected in depreciation

Examples of betterment include

• Replacement of a flat roof with a pitched roof;

• Replacement of single paned glass with double glazing;

• Measures which contribute to the energy efficiency of an area;

• Capital works to comply with government legislation such as obtaining a fire certificate to allow compliance with Disability Discrimination legislation.

2.23 The second and third circumstances seem at first to conflict with the prohibition on capitalising repair and maintenance – an overhaul does not differ much in concept from routine maintenance. The essential differences however are that for such expenditure to be capitalised a separately identifiable component of an asset has to exist, having a substantially different economic life from the remainder of the asset. Alternatively the asset as a whole must have been depreciated in the light of the need for a periodic overhaul. In either case, the



expenditure must have the effect of reversing the consumption of economic value previously recognised in depreciation. A consequence of this of course is that a review of the asset’s expected economic life is triggered.

2.24 The FRS gives an example of an aircraft that must be completely overhauled according to a set timetable, and without that overhaul it has no economic life at all, as it would not be permitted to fly. The expenditure incurred in the overhaul thus extends its life, and can be considered as re-setting the depreciation clock. Such major overhauls tend to be in the nature of re-building, so are analogous to the creation of a new asset.

2.25 Capitalisation of maintenance expenditure would result in the carrying amount of the asset exceeding its recoverable amount (RA). On an impairment review or revaluation (see below) the normal consequence of this would be the recognition of impairment in the revenue account. Maintenance expenditure would thus fall to be treated as revenue expenditure even if initially, and erroneously, treated as capital.

Equipment

2.26 Equipment is initially capitalised at its purchase price. Second-hand equipment however should be taken onto the balance sheet at its purchase price and there will no longer be any entry under depreciation (see NHS Trust MFA Section B Chapter 10).

2.27 When a second-hand item is acquired, an assessment of its remaining economic life must be made to calculate the depreciation chargeable (see Chapter 3, Depreciation and Asset Lives).

Leases

2.28 Finance leases where the NHS body is the lessee will be accounted for as if the underlying asset is owned by that body. Chapter 4 below deals with leases.

Donated assets

2.29 Donated assets are brought to account in the same way as purchased assets, at cost if newly purchased or constructed, then revalued to a current cost valuation. They are valued, depreciated and subject to impairment in the same way as other assets. The donated asset reserve is used however in such a way as to remove donated assets from capital charges calculations (see Chapter 3 below on depreciation and Chapter 5 on capital charges).

2.30 Where a donor has contributed to part of an asset, only that proportion falls to be treated as a donated asset. It is possible therefore for an individual asset to be partly donated and partly purchased, with separate accounting entries associated with each.

2.31 For an asset to be treated as donated, the following condition must apply:



• There should be no consideration given in return (thus the donor, or individuals or organisations nominated by the donor, may not be offered preferential treatment or other advantages or benefits).

2.32 The following examples do not qualify as “donated”:

• An asset transferred between public bodies as a result of a transfer of functions (unless the asset was legitimately a donated asset in the transferor’s books.

• Government grants (see below)

• Subsequent capitalised expenditure on a donated asset

• The provision by a developer of an access road or transport scheme that will benefit the developer’s business. Any asset provided as part of a PFI scheme by the developer cannot be considered as donated.

2.33 Any restrictions imposed by the donor on the use of an asset must be disclosed in the annual accounts.

Assets transferred between NHS bodies

2.34 Assets will transfer between NHS bodies in a variety of circumstances. The accounting bases in respect of valuation are common to the NHS as a whole, so it is appropriate to recognise the asset in the receiving body at the same book value at which it was carried in the original NHS body. There will generally be no need to revalue assets on such transfers. Where an asset is demonstrably inaccurately valued in the original body’s books (e.g. an impairment review has identified that the carrying amount of the asset is greater than its recoverable amount - see paragraphs 2.111 –2.152 below for guidance on impairments) it will be appropriate to revalue prior to transfer. The key point however is that any revaluation is accounted for as an in-year transaction in either the donor's or recipient's books - a revaluation cannot occur "invisibly" at some stage after leaving one balance sheet and appearing in another.

2.35 The term ‘transfer’ is loosely used in the NHS, and care must be taken that “purchase and sale” transactions are not just described as ‘transfers’ of assets. This improper use of ‘transfer’ could lead to the need to organise cash funding flows and PDC payments being overlooked.

2.36 As a matter of principle, where assets transfer between an existing NHS trust and any other body, the transfer must be effected by a cash sale and purchase. This is vital to permit NHS trusts’ PDC to be correctly handled.

2.37 A NHS trust will only transfer assets without a cash transaction in two circumstances:

• the trust dissolves, and its assets pass to a successor organisation

• Donated assets transfer along with the associated Donated Asset Reserve .



2.38 Assets acquired from other Government departments, Local Authorities and other non-NHS bodies, should be purchased at fair value.

2.39 Where transactions are between NHS bodies and third parties, NHS bodies are required to value assets scheduled for disposal at open market valuation for alternative use.

Assets funded from National Lottery funds

2.40 Assets provided from National Lottery funds (via the “Big Lottery Fund”) should be treated as donated assets.

Government grants

2.41 SSAP 4, Accounting for Government Grants, applies in the case of government grants. Grants may be received from the European Union, Local Government or Government Departments from time to time. Government grants are defined in the Standard as “assistance by government in the form of cash or transfers of assets to an entity in return for past or future compliance with certain conditions relating to the operating activities of the enterprise”. This definition does not cover funding from Parliamentary Vote, i.e. in the form of capital (or revenue) allocations, so in this context any funding provided by the NAW must be accounted for as financing as appropriate (for NHS trusts it should be accounted for as either income or PDC financing as appropriate) and not as a grant.

2.42 Assets provided by grant will be treated as any other asset. The asset will be carried at its current cost, and the value of the grant must not be netted off its carrying amount.

2.43 The amount of the capital grant should be credited to a government grant reserve on the balance sheet. Assets financed in whole or in part by a grant should be revalued and depreciated in the same way as other fixed assets. To the extent that a proportion of a fixed asset has been financed by a grant, that proportion of the amount of the revaluation should be credited or debited to the government grant reserve instead of the revaluation reserve. The same proportion of the asset’s depreciation charge will be debited to the government grant reserve and credited to the revenue account (any depreciation arising from capital expenditure in excess of the grant will thus, rightly, go unrelieved). There will be no cost of capital charge in respect of the proportion of the asset financed by grant. The net effect is analogous to treating the grant-aided portion of the asset as “donated” – it is exempted from capital charges.

2.44 Details of the depreciation and capital cost absorption treatments can be found in Chapters 3 and 5 below.

Intangible fixed assets - capitalisation

Research and development



2.45 SSAP 13, Accounting for Research and Development, applies in full. Essentially, capitalisation of research and development (R&D) expenditure is appropriate only in the following circumstances:

• There is a clearly defined project

• The related expenditure is separately identifiable

• The outcome of the project has been assessed with reasonable certainty as to:

• its technical feasibility, and

• its resulting in a service or product that will eventually be brought into use

• Adequate resources exist, or are reasonably expected to be available, to enable the project to be completed.

2.46 It can be seen from the above that in most cases R&D expenditure will be charged to the revenue account in the year in which it is incurred.

2.47 If capitalised, the asset must be amortised over the period in which the product or service will be sold or provided for use.

2.48 All capitalised development expenditure must be indexed (as set out in the FReM). The index figure to be applied is that for equipment.

2.49 A review of the asset and the justification for maintaining it as an asset must be undertaken each year. Where the SSAP 13 criteria are no longer met, the balance of the expenditure should be written off to the revenue account immediately.

Software

2.50 A purchase of any software is essentially the purchase of a licence to use software code developed by, and which remains the property of, a 3rd party. NHS developed software has always been capitalised (and should still be capitalised as a tangible fixed asset) if the NHS body owns the code such that it could copy and sell the application at its discretion.

2.51 Under FRS 10, Goodwill and Intangible Assets, software that remains the property of, for example, Microsoft should be capitalised if the user has bought the right to enjoy the economic benefits of the use of the software for more than one year. Intangible fixed assets (eg software licenses) held for operational use are valued at historic cost and indexation should not be applied.

2.52 The provisions of this Manual on the capitalisation limit and grouping of assets apply to the capitalisation of expenditure on software. As with IT hardware, it is expected that software used on a network will meet the “interdependence” criterion for the grouping of fixed assets.

2.53 The Accounting Policies note to the Annual Accounts discloses that intangible assets are amortised over estimated lives (and in fact, following FRS 15,



standard lives are no longer prescribed for assets in general). It is believed that software assets will tend to have relatively short lives, but this is a matter for an individual body’s judgement. A further complication affecting amortisation might be the practice of upgrading software rather than scrapping it completely. It will be difficult to assess a residual value in this case, so the treatment must depend on individual circumstances, taking into account contractual arrangements and the body’s IT strategy.

Goodwill

2.54 Goodwill does not arise in the NHS as there can be no internally generated goodwill, nor can a NHS body acquire goodwill as a result of the purchase of a subsidiary undertaking or business.

Deferred assets in PFI schemes

2.55 Some PFI transactions involve the disposal of NHS assets to private partners (by lease, sale or otherwise as part of the deal). Unless a NHS body has in substance disposed of the asset at undervalue or for no consideration (in which case a loss on disposal must be recorded in the revenue account) it is to be expected that some benefit will accrue to the NHS in return. This implies that an asset of some kind must have been created in return for the exchange of the original NHS asset. Chapter 8 gives more detail on PFI accounting.

2.56 Where land is "transferred" to the private sector partner for subsequent sale, this will usually be in exchange for a reduction in rental payments. Cash may similarly be injected in exchange for a reduction in payments where the land becomes available later in the contract period. A calculation of the present value of the reduction in payments should be made and this should be present as a prepayment within debtors and written off to the revenue account over the period of the service payment reductions (normally the contract period, i.e. not necessarily the life of the lease). Where buildings are leased to the private sector which are integral to the PFI scheme and the private sector take the risks and rewards, the deferred asset is equivalent to the existing use value of the buildings (i.e. net present value of a reduction in payments) and the write-off to the revenue account in this case will be over the life of the lease.

2.57 For the purposes of this Manual however, it should be noted that these deferred assets are not fixed assets, and should be accounted for as prepayments within current assets. As current assets, they should be included within net relevant assets for the purposes of calculating the cost of capital charge.

Measurement and valuation

General Principles

2.58 As noted above, whether acquired or self-constructed, a tangible fixed asset should be measured initially at cost. Government accounting policy is to



revalue tangible fixed assets systematically (see below) to ensure that assets are carried on a current cost basis.

Net currentreplacement cost

(RC)

Net realisableValue(NRV)

Value in use

Valuation of Tangible Fixed Assets

lower of:

higher of:

Recoverableamount (RA)

2.59 Tangible fixed assets should be valued at the lower of replacement cost and

recoverable amount.

2.60 Replacement cost (or net current replacement cost) for land and buildings is existing use value. For specialised properties, depreciated replacement cost (DRC) should be used. (A specialised property is of a type that is rarely sold on the open market for continuation of their existing use. FRS 15 mentions hospitals and other specialised health care premises as examples of properties that may be considered specialised.)

2.61 For equipment assets, depreciated replacement cost is the appropriate measure. A “modern equivalent asset” calculation may be used in the circumstances described below.

2.62 Recoverable amount is defined as the higher of net realisable value (NRV) and value in use, where:

2.63 Net realisable value (NRV) is the actual or expected sale proceeds realisable on the open market, net of selling expenses etc.

2.64 Value in use is the cost of replacing the asset’s service potential. For specialised property this can be taken to be the depreciated replacement cost of the asset. Given that the NHS exists to provide services rather than generate income streams (other than of course in income-generation activities), the commercial context of “value in use” (as set out in FRS 15) is not helpful.

2.65 Other (non-property) tangible fixed assets’ value in use will be DRC.

Surplus assets



2.66 Surplus non-operational property should be valued at open market value (OMV), less directly attributable selling costs, where material. District Valuers now provide valuations based on OMV for “prevailing use”, i.e. having regard to the likely use to which the asset would be put in the locality, bearing in mind the planning regime ruling in the area.

2.67 For an asset to be treated as "surplus" two conditions must apply:

• there is an explicit intention to dispose, eg a Board Decision

• the asset is not in operational use.

2.68 Where the former alone applies and the asset remains in use until the disposal date, accelerated depreciation is applied to the asset that remains on the balance sheet at a DRC valuation (if specialised). The asset will then be depreciated to its expected realisable value at the date of disposal. Assets temporarily out-of-use continue to be valued and depreciated as normal.

Modern equivalent asset

2.69 The normal basis of valuation may not be appropriate if a modern substitute is markedly different in cost, or where technological advances have resulted in likely replacements having significantly improved quality or quantity of outputs. Under such circumstances, it is necessary to undertake a modern equivalent asset calculation to arrive at a satisfactory replacement cost.

2.70 The following considerations apply:

• the cost of the modern equivalent asset is at least £100,000

• the difference between the replacement cost of the existing asset and that of the modern equivalent asset is at least 25%.

2.71 Use of this adjustment is expected to be exceptional. The assumptions used must be recorded and agreed with external auditors, particularly where those assumptions relate to differences in quality rather than quantity.

2.72 Where these circumstances apply, the replacement cost of the existing asset should be taken as a proportion of the cost of the modern equivalent asset and not the cost of replacing the existing asset. The modern equivalent asset adjustment reduces the cost of the modern equivalent asset to what it would be if it had an output comparable to the existing asset. The reduction in the NBV should be charged to the revenue account as an impairment and not to the Revaluation Reserve. This is because the reduction is a permanent diminution in the value of the asset (see paras 2.111-2.141 on impairments).



2.73 The accounting entries are:

Dr Revenue account Cr Fixed assets

With the reduction in the replacement cost of the existing asset

Dr Provision for depreciation account Cr Revenue account

With the amount of the reduction in the accumulated depreciation on the existing asset

The net amount charged to the revenue account will, therefore, be the reduction in NBV of the existing asset

Example: modern equivalent asset (MEA) calculation

Assuming no operating cost or economic life differences between the existing and MEA, in £s:

Output of existing asset p.a. - 20,000 units Output of MEA p.a. - 40,000 units £ Replacement cost of existing asset 150,000 Accumulated depreciation, existing asset 60,000 NBV existing asset 90,000 Cost of MEA 220,000 Calculation of MEA cost (for same output as the existing asset):

220,000*(20,000/40,000) 110,000 The replacement cost of the existing asset thus becomes 110,000 – a reduction of 40,000 from its present RC of 150,000. The accumulated depreciation therefore needs to be reduced in the same proportion (110/150)* 60,000 = 44,000. Hence:

Revised RC of existing asset 110,000 Revised accumulated depreciation on existing asset 44,000 Revised NBV of existing asset 66,000

2.74 The reduction in the gross replacement cost of 40,000 is debited to the revenue

account, while the written-back depreciation of 16,000 is credited to the revenue account, giving a net charge of 24,000 (being the net fall in the asset value as an impairment).

Valuations, review and impairments

2.75 Initial valuation of tangible fixed assets is at cost. The NHS adopts a policy of revaluation within the meaning of FRS 15, and must consistently apply revaluation policies to each asset within a given class of assets. A tangible fixed asset’s carrying amount at the balance sheet date should be its current value, as calculated below. For land and buildings, the revaluation from cost should take place as soon after the date of acquisition or commissioning new build as possible, and at any event before the end of the financial year in which the asset is acquired or created.

2.76 The Government's policy on the revaluation of land and buildings in the NHS is to fully revalue every five years, and thereafter to revalue by means of applying indices in each of the intervening years. FRS 15 allows a measure of discretion



for public sector and not-for-profit organisations to set their own revaluation policies, having regard to the costs involved.

2.77 Equipment assets are also indexed to maintain a current cost (at depreciated replacement cost).

2.78 Intangible fixed assets are generally not revalued or indexed but maintained at cost less depreciation or amortisation unless they have a readily ascertainable market value, in which case the market valuation is used. Capitalised development expenditure, however, must be indexed (see para 2.48).

2.79 Revaluations of individual assets may be required where there are material changes outside the 5-yearly cycle. Typical examples are:

• A newly constructed asset is first brought into use

• There is an indication that tangible fixed assets may have suffered impairment (see below), or

• Property has been subject to significant enhancement expenditure, or

• There has been a change of use or level of utilisation of an asset, or

• A “modern equivalent asset” calculation is indicated (see above), or

• An asset is to be taken out of use, or is surplus to needs.

2.80 Assets under construction are indexed in the same way as completed buildings. The carrying amount of an asset under construction must be reduced if it becomes apparent that fruitless payments (which are reported in the losses register) have been incurred or other costs have been inappropriately capitalised.

Ad-hoc ‘housekeeping’ revaluations

2.81 FRS 15 requires that where a tangible fixed asset is revalued, all the assets in the same class must be revalued (para 61). The ad hoc revaluation of individual assets on a good-housekeeping principle is not therefore permissible. Clearly individual assets will still be valued singly in the event of their being impaired or their valuation bases being changed (e.g. from cost to DRC or DRC to OMV on commissioning or disposal respectively).

Valuers and Disclosures

2.82 The 5-yearly national revaluation exercises for the NHS have been carried out by the District Valuation Service, which thus maintains records and has built up experience and established a consistent approach to the valuation of NHS properties. The assumption in this Manual is that District Valuers (DV) will also carry out any interim valuations required, although NHS bodies have the freedom to commission such work from other suitably qualified valuers. The standard disclosure of accounting policies (Note 1) in the Manual for Accounts covers the 5-yearly DV revaluations. In the event of revaluations of a class of assets outside the course of the 5-yearly cycle the full disclosure provisions of FRS 15 must be followed.



Non-specialised land and buildings

2.83 Where it is possible to value a property in the context of an active market in that type of property in the locality, the District Valuer will attach an open-market value for existing use (OMVEU), as defined in Annex 1 below, to the property. In effect, this should be the default valuation policy as it gives a clear understandable valuation figure. The existence of a vast specialised estate in the NHS, however, confines the use of OMVEU to such properties as residential accommodation, office buildings and car parks.

2.84 All assets valued at OMV (whether operational or non-operational) are indexed on April 1 each year, using the indices provided by the Valuation Office Service (see below) to maintain their current cost carrying value.

Specialised land and buildings

2.85 FRS 15 and the FReM produced by HM Treasury require specialised assets to be valued on a depreciated replacement cost basis (DRC), as defined in annex 1 below. It is accepted that this valuation base is something of a proxy for a more clear-cut (e.g. OMV) basis of valuation.

2.86 Certain assumptions inherent in the DRC valuation methodology lead to DRC valuations invariably being lower than the initial cost of new buildings. Although inefficiencies and cost over-runs (“abnormal costs”, under FRS15) cannot be capitalised, even as part of initial costs, certain other costs associated with capital projects are legitimately capitalised initially, yet are not taken into account in arriving at DRC. Examples of these might be the cost implications of contractors having to work in an occupied site, or the necessity to put in access roads; the cost of having multiple contracts and phases to construct one building; and the additional cost of inclement weather. These assumptions are currently under review.

2.87 It is expected that the action of revaluing from cost to DRC will produce a fall in value/impairment. In line with Treasury agreement, any fall in difference between capital cost and carrying value should be taken to the Revaluation reserve for new assets.

2.88 The DRC valuation methodology employed by the Valuation Office Service analyses property by approximately 25 separate “elements”, based on the Building Cost Information Service (BCIS) definitions. Certain elements (e.g. substructure, roof, stairs, windows and external doors) relate to the buildings themselves, while others (water, electrical, heating, lift installations) relate to plant or engineering.

2.89 While NHS bodies may wish to track various elements in their registers separately, it is suggested that for the purposes of impairment reviews and tracking revaluation reserve balances associated with discrete assets, the asset unit should be the building as a whole. Clearly, separate wings or blocks of a building might have been added at different times, and be capable of being treated as separate assets, or indeed major elements of plant may have depreciation lives so different from the structure as to merit treatments as



separate assets under FRS 15. Some judgement in defining “an asset” will therefore need to be exercised. It is suggested that any block or asset capable of separate valuation, or disposal or demolition, is treated as a discrete asset (so the elements of a block would not be assets in FRS 11 terms, whereas the block itself would be).

2.90 An exception to this general rule is land included in property. Because land and buildings asset movements are reported separately in Notes to the Balance Sheet, impairments and revaluations need to be apportioned between land and buildings, rather than being assigned to the property asset as a whole.

Equipment

2.91 Equipment is carried at depreciated replacement cost. In practice, it is sufficient to apply indexation and depreciation to the historic cost of the equipment asset. The “modern equivalent asset” calculation may come into play in exceptional cases where technological advances mean that a replacement asset of similar productive capacity would be materially different in cost, such that indexed historic cost exceeds the recoverable amount.

Indexation

2.92 Indexation is intended to maintain assets at current cost values without the expense of frequent revaluations. Indexation is a form of revaluation, and although identified separately in asset registers and reported in a separate line in the Notes to the accounts, it is treated in accounting terms as such.

2.93 Indices are provided by the Valuation Office Service and are based on data available from the Building Cost Information Service (BCIS) and the Valuation Office Property Market Report.

2.94 Indices for a given financial year are published in allocations working papers issued to trusts and LHB’s part of the capital charge estimate (CCE) exercise in the preceding September. Indices are intended to reflect price movements anticipated over the course of the following financial year. Thus, although they are applied to opening asset values as at 1 April, they are intended to provide acceptable values for the year-end balance sheet.

2.95 All tangible fixed assets other than IT fixed assets, operational and non-operational (including assets held under finance leases and assets under construction), should be indexed on 1 April each year. The situation sometimes arises where an asset is to be disposed of, and is valued for that purpose in one year while the transaction does not actually take place until the next. This can result in a loss on disposal if the contract sale price is set at the valuation amount and indexation is then applied on the following 1 April - the carrying amount will exceed the sale proceeds.

2.96 NHS bodies should always ensure that assets are not sold to third parties at undervalue, and so will obtain a valuation to establish a fair price on the date of sale. If this is done, and it can be demonstrated to auditors that the most recent



valuation does indeed represent a fair value on the date of sale, it is acceptable for that particular asset not to be indexed at 1 April. The best course of action will be to instruct the valuers to make the best estimate of value at the anticipated date of sale. Clearly it would not be acceptable to rely on an out-of-date valuation to set a contract price, and indexation may only be set aside in this way if the dates of valuation and sale are close (say, within 6 months) and fall either side of the year-end.

2.97 When assets transfer between NHS bodies on 1 April, the transfers should take place before indexation. For example, if assets are brought onto LHB balance sheets from the NHS trust sector on 1 April, the transactions should take place before the NHS trust has indexed the assets. A full year’s indexation should then be applied in the LHB.

Applying indexation

2.98 The series of indices applied in the NHS to date is shown below:

2001

/02

2002

/03

2003

/04

2004

/05

2005

/06

Land

115 140 148 100 105

Buildings

161 184 202 218 222

Equipment

132 136 139 142 145

Notes to table:

1. For land and buildings, detailed regional figures were used in the early years (1992/93 and 1993/94). Rather than reproduce a complex table of indices by geographical areas, a national index has been estimated using an average for these two years.

2. As an example, the uplift to be applied to building values on 1 April 2002 is:

[(184-161)/161]*100 or 14.286%

Surplus assets and disposals

General

2.99 Where an asset is disposed of, it is important to treat the following transactions as separate and distinct events:

• revaluation to the appropriate carrying amount

• recognition of impairment



• re-profiling of depreciation (only required where there is a time delay between declaring the asset surplus and disposing of it)

• recognition of profit/loss on disposal.

The demolition or scrapping of a building or a piece of equipment is a disposal for no consideration (see para 2.101). Similarly, the transfer of an asset to a non-NHS body is also a disposal, and if no valuable consideration is received in return, a loss on disposal arises (equal to the final carrying amount of the asset).

2.100 Profit/loss on disposal is always calculated as the difference between the final carrying amount and the disposal proceeds (i.e. calculated after any impairment has been recognised).

2.101 Note: the final carrying amount of a building is its open market valuation for alternative use (OMVAU) as assessed by the District Valuer. The DV will have regard to the building's type and condition, property market and planning conditions prevailing locally. This value should not be set to NIL simply because it is intended to demolish the building, or because a deal has been struck to transfer the property for no consideration. Revaluation to NIL should not be used to avoid losses on disposal where an asset has a value, but a management decision results in its destruction or transfer.

2.102 Land and buildings sold together as "property" will attract separate valuations and impairment reviews. Revaluations and profit/loss on disposal calculations will therefore give rise to separate sets of figures for both land and buildings.

2.103 Where equipment is taken out of productive use its value should be written down to its recoverable amount, which in turn (as the asset is not in use) will be its net realisable value. The valuation fall is analogous to the recognition that the asset has been under-depreciated during its period of use, and so the fall should be accounted for as an economic impairment (see paras 2.111-2.141 below).

2.104 Surplus land and buildings not in operational use should be revalued to open market value for alternative use (District Valuers attach valuations based on the “prevailing use” concept, having regard to the likely use to which property sold in the locality could be put).

2.105 Property may be considered as “surplus” when a management decision has been taken to dispose of it. The decision is best evidenced by Board minutes recording a decision, but auditors may accept other written evidence or representations about the status of property.

2.106 Property thus classed as surplus, but still in operational use, must not be written down to OMV for alternative use. It should remain in the balance sheet at its normal operational valuation (DRC, or OMVEU as appropriate). The depreciation charge should however be adjusted such that the asset is fully depreciated to its disposal OMV (equal to its expected net realisable value) over its remaining life in the NHS body (see Chapter 3 - Depreciation).



2.107 The matrix below summarises the transactions:

In operational use

Not in operational use

Not surplus

Carry at DRC (if specialised) Or

carry at OMV for existing use (if market value available)

If temporarily not in operational use treat as in operational use

surplus

carry at DRC or OMVEU as above and

revise depreciation profile to reach OMV for alternative use by disposal date

Revalue to OMV for alternative use and consider economic impairment.

Cease to depreciate

2.108 The term “accelerated depreciation” is used in this Manual to describe “ordinary” depreciation that merits special comment and handling only because its size may have a materially distorting impact on an entity’s financing and revenue performance. Directors of Finance are required to review assets’ expected economic lives at the end of each accounting period (FRS 15) and so adjustments to depreciation profiles will be frequent in the normal course of events. Although accelerated depreciation is similar in nature to an impairment loss (representing the consumption of economic benefits over a period), it is accounted for as depreciation, not impairment. Accelerated depreciation should be included in Capital Charge Estimates and fully recovered in tariffs in the normal way, but it is accepted that in some instances the higher depreciation charge will arise after the CCE exercise and after the SAFF has been agreed. For the year preceding that for which the full depreciation charge can be dealt with via CCEs:

Any LHB or Trust that identifies additional pressures for accelerated depreciation should contact the NAW to establish whether an adjustment to its Revenue Resource Limit/Capital limit is available to cover the additional cost caused by the accelerated depreciation.

2.109 Where accelerated depreciation is calculated in this way, the OMV to be used is

that of an asset of the same age at the present time, and no attempt should be made to predict the OMV at the time of planned disposal. In times of inflation then, it is to be expected that the OMV thus established will be lower than the OMV ruling at the actual date of disposal, and this may then give rise to a profit on disposal. NHS bodies need to take care that an OMV set in the past is not assumed to be a fair market price for setting contract terms.

2.110 Where there is uncertainty about the date an asset will be taken out of operational use, LHBs and NHS trusts may wish to maintain an assets life and depreciation profile unchanged, recognising an economic impairment in the year in which the asset is actually taken out of service.

Impairments

Requirements of FRS 11



2.111 The main objective of FRS 11 is to ensure that all impairment losses (losses of value of fixed assets below their carrying amounts) are recognised immediately in the financial statements, whether an impairment is expected to be temporary or permanent.

2.112 Much of the detail of FRS 11 is concerned with the identification of "income-generating units" (as defined by FRS 11) and the measurement of value in use (the present value of cash flows from the use of an asset). None of that detail is repeated here because it is lengthy and, in the NHS, will apply only to impairment losses of fixed assets dedicated to income generation activities.

2.113 The full text of FRS 11 should be consulted where there is an indication of impairment concerning an asset dedicated to income-generation activities.

Indications of impairment

2.114 Impairment occurs because something has happened to a fixed asset itself or to the economic environment in which it is used. A review for impairment of a fixed asset should be carried out if, and only if, events or changes in circumstances indicate that there has been an impairment.

2.115 Indications of possible impairment include:

• the asset is to be sold

• the asset cannot be used for any reason

• the asset is surplus to requirements

• a newly constructed asset is brought into use

• the asset is overspecified for its current use

• there is a fall in value on indexation or on 5-yearly revaluation

• there is evidence of obsolescence or physical damage to the asset

• there is a commitment by management to undertake a significant reorganisation and fixed assets are involved.

2.116 An indication of impairment does not necessarily mean there has been an impairment but it should prompt a review of the value of the asset, its useful life and its residual value (if any). A review of the useful life and residual value is appropriate even if the review of the asset value shows that it has not been impaired.

2.117 A fall in value of an asset when it is initially re-valued from cost to Depreciated Replacement Cost could be due at least in part to the assumption of ideal conditions underlying the present method of depreciated replacement cost valuations. (A review is being carried out by the Valuation Office to determine a refined approach to valuations, based on assumptions of average conditions. This would reduce the size of impairments on bringing newly constructed assets into use. However, it would increase the value of assets generally and the implications of this will be considered as part of the review). Unless and until the approach to valuations is refined, the fall in value on revaluation of a new



asset from cost to DRC will not be treated as an economic impairment. The correct treatment is to take the revaluation fall to the revaluation reserve, even though that inevitably creates a negative reserve in respect of the particular asset.

2.118 Related to this, it should be noted that construction inefficiencies are not valid costs of building an asset and hence should not be capitalised at all. Instead they should be written off directly to the revenue account.

2.119 Planned disposal of an asset does not necessarily indicate impairment. Where there is the intention of disposing of an asset on a planned date, the depreciation charge must be adjusted so that the asset is written down to its expected realisable value on the planned sale date. The revised depreciation should be included in capital charge estimates at the first opportunity.

Impairment review

2.120 An impairment review compares the carrying amount of an asset with its recoverable amount, where recoverable amount is the higher of net realisable value and value in use (see diagram following para 2.58 for further details).

2.121 Net realisable value is the amount for which an asset can be disposed of, less any direct selling costs. Direct selling costs include legal costs and the costs of removing a sitting tenant but they do not include reorganisation costs e.g. redundancy costs linked to the sale of a property.

2.122 FRS 11 defines value in use as the present value of the future cash flows from the asset's continued use. However, it adds that, where a fixed asset is not held for the purpose of generating cash flows, an alternative measure of its service potential may be more relevant. HM Treasury have interpreted this for the public sector, stating that, other than for commercial profit-making services (which should follow FRS 11 in full) value in use will be assumed to be at least equal to the cost of replacing the service potential provided by the asset. The cost of replacing the service potential of operational assets in the NHS is existing use value or, if such a value is not available (as is the case for specialised property) depreciated replacement cost.

2.123 An impairment review of a NHS asset therefore usually compares the carrying amount of the asset with the higher of existing use value/depreciated replacement cost and net realisable value. However, if an asset cannot be used or is surplus to requirements, the impairment review compares the carrying amount of the asset with net realisable value only, since there is no value in use. Where an asset is over-specified for its current use, the impairment review compares the carrying amount of the asset with the higher of net realisable value and the existing use value/depreciated replacement cost of an asset of the lower specification.

Recognition of impairment losses



2.124 As in the application of all Financial Reporting Standards, impairment losses need only be recognised (i.e. accounted for) when they are material. The following paragraphs relate to material impairment losses.

2.125 If an impaired asset has not previously been indexed or revalued whilst held (even if previously held and indexed/revalued by another NHS body) the impairment loss should be recognised in the revenue account. The exception to this principle relates to newly constructed buildings that attract a first DRV valuation that is invariably lower than cost (see para 2.141 et seq).

2.126 If the asset has been previously indexed or revalued whilst held, the place to recognise the loss depends on its cause. In principle, impairments of revalued fixed assets fall into two general groups:

• those that are “clearly caused by a consumption of economic benefits”, and

• those caused by a general fall in prices.

2.127 The first type is similar to depreciation and is treated in the same way i.e. recognised in the revenue account. The second type is a valuation adjustment, which falls to be recognised in the Statement of Recognised Gains and Losses (SRGL) until the credit balance in respect of that asset on the Revaluation Reserve is used up, after which it should be recognised in the revenue account.

2.128 However, FRS 15 says that if it can be demonstrated that the recoverable amount of the asset remains higher than the revalued amount, the whole of the fall can be charged to the SRGL (see below, para 2.137).

2.129 In practice, it can be difficult to allocate an impairment to one of the two groups with certainty. FRS 11 states that where there is doubt it should be treated as one caused by a general fall in price i.e. the impairment loss should be recognised in the SRGL until the balance in respect of that asset on the revaluation reserve us used up, after which it should be recognised in the OCS/I&E account.

2.130 Having dealt with the effects of price changes annually, as above, it will usually be appropriate to treat any other type of impairment as a clear consumption of economic benefits, with a consequent charge to the revenue account.

Losses of economic benefit

2.131 Impairment losses resulting from the indications listed above (para 2.106) are losses of economic benefits and should be recognised in the revenue account. If in such cases there is a credit balance for the asset on the revaluation reserve, a transfer from the revaluation reserve to the I&E reserve or General Fund should be made equal to:

• The amount of the impairment, or

• The credit balance on the revaluation reserve for the asset, if lower.



2.132 Adjustments to the I&E reserve do not affect breakeven performance for NHS trusts.

Price falls

2.133 Fixed assets within the NHS are indexed annually and property assets are professionally revalued every five years. Indexations purely reflect price changes and the 5-yearly revaluations check the accuracy of the national indices applied in the circumstances of an individual asset, as well as picking up any other changes in the asset.

2.134 If a fall in value on a 5-yearly revaluation is found to be due to a consumption of economic benefits, it should be charged to the revenue account. This, however, should be rare, as an indication of an impairment should prompt an immediate impairment review rather than being left until the 5-year point to be identified.

2.135 If a fall on routine revaluation is not due to a clear consumption of economic benefits, or there is a fall in value on indexation, the general rule is that it should be charged to the SRGL until the balance in respect of that asset in the Revaluation Reserve is used up, after which it should be recognised in the revenue account. However, FRS 15 says that, if it can be demonstrated that the recoverable amount of an asset remains higher than its revalued amount, the whole of the fall in value can be charged to the SRGL. It is acceptable for some temporary negative revaluation reserve balances to be created in these circumstances.

2.136 HM Treasury has stated that, for not-for-profit activities, recoverable amount will be taken as being greater than the revalued amount if it can be demonstrated that:

• The fall in value has not been caused by a consumption of economic benefits

• For assets valued at a market based valuation (e.g. EUV) the reduction is short-term and informed opinion is that it will be reversed in the medium term

• For assets held at DRC changes in technology in the sector are small so that any falls are likely to be short-term.

2.137 If, subsequently, it is decided that any part of the downward price movement is in fact permanent, an adjustment between the revenue account and the revaluation reserve should be made in the current accounting period.

Newly-constructed assets

2.138 On bringing a newly constructed (building) asset into use there is invariably a significant fall in value. If this is due to a loss of economic benefits it should be charged to the revenue account. However, it is more likely that the fall is due to the present approach to depreciated cost valuations which assumes ideal



construction conditions (with, for example, the costs of site works and contingencies not being reflected in present DRC valuations).

2.139 If the fall in value is due to the application of the DRC valuation methodology alone, and costs had been legitimately capitalised as under FRS 15, it should be recognised in the SRGL. Negative revaluation reserve balances will inevitably arise - these are acceptable. A Valuation Office review of the DRC basis is currently underway, and any changes that might be made in consequence would be expected to reduce impairments on completion of new-build.

2.140 Related to this, it should be noted that inefficiencies in construction are not valid costs of construction and so should not be capitalised at all. They should be written-off to the revenue account when recognised. FRS 15 lists as examples of "abnormal costs" not to be capitalised: design errors; industrial disputes; idle capacity; wasted materials, labour or other resources; and production delays.

For NHS trusts, fundsflows are not allowed in respect of abnormal costs.

Enhancement expenditure

2.141 Expenditure legitimately capitalised in enhancing an owned or leased asset is treated in the same way as that incurred in constructing a new asset. It follows that revaluation to DRC on completion of the work may produce valuation falls (impairments) just as revaluation of new-build generally results in a fall. The accounting treatments of impairments are the same in both cases.

Revaluation reserve balances

2.142 It is important to be able to relate balances taken to the Revaluation Reserve with their associated assets. All NHS bodies will therefore need to ensure that they have systems in place to enable Revaluation Reserve balances to be analysed to the level of individual assets. Para 2.79 above defines, as far as possible, an "asset" in the context of revaluation reserve apportionment and impairment calculations.

2.143 When an asset is disposed of the balance on the Revaluation Reserve in respect of it should be transferred to the General Fund/I&E Reserve. Since "price falls" and newly-constructed asset "impairments" are taken to the revaluation reserve, debit entries for individual balances are allowed on this reserve.

2.144 Further, UK GAAP requires a transfer to be made from the revaluation reserve to the General Fund/I&E Reserve where an asset, although carrying a positive revaluation history, suffers a loss of economic value.

“FRS 11 says that a revaluation loss is to be recognised wholly in the profit and loss account if it is caused by a “clear consumption of economic benefits” …… this is equated to an impairment, and accordingly the whole deficit should be charged to the profit and loss account as an operating charge analogous to depreciation. This applies even if the asset was previously



valued upwards and is still worth more than its depreciated historical cost. If the deficit against carrying value is charged to the profit and loss account any corresponding credit balance in the revaluation reserve relating to that asset will be transferred to the profit and loss account as a reserve movement”.

Donated assets, Big Lottery Fund (New Opportunities Fund) and Government Grants

2.145 Similar approaches to those above should be adopted for donated assets and assets provided by a grant from the Big Lottery Fund, using the Donated Asset Reserve or Government Grant Reserve (GGR) instead of the Revaluation Reserve, except that:

• where an impairment loss can be recognised in the SRGL in the first instance the balance of the loss should be recognised in the revenue account when the Donated Asset Reserve or GGR has been reduced to the value at which the asset was first taken on

• where an impairment loss is recognised in the revenue account, an offsetting transfer should be made to it from the Donated Asset Reserve or GGR.

2.146 As price movements impact on the donated asset reserve, and economic losses taken to the revenue account result in the transfer noted above, the donated asset reserve in respect of a particular asset will continue to equal its carrying amount.

2.147 Similar treatment is required for assets financed by Government Grants, where the transfers will be from the Government Grant Reserve.

Reversal of past impairments

2.148 A debit to the revenue account, as shown above, can be reversed (after adjustment for subsequent depreciation) for any reversal of a past impairment. This means that the reversal of an impairment loss is recognised in the revenue account to the extent that it increases the carrying amount of the asset to what it would have been had the impairment not occurred.

2.149 It is expected that reversals of impairments will be rare, as neither indexation nor 5-yearly revaluations are considered as reversals of earlier impairments taken to the revenue account as consumption of economic benefits. Reversals will happen in cases where an economic loss has been recognised on an asset written down to OMV (disposal value) prior to disposal, which subsequently is taken back into operational use on a change of plan.

Presentation and disclosure

2.150 Impairment losses recognised in the revenue account should be included in operating costs. Impairment losses recognised in the SRGL must be disclosed separately on the face of the statement.

2.151 In the fixed asset note to the annual accounts the impairment loss should be treated as follows:



• Impairments charged to the SRGL should be shown in the cost/valuation (top half) part of the note

• Impairments charged to the revenue account should be shown in the depreciation (bottom half) part of the note.

2.152 Where (exceptionally) an impairment loss recognised in an earlier period is reversed, the financial statements should disclose the reason for the reversal.

Presentation and disclosure - examples

2.153 The examples below illustrate the recognition, and reversal, of impairments in accounts.

Accounting entries and examples

2.154 The Manual for Accounts gives details of the correct disclosure of the various movements in the Notes to the accounts on tangible fixed assets. The examples below are intended only to illustrate the principles.

Impairment – price change

In the example the impairment is 100 and the revaluation reserve stands at 20. Dr 20 Revaluation reserve 80 Revenue Account Cr 100 Tangible fixed assets

The loss can be offset first against the revaluation reserve associated with the asset.

Impairment – loss of economic benefits

Impairment 100, revaluation reserve 20. Dr 100 Revenue Account Cr 100 Tangible fixed assets

With the total impairment, as an economic loss

Dr 20 Revaluation reserve Cr 20 General Fund/I&E Reserve

To eliminate the balance on the revaluation reserve

Impairment - price change (donated asset)

The example shows the treatment of an upwards revaluation from 170 to 250 followed by an impairment (price change) of 100 Dr 80 Tangible fixed assets Cr 80 Donated asset reserve With the increase in value

Dr 80 Donated asset reserve 20 Revenue Account Cr 100 Tangible fixed assets

To reflect the impairment

Dr 20 Donated asset reserve

Cr 20 Revenue Account To neutralise the impact of the impairment on the Revenue Account



Impairment - loss of economic benefits (donated asset) As above, but the loss is a loss of economic benefits rather than a price change Dr 100 Revenue Account Cr 100 Tangible fixed assets With the impairment

Dr 100 Donated asset reserve

Cr 100 Revenue Account To neutralise the impact of the impairment on the Revenue Account



Annex 1 - Definitions

Existing use value

“An opinion of the best price at which the sale of an interest in property would have been completed unconditionally for cash consideration on the date of valuation, assuming:

(a) a willing seller;

(b) that, prior to the date of valuation there had been a reasonable period……. for the proper marketing of the interest, for the agreement of price and terms and for the completion of the sale;

(c) that the state of the market, level of values and other circumstances were, on any assumed date of exchange of contracts, the same as on the date of valuation;

(d) that no account is taken of any additional bid by a prospective purchaser with a special interest;

(e) that both parties to the transaction had acted knowledgeably, prudently and without compulsion;

(f) that the property can be used for the foreseeable future only for the existing use; and,

(g) that vacant possession is provided on completion of the sale of all parts of the property occupied by the business.”

Depreciated replacement cost (property)

“The aggregate amount of the value of the land for the existing use or a notional replacement site in the same locality, and the gross replacement cost of the buildings and other site works, from which appropriate deductions may then be made to allow for the age, condition, economic and functional obsolescence, environmental and other relevant factors; all of these might result in the existing property being worth less to the undertaking in occupation than would a new replacement.”

Value of plant and machinery

“An opinion of the price at which an interest in the plant and machinery utilised in the business would have been transferred at the date of the valuation assuming:

(a) that the plant and machinery will continue in its present uses in the business

(b) adequate potential profitability of the business, or continuing viability of the undertaking, both having due regard to the value of the total assets employed and the nature of the operation, and



(c) that the transfer is part of an arm’s length sale of the business wherein both parties acted knowledgeably, prudently and without compulsion.”

Open market value

“An opinion of the best price at which the sale of an interest in property would have been completed unconditionally for cash consideration on the date of valuation, assuming:

(a) a willing seller

(b) that, prior to the date of valuation there had been a reasonable period……. for the proper marketing of the interest, for the agreement of price and terms and for the completion of the sale

(c) that the state of the market, level of values and other circumstances were, on any assumed date of exchange of contracts, the same as on the date of valuation

(d) that no account is taken of any additional bid by a prospective purchaser with a special interest

(e) that both parties to the transaction had acted knowledgeably, prudently and without compulsion.

Extracts from the Appraisal and Valuation Manual (Royal Institution of Chartered Surveyors, quoted in FRS 15).



3 Depreciation and asset lives

Introduction

3.1 Depreciation is a measure of consumption of economic benefits, rather than a means of valuation. This Chapter outlines the provisions of FRS 10 and FRS 15 in relation to depreciation in the NHS. Of particular importance is the treatment of depreciation of revalued assets.

The concept of depreciation

3.2 Depreciation is defined by FRS 15 as “the measure of the cost or revalued amount of benefits of the tangible fixed asset that have been consumed during the period”. “Depreciation” is the term normally applied to tangible fixed assets, while “amortisation” is used in respect of intangibles – the two terms are equivalent, and in this Manual depreciation should be taken also to embrace amortisation.

3.3 As noted above, depreciation is not a measure of loss of value and so the arguments that it should not be applied to some categories of assets (that have indefinite life, perhaps by virtue of routine maintenance and refurbishment) is not valid. Only in the case of investment properties, not applicable in the NHS (other than for charitable funds), does SSAP19 permit depreciation not to be recognised. Depreciation must be charged whether or not there has been a loss in value over the period. UK GAAP points out that the concept of depreciation is one of profit and loss rather than balance sheet – it matches the consumption of an asset with the benefits arising from its use in a given period.

3.4 Depreciation is not intended to provide a fund for replacement, as FRS 15 makes clear.

The operation of the NHS trusts capital charges regime (see also Chapter 5) does indeed have the effect of generating a pool of cash from which replacement assets may be partially or wholly provided. This is however a function of the NHS trust financial regime and funding mechanisms rather than a function of the concept of depreciation.

Depreciation policy for NHS bodies

3.5 The policies set in accordance with the Accounts Direction to comply with UK GAAP and the FReM are outlined below.

3.6 The NHS adopts a policy of straight-line depreciation. FRS 15 suggests that this method is usually adopted as a default where the pattern of consumption of economic benefits is uncertain (as it generally is in the NHS specialised estate). This being the policy adopted for the NAWs Summarised Accounts, other methods (e.g. reducing balance, sum of digits methods) are not permissible.



Land

3.7 Land is not depreciated, because it is considered to have an infinite life.

Building assets

3.8 Building assets are depreciated over the period of their assessed lives, as determined by District Valuers’ valuations. Property consists of land and building elements, and Valuers will apportion the cost of the property between (depreciable) buildings and (non-depreciable) land elements.

3.9 Surplus buildings with a known disposal date (but still in operational use) continue to be carried at their DRC or OMVEU valuations, but are depreciated at a rate such that they reach their OMV for disposal value on the disposal date (see paras 3.23 – 3.27 for accelerated depreciation).

Equipment

3.10 Equipment is depreciated over its useful economic life. Prior to 1999-2000, standard lives for various categories of assets were determined by the NAW, but the implementation of FRS 15 requires Directors of Finance to review equipment asset expected lives (and residual values) at the end of each accounting period. This may lead to a departure from standard lives where expectations of useful economic life are "significantly different".

3.11 FRS 15’s instruction is:

“The useful economic life of a tangible fixed asset should be reviewed at the end of each reporting period and revised if expectations are significantly different from previous estimates. If the useful economic life is revised, the carrying amount of the tangible fixed asset at the date of the revision should be depreciated over the revised remaining useful economic life”

and on residual value:

“Where the residual value is material it should be reviewed at the end of each reporting period to take account of reasonably expected technological changes based on prices prevailing at the date of acquisition (or revaluation). A change in its expected residual value should be accounted for prospectively over the asset’s remaining useful economic life, except to the extent that it has been impaired at the balance sheet date”.

3.12 FRS 15 however only requires a change in the depreciation profile of an asset to

be made where the review suggests that a “significant” adjustment to lives or residual value is appropriate. It is suggested then that NHS bodies adhere to the standard lives of equipment assets as laid down in previous Manuals, and repeated below, adopting individual lives only where it is clear that the standard lives are materially inappropriate:

• Short life engineering plant and equipment - 5 years

• Medium life engineering plant and equipment – 10 years



• Long life engineering plant and equipment – 15 years

• Vehicles – 7 years

• Furniture – 10 years

• Office and IT equipment – 5 years

• Soft furnishings – 7 years

• Short life medical and other equipment – 5 years

• Medium life medical equipment – 10 years

• Long life medical equipment – 15 years

• Mainframe-type IT installations – 8 years

Residual value

3.13 As noted above – the residual value is based on the prices prevailing at the time of purchase or revaluation. It is not an estimate of how much the asset could be sold for at the end of its useful economic life. Thus, if an asset has a 6 year estimated useful life, the residual value is the net realisable value of a 6 year old asset at the date of purchase or revaluation. This means, for example, that holding gains cannot be anticipated.

Assets under construction

3.14 Assets under construction are not depreciated, because depreciation is appropriate only when assets are in operational use.

Intangible fixed assets

3.15 Intangible fixed assets are amortised over the period of the assets' expected economic lives.

Finance leases

3.16 Assets leased under finance leases should be depreciated over the shorter of the primary lease term and the assessed remaining life of the asset. If the leased asset continues to be used by the lessee after the end of the primary lease term it should be revalued by the District Valuer to its residual value. The residual value should then be depreciated over the remaining useful economic life of the asset.

Chargeable period

Availability for use

3.17 Depreciation is payable on assets from the start of the quarter following the quarter in which the asset first became available for use.

3.18 The date at which an asset becomes available for use will not always be clear and a realistic approach must be adopted in deciding the appropriate date.



3.19 Buildings are deemed to become available for use at the earlier of:

• first use

• the date Unified Business Rate first becomes payable (whether at full or half rate).

Disposals and surplus assets

3.20 Depreciation ceases to be payable when an asset is disposed of. Disposal is deemed to arise when the asset is no longer available for use and is removed from the asset register. This will occur because the asset is:

• sold (or ownership is transferred, e.g. in PFI transactions)

• recorded in the asset register and losses register as being lost or destroyed. An asset that is totally lost or destroyed will be accounted for as being disposed of. If a partial loss occurs, e.g. when an asset is damaged, this is treated as an impairment and the net book value of the asset will be reduced as appropriate. This will result in a reduced depreciation charge

• scrapped.

3.21 Depreciation also ceases to be payable when an asset is formally declared as surplus, is taken out of operational use, and is revalued to open market value for alternative use, but has not yet been disposed of.

Other considerations

Transfer of an asset under construction to use

3.22 Assets under construction are not subject to depreciation, but when they become available for use they must be reclassified as buildings or equipment. Depreciation is chargeable from the beginning of the quarter following the asset becoming available for use.

Functional life adjustment – accelerated depreciation

3.23 The situation often arises where an asset remains in operational use although it is scheduled for disposal. This fact does not itself prove impairment, but does affect the life and depreciation profile of the asset. The previous NHS practice of revaluation with a functional life adjustment is now replaced by the technique outlined below.

3.24 When there are firm plans to dispose of a currently operational building asset in the future, a review should be carried out of its economic life and residual value, and the asset should be depreciated accordingly. In practice this will result in accelerated depreciation as the charge is set so as to depreciate the asset down to its open market value for alternative use (effectively, its net realisable value). This value should be set, in compliance with FRS 15 principles, on the basis of current prices. In other words, no attempt should be made to predict its realisable value at the future date of sale.



3.25 The increased depreciation must be included in capital charge estimates at the first opportunity. Where there is uncertainty about the date an asset will be taken out of operational use, NHS bodies may wish to maintain an assets life and depreciation profile unchanged, recognising an economic impairment in the year in which the asset is actually taken out of service.

3.26 Where accelerated depreciation is to be calculated in this way, the OMV to be used is that of an asset of the same age at the present time, and no attempt should be made to predict the OMV at the time of planned disposal. In times of inflation then, it is to be expected that the OMV thus established will be lower than the OMV ruling at the actual date of disposal, and this may then give rise to a profit on disposal. All NHS bodies will need to take care that an OMV set in the past is not assumed to be a fair market price for setting contract terms.

3.27 In the unlikely event that the open market disposal value exceeds the current

carrying amount, it should continue to be carried at depreciated replacement cost (this being lower than the recoverable amount) with depreciation charges as normal, calculated on its assessed life. The revaluation to OMV on taking the asset out of use, and prior to disposal, will then result in a revaluation gain.

Disposal of a surplus asset

3.28 Depreciation is chargeable in the quarter in which disposal of an asset takes place. Depreciation is also chargeable in the quarter in which a building asset is formally declared surplus and revalued to open market value for alternative use, but has not yet been disposed of. No further depreciation is charged on a surplus building asset after this point provided that it is not in operational use.

Collective assets

3.29 Collective or grouped assets should be treated as single assets for the calculation of depreciation.



Fully depreciated assets

3.30 When an asset reaches the end of its useful economic life it is fully depreciated, giving a nil net book value. If it continues to be used, no adjustment is made in the books and its cost and full depreciation continue to be carried (though the net of these two is nil), until it is no longer available for use. Fully depreciated assets should continue to be recorded in the asset register. The replacement cost and accumulated depreciation continue to be indexed, but as the same index is applied to both cost and depreciation the net book value remains nil.

3.31 The necessity to adopt this treatment should be rare in future, if estimates of useful economic life are made regularly. If the amount of fully depreciated assets still in use is significant enough to distort the financial statements, the assets should be revalued to their estimated value to the NHS body and further depreciated over their estimated remaining useful lives.

Long-life assets

3.32 FRS 15 recognises that some assets with very long lives and/or high residual values will attract immaterial levels of depreciation. In the NHS all assets, including ones falling into this category, should be depreciated as a matter of policy to achieve consistency.

Infrastructure assets

3.33 It is very unlikely that infrastructure assets as defined by FRS 15 and the FReM will be found in the NHS. They are generally those assets that form part of an integrated network servicing a wide geographical area. Typically, they are maintained on a rolling basis and under renewals accounting the expenditure required to maintain the operating capacity of the infrastructure asset is treated as the depreciation charge for the period and deducted from the carrying amount (as accumulated depreciation). Actual expenditure is capitalised as part of the cost of the asset as incurred.

3.34 The FReM gives motorway and trunk roads as examples of infrastructure assets but excludes local roads. It is clear then that infrastructure assets are unlikely to be found in the NHS, and bodies should contact the NAW to discuss the accounting treatment to be adopted where it is believed that renewals accounting may be appropriate.

Heritage assets

3.35 Heritage assets have cultural, environmental or historical associations that confer an obligation on the owner to preserve them in trust for future generations. It is unlikely that any NHS body will have any such assets (as defined by the FReM), and individual works of art lying outside main national collections are unlikely to merit this classification. Characteristics of heritage assets are:

• A value to the Government and public in cultural, educational and historic terms that is unlikely to be reflected in a financial mechanism or price



• Established custom or primary statute or trustee obligations that impose prohibition or severe restrictions on sale

• They are often irreplaceable and their value may increase over time even if their physical condition deteriorates

• They may require considerable maintenance expenditure, and

• Their life is measured in hundreds of years.

3.36 A distinction must be drawn between operational and non-operational heritage assets. Operational heritage assets e.g. historic buildings in use, should be treated as any other type of tangible fixed asset in terms of valuation, depreciation and capital charges.

3.37 Non-operational heritage assets should be valued and capitalised where possible. This assists the NHS to inform the public about assets held, aids stewardship and informs decisions on holding and maintaining assets. It will be necessary for any NHS body holding what may be considered as non-operational heritage assets to discuss their classification and accounting treatment with the NAW.



4 Leases

Introduction

4.1 In addressing the accounting treatment for leases and hire purchase transactions, SSAP 21 Accounting for Leases and Hire Purchase Contracts sought to improve comparability between companies in terms of gearing and asset rates of return. Further, it was important that the users of financial statements should be able to understand the heavy obligations falling on companies that rely on long-term lease finance.

4.2 In the NHS the main impact of SSAP 21 is in the area of Capital Charges, Capital Resource Limits and, for NHS trusts, External Financing Limits (EFLs). The classification of a lease as “finance” or “operating” determines whether an asset is recognised in the balance sheet and so attracts Capital Charges and counts as capital expenditure, or is simply a revenue transaction.

4.3 SSAP 21 needs to be considered alongside FRS 5 Reporting the Substance of Transactions and the Treasury Guidance Technical Note 1 (revised) on FRS 5 in dealing with more complex or PFI transactions. FRS 5 gives way to any SSAP or FRS containing more specific guidance, and so SSAP 21 is appropriate for single transactions, while wider complex arrangements invoke FRS 5. Both the SSAP and FRS follow the “substance over form” principle and in complex related transactions (e.g. sale and leaseback, PFI schemes) the nature of the series of transactions needs to be considered as a whole, rather than concentrating on individual transactions.

4.4 The guidance in this Chapter is consistent with the approaches taken by the Wales Audit Office and the Valuation Office Service, and (as for the Manual generally) complies with Treasury’s guidance on Resource Accounting in the FReM.

4.5 Quotations used in this Chapter are, unless otherwise stated, taken from SSAP 21.

4.6 Chapter 8 on PFI transactions lists some quantitative and qualitative indicators that may be of use in helping define lease types.

4.7 The ASB Discussion Paper “Leases: Implementation of a New Approach” is mentioned at the end of the Chapter: any subsequent FRS arising from these proposals will require major revisions to NHS capital accounting policy.

4.8 NHS bodies should not make any changes in their asset procurement policies simply because of possible changes to the accounting treatment. Any change will affect all Government entities and Treasury will issue guidance on accounting and capital expenditure controls (e.g. External Financing Limit (EFL) and Capital Resource Limit (CRL)) in due course. In the meantime, purchase or lease decisions should remain based on value for money considerations.

http://www.ogc.gov.uk/pfi/series_3/technote/tech_contents.htm



Leasing arrangements between NHS bodies

4.9 There has been a convention that leases between NHS bodies should always be treated as operating leases, whatever the terms of the lease. This arrangement had the merit of being simple to operate and could be justified as reflecting the ultimate control of the asset concerned by the NAW. To comply with UK GAAP however, it is necessary for bodies to consider the nature of the lease, and treat it as finance or operating as required. There should be no possibility of a lease being treated differently in the books of the lessor and lessee, as the lack of information that can cause this in the commercial sector does not apply in the NHS.

Definitions

Lease

“A lease is a contract between two parties (the lessor and lessee) for the hire of a specific asset. The lessor owns the asset, but conveys the right to use the asset to the lessee for an agreed period of time in return for the payment of specified rentals”.

Finance lease

4.10 A finance lease is a lease “that transfers substantially all the risks and rewards of ownership of an asset to the lessee”.

Operating lease

4.11 “a lease other than a finance lease”.

The lease term

4.12 This “is the period for which the lessee has contracted to lease the asset and any further terms for which the lessee has the option to continue to lease the asset, with or without payment, which option it is reasonably certain at the inception of the lease that the lessee will exercise”. Generally, the lease period can be divided into primary and secondary terms. In the primary lease term the lessee is committed to make certain rental payments, with a termination payment sometimes payable on termination of the primary term. The secondary lease term is that in which the lessee may extend the lease if desired. The secondary term is normally included in the lease term for the purposes of the 90% test (see below) if it is reasonably certain that the lease will so be extended. A nominal or peppercorn rent in the secondary term may be ignored for the purposes of the 90% test if it is not material.



Fair value

4.13 “The price at which an asset could be exchanged in an arm’s length transaction less, where applicable, any grants receivable towards the purchase or use of the asset”. In applying the 90% test, if this value is not known, an estimate may be used.

Determining the lease type - the 90% test

4.14 This test is not definitive: UK GAAP notes a move towards more qualitative tests in deciding whether risks and rewards of ownership have been transferred, with the 90% test being just one factor. It suggests that FRS 5 leans towards the approach of considering the factors affecting the economic substance of a transaction. NHS bodies are encouraged then to look more widely at all the factors surrounding the terms of a lease, given the narrow deterministic nature of the 90% test.

4.15 The 90% test is satisfied if the Present Value (PV) of the minimum lease payments over the period of the lease amounts to substantially all (i.e. in excess of 90%) of the fair value of the asset.

4.16 Minimum lease payments may be made up (depending on the intended use of the minimum lease calculation) of:

(a) the minimum payments over the remaining part of the lease term

(b) any residual amount guaranteed by the lessee or a party related to him, and

(c) any residual amounts guaranteed by any other party.

4.17 In the calculation of the implicit interest rate for the 90% test, all the above components (a), (b)&(c) are used. The lessor will use all the components (a), (b)&(c) in his 90% test. The lessee uses (a) and (b) only in his 90% calculation.

4.18 The implicit interest rate is the discount rate that “at the inception of the lease, when applied to the amounts which the lessor expects to receive and retain, produces an amount (the present value) equal to the fair value of the leased asset”. The “amounts the lessor expects to receive and retain” are:

(a) the minimum lease payments to the lessor [(a), (b)&(c) above] plus

(b) any unguaranteed residual value: less

(c) any amounts included in (a)&(b) for which the lessor will be accountable to the lessee.

4.19 It is expected that the implicit interest rate will be known in most cases, however the lessee may not be in possession of the full details, as the lessor is likely to be, to calculate the implicit interest rate. In these circumstances, estimates may be made of the amounts the lessor expects to receive, or failing that, the rate that the lessee would expect to pay on a similar lease may be used.



UK GAAP suggests that where this is not known, the lessee’s rate of incremental borrowing should be used.

4.20 As LHBs have no powers to borrow (except in relation to finance leases and PFI arrangements) and an interest rate of incremental borrowing is not readily available for NHS trusts, the Treasury discount rate of 3.5% + inflation may be used instead.

4.21 Examples of the use of the 90% test are given at the end of this chapter. In applying the test, NHS bodies and their auditors will need to consider the reliability of fair value, residual value and implicit interest rate figures used. Care must be taken that these values are not manipulated to produce a figure under 90% to “prove” the existence of an operating lease. It is perfectly possible for transactions returning a lower PV than 90% to be finance leases in substance and vice versa. Other indicators are noted below.

Determining the Lease Type – Other Factors

4.22 UK GAAP notes that affirmative answers to the following questions would tend to indicate that a finance lease exists:

• if the lessee can cancel the lease, will he bear any losses associated with the cancellation?

• will the lessee gain or lose from any fluctuations in the market value of the residual amount? For example, the lessee could receive a rental rebate equalling most of the sale proceeds at the end of the lease

• does the lessee have the ability to continue to lease the asset for a secondary term at a nominal rental?

• is the expected lease term equal to substantially all of the asset's expected useful life?

• are the leased assets of a specialised nature such that only the lessee (or a limited number of other parties) can use them without major modifications being made?

4.23 Responsibility for maintenance, insurance etc can be an indicator, but the fact that a lessor bears these costs is meaningless if he recovers them through rentals.

Property leases

4.24 The principles outlined above apply equally to property leases. Some specific considerations are noted below.

Statutory rights of renewal

4.25 The lease agreement may contain an 'option to renew' clause. Alternatively there is in England and Wales a statutory right of renewal for a period equal to the length of the original contractual term subject to a maximum of 14 years



under the Landlord and Tenant Act 1954, assuming the parties have not elected to opt out of these provisions. At the end of each renewal period, the statutory extension provisions can be reapplied, giving the possibility of a primary lease term approaching or equal to the physical life of the building in some cases. For leased property assets, unless for operational reasons the contrary is apparent, it should be assumed that, where available, statutory rights of renewal of the lease will be exercised at the end of the primary lease term. The lessee's intentions with regard to continued occupation are not always clear at the inception of the lease. Where the lessee has a clear intention not to occupy the building after the initial contractual period expires, e.g. when a new building is being constructed or services relocated, then the lessee is regarded as having waived his option to renew. Where the lessee is unable to clarify his intentions one way or the other the assumption by default, in the absence of any contrary information, is that the occupation will continue with the statutory right of renewal being invoked on the next occasion.

Break clauses

4.26 The existence of a break clause in what appears to be a finance lease can be sufficient to make it an operating lease where the power to break lies only with the landlord. If, on the other hand, only the lessee has the power to exercise the break clause, this should be considered along with all other factors to decide whether the lease can be classified as an operating lease or a finance lease.

Other considerations

4.27 Short-term hire of property for a period considerably less than the remaining life, e.g. rental of office or storage space for five years when it has a remaining life of 30 years, may be regarded as an operating lease. Also a property lease may be an operating lease if the purpose for which the asset is used is not a main core use or the parties have opted out of the security provisions of the Landlord and Tenant Act 1954. Leases of parts of a building where the landlord is responsible for repairs to the structure, but does not impose a service charge for this, are likely to be regarded as operating leases. Leases where the landlord would be expected to be able to obtain possession for their own purposes, e.g. parts of former health centres disposed of to GPs and leased back, are likely to be regarded as operating leases. In all cases the classification will depend on the substance of the lease agreement over the form, in accordance with FRS 5.

Accounting for finance leases – lessees

4.28 NHS bodies will far more frequently be lessees rather than lessors. The treatment of assets held under finance leases by the NHS in terms of the 3.5% cost of capital. Assets held under finance leases and finance lease creditors will be included in the cost of capital calculation when calculating average relevant net assets.

4.29 While the asset held under a finance lease attracts a cost of capital charge, the related finance lease creditor attracts a negative charge. The net asset value held under a finance lease will often therefore be marginal.



Capitalisation

4.30 The leased asset should be first recorded in the lessee’s books and asset register at the present value of the minimum lease payments. In practice, the present value of the minimum lease payments in a finance lease will normally be at least 90% of the fair value of the leased asset and it is therefore acceptable to record the leased asset in the lessee’s books and asset register at its fair value, i.e. at valuation (land and buildings), or replacement cost (equipment).

4.31 The date the asset is capitalised will be the date the asset becomes operational. Where a contractual commitment is entered into in advance of the operational date, a disclosure in the Notes to the Accounts must be made.

Revaluation

4.32 Having taken the leased asset onto the balance sheet as noted above, the asset should be revalued before the year-end to place it on the same basis as assets owned by the NHS body. Specialised properties will be valued under the Depreciated Replacement Cost (DRC) basis of valuation, while other assets capable of market valuation will be revalued to open market valuation for existing use.

4.33 The District Valuer will carry out a periodic revaluation of leased land and buildings, usually every five years. NHS bodies must also revalue leased land and buildings on an indication of impairment under FRS 11. Valuation gains and losses will be treated as for owned assets, applying the provisions of FRS 11 and as outlined in Chapter 2.

Indexation

4.34 Annual indexation must be applied to the asset on the first day of the financial year. If an asset is leased part way through a year no indexation is applied in that year.

Depreciation

4.35 The leased asset must be depreciated on a straight line basis, over the shorter of the lease term and the assessed remaining life of the asset (the secondary lease period is included in the lease term if it is reasonably certain that the lessee will exercise an extension option). Leased land and assets under construction must also be depreciated. This is because the depreciation of a leased asset represents the consumption of the lease rather than of the asset itself. As land has an infinite life and assets under construction have not yet started their lives, the choice to depreciate over the shorter of the primary lease term and the asset life does not arise; the asset will always be depreciated over the primary lease term.

4.36 The depreciation on leased assets should be charged to the revenue account, and is separately identified in the tangible fixed assets Note to the Accounts.

4.37 Depreciation is charged from the beginning of the quarter following the date at which the lease is acquired (or becomes available for use). It is charged in the



quarter in which the lease expires. Depreciation must be charged even if the asset has been sublet for another purpose, whether at a 'peppercorn' rent or otherwise.

4.38 Backlog depreciation will arise on leased assets because of indexation and revaluations of the accumulated depreciation. This should not be charged to the reserve account but should be debited to the Revaluation Reserve.

4.39 Depreciation will arise on the residual value of an asset (which needs to be capitalised) during a secondary lease term. This is charged to the revenue account as normal, but matched by a transfer from the revaluation reserve to the General Fund/I&E Reserve (where any positive revaluation reserve still remains in respect of the asset).

Finance lease creditor

4.40 At the inception of the lease the lessee body will have a financial obligation equal to the present value of the total minimum lease payments (or the fair value of the asset). The opening lease creditor balance and opening NBV of the leased asset will therefore be equal. The lease creditor balance will be reduced each year by the amount of the capital element of the annual rental payment, and must be shown in the Creditors note to the Accounts, analysed between creditors due within one year and creditors due after more than one year.

Finance charges

4.41 The total finance charge is the difference between the total undiscounted minimum lease payments borne by the lessee over the primary lease term and the capitalised fair value of the leased asset at the inception of the lease. It represents the interest element of the rental payments. The finance charge should be allocated to accounting periods to produce a constant rate of interest on the outstanding balance, or a close approximation. There are three methods of doing this:

4.42 Straight-line Method. This is the simplest, but least accurate, method. It involves calculating the total finance charge for the term of the lease, and apportioning this on a straight-line basis over the full lease term. For example, if the total rental payments for a 10 year lease are £20000 and the fair value at the inception of the lease is £15000, then the total finance charge is £5000, or £500 per year.

4.43 Sum of Digits (Rule of 78) Method. In practice, this is probably the best compromise between simplicity and accuracy. It involves establishing, at the inception of the lease, the number of rentals that are payable and calculating the sum of the digits. For example, if there are 10 rental payments then the sum of the digits is 1+2+3+4+5+6+7+8+9+10 = 55. For long lease periods it is best to use the formula:

sum of digits = (n (n+1))/2 where n is the number of rentals. The finance charge can then be allocated to accounting periods using the following formula:



Number of rentals remaining/total number of rentals x Total finance charge = Finance charge for period.

4.44 For example, in the first year the finance charge will be (10/55) x £5000 = £909, in the following year it will be (9/55) x £5000 = £818, and so on. This assumes that the rental payments are made in arrears. If the payments are made in advance of the accounting period to which they relate, then the sum of the digits at the inception of the lease in the example will be 45. The finance charge in the first year will be (9/45) x £5000 = £1000 and so on, and no finance charge will arise in the final year of the lease term.

4.45 The Actuarial Method. This is the most accurate method, but it involves more complex calculations and it is suggested that it should only be used if a material difference from the sum of digits result is expected. These differences are likely in long leases (e.g. in on-balance sheet PFI) and so should be tested where the lease runs for over 10 years. NHS bodies are advised to refer to SSAP21 for an explanation of this method of apportioning finance charges to accounting periods.

Rental payments

4.46 The rental payment to the lessor consists of a capital element and an interest element, the finance charge, representing the lessor's return from leasing out its asset.

4.47 The NBV and lease creditor balance will only match when the lease is first taken out. Subsequently there will be a mismatch because:

• Annual indexation and periodic revaluation will affect the net book value of the asset, but will not affect the annual rental payments

• Depreciation does not commence until the quarter following acquisition of the asset, whereas lease payments and hence the reduction in the capital liability may commence before this

• If the actuarial or sum-of-the-digits methods of allocating finance charges are used, the finance charge will not simply be the rental payment less the depreciation for a period.

4.48 Because of the mismatch the depreciation charge in a period does not represent the capital element of the rental. The capital element must be calculated as the total rental payment for the period minus the interest element (i.e. the finance charge). The finance charge is the same in each period if the straight-line method of apportionment is used.

Cost of capital charge

4.49 The guidance on Capital Charges Estimates, will be issued each September by the Health and Social Care Finance Department. This change will ensure compliance with any future changes to Treasury guidance (see Chapter 5: Capital Charges).

Improvements to leased assets



4.50 Normal repair and maintenance expenditure on a leased asset should be charged to revenue. Expenditure can be capitalised where it involves renovation or upgrading which has significantly enhanced the standard of the asset. The improvements should be capitalised and treated as a separate, purchased asset. This applies equally to operating and finance leases, even though under an operating lease the original leased asset was not capitalised. Depreciation on the 'improvements' asset is charged to the revenue account and the asset is included in average relevant net assets when calculating the rate of return. The life of the improvements will be the shorter of the remaining primary lease term and the assessed life of the improvement. On reversion of the original asset to the lessor the improvements should be treated as a disposal. Enhancement expenditure is discussed in more detail in Chapter 2 .

4.51 Under law in England and Wales, provided the landlord's consent to carry out improvements was obtained, improvements remain the tenant's property for a period of 21 years from the next renewal of the lease. The improvements should be shown on the tenant's balance sheet. If the landlord obtains possession, the tenants are generally entitled to compensation based on the value of the improvements to the landlord, or, depending on the terms of the lease, to take the improvements away. The only exception to this is where the improvements were carried out as a condition of the lease and the rent was reduced to reflect this requirement. This is sometimes done when property is in bad repair and the tenant is really doing some typical landlord's work. In this case the improvements are treated as the landlord's for rent review purposes after the rent reduction period and should be capitalised by the landlord. The lessor would therefore treat such costs as revenue expenditure as no asset is created in the lessor's books.

Termination of lease

4.52 Early termination of a finance lease can be considered as a disposal of the capitalised asset by the lessee if the asset reverts to the lessor. In this case a profit or loss on disposal may arise. Profit/loss on disposal is calculated by comparing the net book value of the asset, less the outstanding lease creditor, with any final cash settlement.

Operating Leases

Operating Lease incentives

4.53 Accounting for operating lease rentals is straightforward. One complication concerns the use of "operating lease incentives". In negotiating a new or renewed operating lease, a lessor may provide incentives for the lessee to enter into the agreement. Examples of such incentives are an up-front cash payment to the lessee or the reimbursement or assumption by the lessor of costs of the lessee (such as relocation costs, and costs associated with a pre-existing lease commitment of the lessee). Alternatively, initial periods of the lease term may be agreed to be rent-free or at a reduced rent.



4.54 UITF Abstract 28 addresses the issue. The consensus treatment is that the lessee should recognise the aggregate benefit of incentives as a reduction of rental expense. The benefit should be allocated over the shorter of the lease term and a period ending on a date from which it is expected the prevailing market rental will be payable. The allocation should be on a straight-line basis unless another systematic basis is more representative of the time pattern of the lessee’s benefit from the use of the leased asset.

Leases and the External Financing Limit

4.55 Chapter Six gives details of the treatment of finance leases for external finance purposes. Essentially, all finance leases are classified as sources of external finance, and so count toward the external financing limit.

Accounting for leases – lessors

4.56 NHS bodies will more frequently be lessees than lessors, although one may lease out an asset that it owns to another body. This could be another NHS body or a private organisation or individual. For operating leases, the asset will be shown in the NHS body’s books and asset register at its full value, i.e. the value is not reduced to reflect the lease. The asset will be depreciated and included in “average relevant net assets”.

4.57 Exceptionally, where existing occupiers (e.g. agricultural tenants and some occupiers of dwelling houses) became entitled to security of tenure under the relevant Acts, following the removal of crown immunity, the value of the NHS body’s freehold interest will be assessed, by the District Valuer, to reflect the existence of the tenancies.

4.58 In certain cases where leasehold agreements have resulted in full consideration (by means of a capital receipt) being received by the lessor body, the lease may be treated as a finance lease. In such cases, the NHS body that granted the lease should not continue to record the asset as an operational fixed asset within its accounts and will not have to pay depreciation or charge for the cost of capital on the asset. Any residual payments, accruing to the lessor after full consideration has been received (e.g. from ground rent) should be accounted for as miscellaneous revenue income. In essence, the transaction is accounted for as a sale or disposal.

4.59 In cases where a NHS body leases out assets at low or peppercorn rent, there is a net cost to the NHS. NHS bodies are required to weigh this cost (which includes the depreciation and the cost of capital charge on the asset) against the overall benefits received from the lessee. These benefits may be of a non-financial nature.



Hire purchase contracts

4.60 In the UK there is normally no provision in a lease contract for legal title to the leased asset to pass to the lessee during the lease term. However, under a hire purchase contract the lessee may acquire legal title by exercising an option to purchase the asset upon fulfillment of certain conditions. The precise conditions of a hire purchase contract may vary, but normally when an asset is purchased in this way the legal title does not pass to the purchaser until every installment has been paid and a small amount, usually included in the last payment, is paid which legally exercises an option to buy the asset. In other words, to buy on hire purchase is to legally hire the asset until a certain time, when an option can be exercised to take over the legal title to the asset. The hire purchaser is not normally compelled to complete the transaction, and may return the goods and not pay any further installments. They will, however, forfeit the right to have any of the previous installments repaid to them. The accounting treatment for a hire purchase contract will be basically the same as for a finance lease, but the final payment to acquire legal title must be included when calculating the present value of the rental payments.

Future developments

4.61 A discussion paper “Leases: Implementation of a New Approach” from the ASB and other members of the G4+1 group was issued in December 1999. It questions the distinction between operating and finance leases and seems likely to give rise to an FRS that will fundamentally affect lease accounting in the UK.

4.62 As stated previously, NHS bodies should not make any changes in their asset procurement policies simply because of possible changes to the accounting treatment. Any change will affect all Government entities and Treasury will issue guidance in due course. In the meantime, purchase or lease decisions should remain based on value for money considerations.

Accounting entries

Capitalisation of leased asset

Dr Tangible fixed assets Cr Creditors With the present value of total minimum

lease payments (or fair value of asset) Depreciation of leased asset

Dr Revenue account Cr Provision for depreciation account With depreciation for period (based on shorter

of primary lease period or assessed life)

Payment of rental to lessor – finance charge

Dr Revenue account Cr Finance Charges With the finance charge element

of rental payment



Dr Finance Charges Cr Cash/bank With the finance charge element

of rental payment Payment of rental to lessor – capital element

Dr Creditors Cr Cash/bank With the capital element of rental

payment Revaluation of leased asset

Dr Tangible fixed assets Cr Revaluation reserve With increase in value (no adjustment

of finance lease creditors) Dr Revaluation reserve Cr Provision for depreciation account With backlog depreciation

Indexation of leased assets

Dr Tangible fixed assets Cr Revaluation reserve With increase in value (no adjustment

of finance lease creditors) Dr Revaluation reserve Cr Provision for depreciation account With backlog depreciation

Expiry of lease

Dr Provision for depreciation Cr Tangible fixed assets With accumulated depreciation – sets NBV to zero as

asset has been fully depreciated over the lease term Continuation of lease after primary lease term

Dr Tangible fixed assets Cr Revaluation reserve With residual value, calculated or

on valuation Depreciation in secondary lease term

Dr Revaluation reserve Cr Provision for depreciation account With depreciation for the period

Rental payment in secondary lease term

Dr Revenue account Cr Cash/bank With total rental payment (all finance charge

as capital element now fully discharged)

Finance lease – example calculation

4.63 Lease of equipment for 10 years. Assessed life is 15 years. Depreciate over 10 years. Rental payments are £2000 per annum or £20000 total. Fair value at inception of the lease is £15000. The total finance charge is therefore £5000, and is apportioned using the sum of digits method. The asset is revalued part-way through year 3 of the lease.



Asset Value Movements in Year

£ Lease Creditor Movements in Year

£ Fin. Lease Obligations at Balance Sheet Date

£

YEAR 1 Opening RC

15000

Opening Creditors

15000

Within 1 Year

2000

Indexation 4% 600 Total Rental Payment 2000 Between 1 and 5 years 10000

Indexed RC 15600 Finance Charge (909) After 5 Years 6000

Opening AD 0 Capital Repayment (1091) Subtotal 18000

Backlog Depreciation 0 Closing Creditors 13909 Future Finance Charges (4091)

Depn. of indexed RC (1560) Outstanding Obligation 13909

Closing AD (1560)

Closing NBV 14040

YEAR 2 Opening RC

15600

Opening Creditors

13909

Within 1 Year

2000


Indexed RC 16380 Finance Charge (818) After 5 Years 4000

Opening AD (1560) Capital Repayment (1182) Subtotal 16000

Backlog Depreciation (78) Closing Creditors 12727 Future Finance Charges (3273)

Depn. of indexed RC (1638) Outstanding Obligation 12727

Closing AD (3276)

Closing NBV 13104

YEAR 3 Opening RC

16380

Opening Creditors

12727

Within 1 Year

2000


In-Year Revaluation 337 Finance Charge (727) After 5 Years 2000

Indexed Revalued RC 17208 Capital Repayment (1273) Subtotal 14000

Opening AD (3276) Closing Creditors 11454 Future Finance Charges (2546)

Backlog Depn (index) (98) Outstanding Obligation 11454

Backlog Depn (reval) (66)

Depn. of indexed RC (1721)

Closing AD (5161)

Closing NBV 12047 etc...



5 Capital charges

Introduction

Capital charges

5.1 Capital charges are taken to mean:

For LHBs

• Depreciation and amortisation charged annually to the OCS, and

• The cost of capital charge.

For NHS trusts

• Depreciation and amortisation charged annually to the I&E account, and

• The cost of capital charge.

5.2 Depreciation is dealt with in Chapter 3, and the cost of capital charge is discussed below.

Background

5.3 The capital charging system was designed to:

• increase the awareness of health service managers of the cost of capital

• provide incentives for the efficient use of capital resources, and

• recognise the cost of capital.

5.4 Capital charges reflect the costs of capital which are:

• the wearing out of assets – depreciation, and

• the money tied up in assets and not available for use elsewhere - cost of capital.

5.5 All NHS bodies are required to earn a return (currently 3.5%) on their relevant net assets. This capital cost absorption target is set so as to be consistent with the returns required from all Government bodies. The FReM requires a cost of capital charge for all Government organisations.

5.6 The treatment of Capital Charges differs between LHBs and NHS trusts reflecting their differing financial regimes. A circular is issued each year in September / October giving details of the capital charges procedure to be followed by NHS bodies in Wales.



Capital charges estimates (CCEs)

5.7 The NAW requires trusts and LHB’s to submit returns detailing NHS bodies’ estimates of the capital charges they will bear in the next financial year.

5.8 On receipt of the CCEs, the NAW will calculate the overall funding requirements to meet NHS capital charges. Generally, adjustments to LHB and trust funding baselines will be re-based in respect of capital charge changes that arise from price movements. In principle, volume changes do not give rise to re-basing.

5.9 It is to be expected that all NHS bodies will find the task of estimating capital charges demanding and time consuming: asset acquisitions, disposals, revaluations, impairments and reviews of economic life and residual values all impact, and need to be predicted up to 18 months ahead. The potential for inaccuracy in estimates has increased with the necessity to annually review equipment lives and to consider impairments under FRS 11 & 15.

5.10 It is important to make realistic estimates of capital charges, as all NHS bodies are now required to charge 3.5% cost of capital on actual average net relevant assets through their revenue account. There is no automatic increase to Resource Limits to offset the effects of inaccurate estimates of capital charges.

Cost of capital charge – calculation of relevant net assets

5.11 Average relevant net assets are normally found by adding the opening and closing balances for the year (as calculated below) and dividing by 2. Opening relevant net assets are the values carried forward from the previous year and before indexation. In addition, assets transferred from other NHS bodies on 1 April must be included as opening balances in the calculation (even though summarisation schedules may show them as in-year acquisitions). Closing relevant net assets are normally those reported at the balance sheet date, after all the year’s transactions and valuations have taken place.

5.12 Occasionally, assets are acquired or disposed of by NHS bodies so close to the balance sheet opening or closing dates that the calculation of NRAs is materially distorted. In these cases it is permissible for bodies to adjust the opening or closing balances to give a more accurate average value. A point of principle is that NHS assets in aggregate should not be misstated in the averaging calculation, and assets must not 'disappear' from NHS accounts as a whole through this method. NHS bodies must prepare working papers to reconcile the cost-of-capital charge calculated on simple opening/closing values to that actually presented in the OCS.

5.13 Liabilities attract a negative cost of capital charge, so it is possible for a commissioning body to have a credit to its OCS. The simplest way to view the cost of capital charge calculation is to appreciate that a 3.5% charge is made on



the total net assets employed (ie including current assets/working balances) with a few exclusions as detailed below.

Cost of Capital Charge -

5.14 The calculation of average relevant net assets in 2005-06 is as follows;

LHBs

Total capital and reserves (total assets employed) X less donated asset reserve (X) less government grant reserve (X) less cash balances in Paymaster accounts (X) X/(X)

NHS trusts

Total capital and reserves (total assets employed) X less donated asset reserve (X) less government grant reserve (X) less cash balances in Paymaster accounts (X) less National Loans Fund deposits (X) X/(X)



6 Capital Resource Budgeting

Introduction

6.1 Capital Resource Limits at the time of publication of this manual have not yet been introduced in NHS Wales except for Powys LHB. The examples in this section are indicative of how they operate in NHS England.

6.2 The introduction of Resource Accounting and Budgeting in the NHS required the introduction of a capital control - the capital resource limit (CRL), which controls capital expenditure in full accruals terms. All NHS bodies have capital resource limits. The CRL is accruals based as opposed to the cash-based EFL in NHS trusts.

6.3 Underspends against the CRL can be carried forward (but should not exceed 5% of the CRL). Overspends against the CRL are not permitted.

Capital Resource Limits

6.4 A capital resource limit controls the amount of capital expenditure that a NHS body may incur in the financial year.

6.5 Initial CRLs are issued before the start of the financial year. CRL adjustments are made in the course of the year.

6.6 The charge against the CRL is:

• Gross capital expenditure ( including the capitalised value of finance leases)

• Less, net book value of assets disposed of

• Less, capital grants and donations

Expenditure can be of money or money’s worth – including the OMV of an asset “part-exchanged” or swapped for another asset. Assets injected to a PFI project in return for a deferred asset are “disposed of” in CRL terms and are credited to the CRL calculation.

Example £000s Gross capital expenditure 50,000 Less, NBV of capital assets disposed of -4,000 Less, capital grants and donations -10,000 Charge against the capital resource limit 36,000 6.7 These lines are defined as follows:

Gross capital expenditure is:



• Expenditure to acquire tangible fixed assets, and

• Expenditure to acquire intangible fixed assets, and

• The capital value of finance leases taken out in the year

The net book value of assets disposed of is:

• value of capital assets in the balance sheet before disposal1

Capital grants and donations are:

• Capital income from funds held on trust

• Big Lottery Fund money, and

• Other grants (EC or other Government Departments included) that are not part of NAW funding

6.8 Note – the credit to the CRL arising on the disposal of fixed assets is equal to the NBV (carrying amount) of those assets and not the cash receipt. Assets scrapped or demolished are considered as disposed of and so will be recorded alongside sales.

6.9 Assets transferred (as opposed to purchased and sold) between bodies within the RA boundary are not considered as disposals in the context of the CRL control (although they are accounted for as disposals in notes to the balance sheet in accounts).

6.10 Where donated assets are transferred from a NHS trust to an LHB, the CRL is similarly unaffected. Such transfers are accounted for by the NHS trust as disposals, but not in the context of the CRL.

Example: calculation of charge to the CRL

6.11 An LHB incurs capital expenditure of £18,750k; sells a property with an OMV of £3,125k; receives a grant of £1,000k and a donation of £320k. The charge against the CRL is:

Gross cap expenditure 18,750 Less, NBV of capital assets sold (3,125) Less, capital grants and donations (1,320) Charge against CRL 14,305

Finance leases and PFI

6.12 On balance-sheet PFI projects, together with finance leases, are charged to the CRL in the year in which the asset becomes operational. Where assets (land and buidings, typically) are contributed to a PFI project, the disposal of the fixed asset counts as a disposal in CRL terms.The capital element of annual repayments do not score against the CRL. Capital additions will occur for certain PFI assets as a result of unwinding of discount over the life of the asset.

1 this will be an open-market valuation



6.13 Annual payments under PFI contracts that are revenue in nature (service charges and interest charges) continue to be charged to the Operating Cost Statement (OCS), as do finance lease interest charges.

The rest of this chapter deals with NHS trusts

External Financing and Capital Resource Budgeting for NHS trusts

Introduction

6.14 The External Financing Requirement (EFR) and External Financial Limit (EFL) are fundamental elements of the NHS trusts financial regime. As funding and expenditure control mechanisms they are not directly relevant to a manual dealing with capital accounting, but in view of their inter-relation with capital financing and capital charges an outline of their use is worth including in the CAM.

6.15 Where finance generated by NHS trusts in the course of their operations is insufficient to fund all their activities (including the acquisition of assets) external finance is required. External finance provided by HM Treasury is a charge against the Public Sector Borrowing Requirement (PSBR) and so is tightly controlled and monitored.

6.16 The introduction of Resource Allocation and Budgeting in the NHS required the introduction of a further capital control - the Capital Resource Limit (CRL).

6.17 The EFL is a cash-based control, while the CRL controls capital expenditure in full accruals terms.

The External Financing Requirement (EFR)

6.18 The EFR can be defined as the difference between what a NHS trust plans to spend in a year and what it can generate from its operations. In practice, the EFR will be the NHS trust’s capital requirement less its internally generated resources. The EFR can be negative if it is planned to spend less overall than is generated. External finance = capital requirements – internal resources

Capital requirement

6.19 The capital requirement consists of:

• Expenditure to acquire fixed assets – capital expenditure as defined in Chapter 2; and,

• A working capital requirement. This is positive where net working balances increase over the year (e.g. as stocks build up or debtors increase or creditors decrease). It is negative when working balances decrease.



Internally generated resources

6.20 A NHS trust’s internally generated resources are:

• Depreciation charged to the I&E account (provided matching income is received)

• Any I&E surplus arising after payment of PDC dividends, and

• Cash proceeds from the disposal of assets.

External Financing Limit (EFL)

6.21 Where the NAW approves a NHS trust’s planned capital expenditure, the EFR becomes in effect the EFL. A positive EFL arises as a NHS trust is required to draw on Government funding or utilise its cash resources. A negative EFL arises where the NHS trust is required to repay PDC or save cash.

6.22 Capital charge estimates are important in calculating the level of internally generated resources (IGR) and setting EFLs. A lower or higher outturn depreciation than planned should not impact on the achievement of the EFL – the I&E surplus (another component of IGR) will be higher if depreciation is lower, and vice versa, thereby neutralising the effect on the EFL.

Components of external finance

6.23 The following elements count as external finance:

• Grants from central government

• Issue and repayment (cash) of PDC

• All other borrowing regardless of source or time to maturity

• The capital value of finance leases and similar transactions where the risks and rewards of ownership remain with the NHS trust.

6.24 The capital element of subsequent lease payments is treated as negative external finance (although in NHS trust accounts the calculation of the EFR does not take account of the capital element of lease payments. Where cash funding is required to meet these repayments, an advance of PDC may be sought from the NAW).

6.25 Trust accounts disregard movements of cash in and out of short-term deposits for the EFR calculation.

6.26 For NHS trusts, external finance will, in the main, be provided from PDC issues/repayments and finance leases.

Finance leases

6.27 All finance leases and most transactions that are in substance borrowing are capitalised in Treasury’s control total. The taking out of such a lease can be thought of as the acquisition of an asset and the borrowing of the funding for the asset in the same transaction.



6.28 The Treasury definition of a finance lease for these purposes matches the accounting definition.

• The capital value of a finance lease increases the EFR

• The capital value of repayments under a finance lease reduce the EFR (although this is not reflected in NHS trust accounts pro-formas)

• The finance charge element of lease payments is a revenue expense that represents a reduction in internal resources

• Depreciation on leased assets is a positive internal resource, as it generates cash receipts from commissioners to match the non-cash expenditure item.

Disposal of an asset at other than book value

6.29 The book value of the asset disposed of determines the amount available for further capital investment. Where the sale proceeds differ from the final carrying amount (which should be OMV for alternative use less disposal costs, if material), the profit or loss is taken to the I&E account.

6.30 Where a loss on disposal is incurred, the cash received will be less than the capital expenditure that the trust can incur. The "cash shortfall" will then be financed from revenue.

6.31 Where the asset realises more than its book value, the profit credited to I&E may be spent on increased revenue expenditure or transferred to the CRL to finance additional capital expenditure.

Working capital movements

6.32 An important feature of the CRL is that additional capital expenditure cannot be financed by the use of working capital (e.g. by an increase in revenue creditors).

The CRL and EFL

6.33 The EFL remains an important control over cash consumption. The EFL will be derived from the financing requirement determined by the CRL.

6.34 The EFL is:

• The CRL

• Less, cash funding from planned depreciation



7 Donated assets

Introduction

7.1 Chapter 2 on Capitalisation and Valuation outlines the criteria for the recognition of donated assets. This chapter gives more detail on accounting for the acquisition, depreciation and disposal of such assets.

Accounting for donated assets

Capitalisation

7.2 The provisions in Chapter 2 apply: essentially, donated assets are valued on precisely the same basis as purchased assets; being carried at cost, DRC or market valuation as appropriate. It is necessary to be able to identify donated assets separately from purchased, and this enables disposals and impairments to be correctly accounted for.

7.3 Assets provided from National Lottery funds are to be treated as donated.

Revenue expenditure

7.4 Where donations are of assets that fall below the normal capitalisation thresholds, the accounting treatment is to record both income and expenditure, the expenditure being the value of the items received but not capitalised. No entries are made to the revaluation reserve or to the fixed assets note. The different Manuals for Accounts give further guidance on this.

Improvements to donated assets

7.5 The normal rules on the capitalisation of enhancement expenditure, and the charging of repairs and maintenance to revenue expenditure, apply. Capitalised expenditure has the effect of creating a part-purchased and part-donated asset. The purchased element should be separately identified and attracts capital charges. It does not give rise to any donated asset reserve transactions. Any impairment will need to be apportioned between purchased and donated elements, because of their different treatments.

Cost of Capital charges

7.6 As shown in the note on calculation in paragraph 5.14, donated assets are not included in the calculation of average relevant net assets.

Donated asset reserve

7.7 The donated asset reserve is maintained to: (a) represent the financing associated with the receipt of a donated asset (i.e. provides the credit side to the transaction debiting fixed assets); and (b) to provide a mechanism for



neutralising depreciation, impairments or profit/loss on disposal charged to the revenue account in respect of donated assets (a transfer from the donated asset reserve is made to the revenue account to match the revenue account charge).

7.8 The donated asset reserve is used to account for the following transactions involving donated assets:

• On revaluation of donated assets, the debit or credit is taken to the donated asset reserve, not the revaluation reserve

• On indexation of donated assets, the debit or credit is taken to the donated asset reserve, not the revaluation reserve. Indexation adjustments are applied in the same way as for purchased assets and so do not apply to donated assets received after 1 April in any year

• On impairment of a donated asset, the principles outlined in Chapter 2 (paragraph 2.114) apply. Donated assets are analysed with purchased assets in the Fixed Asset Notes to the Accounts, and impairments need to be recorded against donated assets as normal. For the sake of consistency, impairments of donated assets should be calculated and accounted for as for purchased assets, although the use of the donated asset reserve means that both “price” and “economic” impairments have the same net (nil) impact on the revenue account.

• The debit for a price impairment is taken to the donated asset reserve, whereas for purchased assets it would go to the revaluation reserve where a sufficient balance exists

• For an economic impairment, the debit is taken to the revenue account, as it would be for a purchased asset. However, an equal sum is debited to the donated asset reserve and credited to the revenue account to neutralise this

• The ultimate effect then of either treatment is to reduce the donated asset reserve by the amount of the impairment, and neutralise its impact on the revenue account. The carrying amounts of donated assets continues to equal the value of the donated asset reserve

• Depreciation is charged to the revenue account in exactly the same way as would the depreciation on a purchased asset. It is chargeable from the quarter following the date of acquisition, and in the quarter of disposal. A transfer is made from the donated asset reserve to the revenue account to match the depreciation charged. No release is made in respect of revalued amounts to the General Fund/I&E Reserve (as for purchased revalued assets) as the full credit is required in the current year revenue account to neutralise the charge.

Disposal of donated assets

7.9 Where equipment is taken out of productive use its value should be written down to its recoverable amount, which (as the asset is not in use) will be its net realisable value. The valuation fall is analogous to the recognition that the asset has been under-depreciated during its period of use, and so the fall should be accounted for as an impairment.



7.10 Surplus land and buildings not in operational use should be revalued to open market value for alternative use.

7.11 Property classed as surplus, but still in operational use, must not be written down to OMV for alternative use. It should remain in the balance sheet at its normal operational valuation (DRC, or OMVEU as appropriate). The depreciation charge should however be adjusted such that the asset is fully depreciated to its disposal OMV (equal to its expected net realisable value) over its remaining life. This accelerated depreciation is again matched by transfers from the donated asset reserve to the revenue account.

7.12 Profit or loss on disposal are calculated in the normal way, as the difference between the carrying amount and net sale proceeds, and credited or charged to the revenue account. A transfer from the donated asset reserve to the revenue account is made to match the profit/loss. This transfer is treated as transfer from the donation reserve in note 4 to the accounts. The net result of this transaction is to re-state the donated asset reserve such that it is equal to the value of the sale proceeds. Finally, a transfer clears any remaining donated asset reserve balance to the General Fund/I&E Reserve.

Realised donation reserve

7.13 Under the Treasury FReM guidance, it is no longer necessary for NHS bodies to maintain a realised donation reserve. On disposal of a donated asset, the entries described in the preceding paragraph effect (a) a transfer to or from the donated asset reserve to balance any profit or loss on disposal, and (b) the clearance of any remaining balance on the donated asset reserve to the General Fund/I&E Reserve. Final balances transferred in this way should equal the sale proceeds.

7.14 If the covenants around the original donation require that if the asset is sold it must be replaced by another specified fixed asset, the resulting asset is still considered as donated and so a donated asset reserve is maintained.

7.15 Where an NHS body chooses to purchase a new or replacement asset, using donated asset sale proceeds, no new donated asset is created. The replacement or new asset is a purchased, not donated, asset.

Accounting entries for donated assets

Acquisition of donated asset

Dr Tangible fixed asset (donated) Cr Donated asset reserve With cost, DRC, or market valuation

(equipment at cost) Depreciation of donated asset

Dr Revenue account Cr Provision for depreciation account With full depreciation charge for

period, including on revalued amount Dr Donated asset reserve Cr Revenue account With the same amount as charged to

revenue account above



Revaluation of donated asset (price change)

Dr Tangible fixed assets (donated) Cr Donated asset reserve With increase in value

Dr Donated asset reserve Cr Provision for depreciation account With backlog depreciation (buildings

and equipment) Entries reversed if there is a fall in value on revaluation (and see impairments) Indexation of donated asset

Dr Tangible fixed assets (donated) Cr Donated asset reserve With increase in value

Dr Donated asset reserve Cr Provision for depreciation account With backlog depreciation (buildings

and equipment) Entries reversed if there is a fall in value on indexation Impairment of donated asset (price change)

Dr Donated asset reserve Cr Tangible fixed assets (donated) With fall in value

Impairment of donated asset (economic loss)

Dr revenue account Cr Tangible fixed assets (donated) With fall in value

Dr Donated asset reserve Cr revenue account With the same amount

Disposal of donated asset – closure of asset account

Dr Asset disposals account Cr Tangible fixed assets (donated) With asset valuation

Dr Cumulative depreciation account Cr Asset disposals account With the accumulated depreciation

Disposal of donated asset – sale proceeds, profit/loss on disposal

Dr Cash Cr Asset disposals account With sale proceeds

Dr Asset disposals account Cr Revenue account With profit on disposal (entries reversed for

loss on disposal) Dr Revenue account Cr Donated Asset Reserve With the same profit as posted above to OCS

(entries reversed for loss on disposal) Dr Donated Asset Reserve Cr General Fund/I&E Reserve With the remaining balance – this now equals

the same proceeds



8 Private Finance Initiative

Introduction

8.1 The objective of the PFI is to harness the benefits of private sector management by purchasing services rather than fixed assets.

8.2 The various transactions that comprise a PFI project differ from “routine” NHS accounting only by virtue of their novelty and complexity. UK GAAP applies equally to PFI accounting and so the provisions on capital accounting contained in this Manual, and the guidance on general LHB/NHS trust accounting in the various Manuals for Accounts, apply in full to PFI transactions. Specific relevant PFI accounting guidance is to be found in:

• ASB Application Note “Amendment to FRS 5 – Reporting the Substance of Transactions: Private Finance Initiative and Similar Contracts” (September 1998).

• Treasury Taskforce Technical Note No 1 (Revised) (July 1999).

• Land and Buildings in PFI Deals

• Website: http://www.doh.gov.uk/pfi/

8.3 The specialised and complex nature of PFI accounting is addressed in detail in guidance issued by HM Treasury. The purpose of this Chapter is to highlight the key accounting issues arising from PFI and outline their accounting treatment.

FRS 5 and SSAP21

8.4 These standards apply in full to PFI transactions. SSAP21 details the categorisation of leases into “finance” or “operating”. Chapter 4 discusses lease accounting. In the PFI context, however, lease or lease-type transactions will often be part of a wider inter-related series of transactions and so it will not always be possible to apply SSAP21 in isolation to individual transactions. Rather, FRS 5 should be applied and the substance of the transactions as a whole considered. The Treasury Technical Note (TN1) (revised) gives the definitive guidance for the Public Sector.

8.5 Similarly, if a PFI contract’s elements are separable such that service elements can be identified and valued, the remaining property element can be subjected to SSAP21 analysis.

http://www.doh.gov.uk/pfi/land.htm

http://www.doh.gov.uk/pfi/



PFI Accounting

Separation of contract elements

8.6 The first stage of the accounting analysis is to determine if the PFI contract is separable (i.e. the commercial effect is that the individual elements of the PFI payments operate independently from each other). “Operate independently” means that the elements behave differently and can therefore be separately identified. Any such separable elements that relate solely to services should be excluded when determining which party has the asset of property.

8.7 The Technical Note gives examples of separable and non-separable contracts. Having excluded any separable service elements PFI contracts can then be classified into:

• Those where the only remaining elements are payments for property. These will be akin to a lease and SSAP21 should be applied or,

• Other contracts, where the remaining elements include some services. These contracts will fall directly within FRS 5 rather than SSAP21.

Application of FRS 5

8.8 For those assets that fall to be considered under FRS 5, whether a party has an asset of the property will depend on whether it has access to the benefits of the asset and exposure to the associated risks. This will be reflected in the extent to which each party bears the potential variations in property profits or losses. The principle is to distinguish potential variations in costs and revenues that flow from features of the property from those that do not (and which therefore are not relevant to determining who has the asset of the property).

8.9 Service-related variations in costs and revenues are irrelevant to determining which party has the asset of property. Thus, penalties related to below-standard food quality will not be relevant in considering the holding of a catering facility asset.

8.10 In quantitative risk analyses the private sector should be treated as one single entity (so the contractor’s laying off risks to other private sector entities will not affect the comparative risk analysis). The potential variations in property profits must be evaluated in NPV terms using the real discount rate used by Treasury in the evaluation of public sector projects (currently 3.5%).

8.11 The Technical Note discusses the following types of risk in quantitative terms:

• Demand risk

• Design risk

• Construction risk

• Penalties for under-performance or non-availability

• Potential changes in relevant costs



• Obsolescence and changes in technology

• Residual value risk

8.12 Qualitative indicators of asset holding:

Feature Indications that the property is an asset of the NHS body

Indications that the asset is an asset of the operator

Termination for operator default

The Application Note says: “a financing arrangement would be indicated where, in the event that the contract is terminated early, the bank financing will be fully paid out by the purchaser under all events of default, including operator default".

There is no guarantee that the bank financing will be fully paid out by the purchaser.

Nature of operator’s financing

“An assessment of the operator’s financing arrangements (all aspects should be taken into account, eg the use of senior or subordinated debt and the presence of any guarantees) may indicate a level of debt funding that could be credible only if another party stood behind the operator.” This means that very high levels of gearing are an indicator that insufficient risk has been transferred and that the property is an asset of the purchaser.

The level of equity funding should not be used as an indicator that the property is an asset of the operator, because the operator may require that level of equity to match the service risk it has accepted under the contract. This is therefore a one-sided test.

Who determines the nature of the property

“The purchaser determines the key features of the property and how it is to be operated, bearing the cost implications of any changes to the method of operation. The purchaser may determine the key features of the property explicitly by agreeing them as terms of the PFI contract or, for example, through a contractual acceptance provision at the end of the construction phase. Alternatively, the purchaser may implicitly determine the key features of the property. For example, a contract for a road may specify that the road will revert to the purchaser in a predefined state after a relatively short period: this may have the effect that the operator has little discretion over the standard of road to build in the first instance or how it is maintained subsequently.”

“The operator has significant and ongoing discretion over how to fulfil the PFI contract and makes the key decisions on what property is built and how it is operated, bearing the consequent costs and risks. For example, this would be the case if the operator is free to redesign the property extensively during the term of the contract (perhaps even to scrap the original property and build a replacement), in the hope of reducing its costs. Similarly, in a PFI contract to design, build and operate a road, the operator may have complete discretion over the balance between the quality of the original road build and the consequent level of maintenance costs.” The operator may have the freedom to make design changes during the



For the avoidance of doubt: The fact that the key features of the property are recorded in the PFI contract, which is agreed by the purchaser, does not necessarily mean that the purchaser has determined those key features. In practice, prior to service commencement, the operator may be required to demonstrate to the purchaser that the arrangements put in place will meet the output specification. Acceptance of the service by the purchaser (based as far as possible on service commencement based tests), without any “approval” of the means of delivery of the service will not, in most cases, mean that the purchaser determines the key features of the property.

construction period that, whilst not being necessary to meet the contract requirements, are made in the expectation of reducing (or avoiding an increase in) expected operating and life cycle costs.

Required accounting

Purchaser (NHS body) has an asset of the property

8.13 Where it is concluded that the purchaser has an asset of the property and a liability to pay for it, these should be recorded in its balance sheet. The initial amount recorded for each should be the fair value of the property, and the asset should be recognised in the balance sheet in its first year of operation. Finance lease commitments (i.e. contracts entered into but asset not yet delivered) must be disclosed in the accounts but should not be capitalised.

8.14 Subsequently, the asset should be depreciated over its useful economic life and the liability should be reduced as payments for the property are made. In addition, an imputed finance charge on the liability should be recorded in subsequent years using a property-specific rate. The remainder of the PFI payments (i.e. the full payments, less the capital repayment and the imputed financing charge) should be recorded as an operating cost. If the purchaser has any other obligations in relation to the PFI contract, these should be accounted for in accordance with FRS 12 ‘Provisions, Contingent Liabilities and Contingent Assets’.

8.15 Generally, the purchaser should recognise each property when it comes into use. An exception is where the purchaser bears significant construction risk, in which case it should recognise the property as it is constructed.

8.16 For NHS trusts, there will be charges to the EFL and CRL at the point the asset is capitalised.



Operator (PFI Partner) has an asset of the property

8.17 Where it is concluded that the purchaser does not have an asset of the property, there may nevertheless be other assets or liabilities that require recognition. These can arise in respect of the acquisition of the residual interests and other obligations of the purchaser and in respect of contributions.

Residual Interests

8.18 In some PFI transactions, all or part of the property (e.g. the land element) will pass to the purchaser at the end of the contract. Where the contract specifies that this transaction should take place at market value at the date of transfer, no accounting is required until the date of transfer, as this represents future capital expenditure for the purchaser.

8.19 Where the contract specifies the amount (including zero) at which the property will be transferred to the purchaser at the end of the contract, the specified amount will not necessarily correspond with the expected fair value of the residual estimated at the start of the contract. Any difference must be built up over the life of the contract in order to ensure a proper allocation of payments made between the cost of services under the contract and the acquisition of the residual. At the end of the contract the accumulated balance (whether positive or negative), together with any final payment, should exactly match the originally estimated fair value of the residual. For example, if the expected residual value at the end of a 30-year contract is £20 million, but the contract specifies that £30 million should be paid by the purchaser for that residual at that date, then a credit balance of £10 million should be accrued over the life of the contract, with the corresponding charge each year being included in the service expense. The payment of £30 million at the end of the contract will extinguish the balance of £10 million and establish an asset of £20 million, representing the value of the residual.

8.20 If, during the life of the contract, expectations change so that the expected value of the residual falls (but there are no changes to the payments scheduled under the contract), then consideration should be given to whether there has been an impairment. Ultimately, a positive difference may become negative, in which case a provision is required. Using the example above, if the expected residual value fell to zero after five years, then an expense and liability of £20 million would be recorded immediately. The remaining £10 million is still accrued over the life of the contract, giving a final liability of £30 million which is paid at the end of the contract.

8.21 It should be noted that an asset thus created falls to be included in the calculation of relevant net assets and so impacts on capital charges. The asset is carried in the balance sheet under the relevant category (land or buildings), rather than as a current asset (as is the case with deferred assets, for example).

8.22 Unitary payments should be analysed between service costs (revenue) and the capital element that gives rise to the residual interest. The capital additions counting against the CRL will be the unwinding of the discount on residual assets.



Contribution of existing assets – debtor (prepayment)

8.23 Contributions to a PFI contract by the purchaser may take a number of forms, including an up front cash payment or the contribution of existing assets for development by the operator. The accounting treatment of such contributions depends on whether they give rise to future benefits for the purchaser. For example:

• If the contribution of an existing property results in lower service payments, the carrying amount of the property should be reclassified as a debtor (prepayment) in current assets and subsequently charged as an operating cost over the period of reduced PFI payments. The asset is valued at the NPV of the future stream of service payments savings. If there is in effect a sale of part of the contributed asset (for example, a parcel of surplus land that is not used in the PFI contract), any profit should be recognised

• If the contribution does not give rise to a future benefit for the purchaser, it should be charged as an expense when the contribution is made. For example, a capital grant might be given for which the operator would have qualified even if the transaction had not been part of the PFI, or short life assets might be donated to the contract for no value. Disposal of a capital asset in this way will result in a loss on disposal of assets as a charge to the Operating Cost Statement, as the asset is disposed of for no consideration

• Land and Buildings in PFI Deals gives more detail on the recognition and handling of such assets.

Disclosure requirements

8.24 The disclosure requirements for a lessee under a PFI contract are set out in SSAP21: Leases and the Purchase Contracts. However to take account of the long term nature of most PFI contracts, the following additional disclosures are required for off balance sheet transactions and the “services” element of any on balance sheet transactions:

• The total amount charged as an expense in the Operating Cost Statement in respect of PFI transactions;

• The payments which it is committed to make during the next year, analysed between those in which the commitment expires:

• within one year

• in the 2nd to 5th year inclusive

• in the 6th to 10th year inclusive

• and so on in five year bandings

8.25 Since the annual payments under PFI contracts are likely to vary from year to year, beyond an adjustment due to indexation, the payments in later years might differ from those which the purchaser is committed to make during the next year. If the estimated annual payments in future years are expected to be




materially different from those which the purchaser is committed to make during the next year, the likely financial effect also needs to be disclosed in the financial statements.

8.26 The following information is also required for those schemes assessed as off balance sheet:

• description of scheme

• estimated capital value, and

• contract start and end dates.

8.27 The disclosure requirements of paragraph 30 of FRS 5: Reporting the substance of transactions are also relevant to PFI transactions. This requires that:

• the disclosure of a transaction in the financial statements; whether or not it has resulted in assets or liabilities being recognised or ceasing to be recognised, should be sufficient to enable the user of the financial statements to understand its commercial effect, and

• where a transaction has resulted in the recognition of assets or liabilities whose nature differs from that of items usually included in the relevant balance sheet heading, the differences should be explained.

8.28 Therefore, even where the transaction does not result in any items being recognised in the balance sheet, the transaction may give rise to guarantees, commitments or other rights and obligations which, although not sufficient to require recognition of an asset or liability, require disclosure in order that the financial statements give a true and fair view.



9 Asset registers

Introduction

Maintenance of an asset register

9.1 Each NHS body must maintain an asset register. Asset registers support the annual accounts and so are subject to audit by an auditor appointed by Wales Audit Office. The benefits arising from keeping a comprehensive asset register are:

• improved physical asset accountability and risk management

• access for managers to an information system covering all their assets

• the provision of a firm baseline for improved asset management

• the capacity for a planned asset maintenance, repair and replacement programme

• assistance in the calculation of capital charges

• the ability to make comparisons between NHS bodies of a similar type e.g. between NHS trusts.

9.2 The asset register may also be used to ensure proper management and control over assets that cost less than the capitalisation threshold or those held under operating leases. If this is done, the asset register must be so designed to ensure that capital assets are distinguishable from non-capital assets.

Minimum data set

9.3 The minimum data set to be used to establish and maintain an asset register for capital accounting purposes is as follows:

• Asset identification and description

• Asset location

• Date of acquisition

• Method of acquisition

• Initial capital expenditure

• Gross replacement cost (for equipment)

• Depreciated replacement cost (for buildings)

• Cumulative depreciation charged (including buildings since date of acquisition or revaluation)

• Indexation adjustments

• Revaluation adjustments

• Impairments



• Assessed life

9.4 This is a minimum data set for accounting purposes, and should permit the analysis of the revaluation reserve asset by asset. Additional data will be required for asset management purposes. Data recorded in the minimum data set should allow a NHS body to produce reports that detail the revaluation reserve attached to individual assets, and show a value for historic cost depreciation that can be compared with current depreciation to calculate the revaluation reserve to General Fund/I&E Reserve annual transfer.

Scope of asset registers

9.5 All capital assets must be itemised on the asset register, including donated assets, assets held under finance leases, collective assets, and fully depreciated assets. The initial equipping and setting-up costs of a new building must be included where these are capitalised.

9.6 The asset register must clearly distinguish between:

• purchased capital assets on which depreciation is charged and a cost of capital charge made

• leased capital assets

• donated assets which are depreciated (although the depreciation charge is met from the donated asset reserve), but upon which no cost of capital is charged

• assets provided under Government grants

• non-capital assets

• grouped assets.

9.7 The asset register must be structured in such a way as to itemise:

• land separately from the buildings upon the land

• different buildings on the same site with:

building structure

engineering services

shown separately.

9.8 The asset register may itemise the different building elements.

9.9 The asset register must also be designed so as to allow the allocation or apportionment of depreciation charges to the appropriate cost centre.

9.10 Where assets are disaggregated for the purpose of applying separate depreciation regimes to different components, registers must facilitate this.

Periodic Revaluations



9.11 Land and buildings are revalued by District Valuers periodically and given an

assessed remaining life at the time of the revaluation.

9.12 Where other changes occur between formal revaluations, and a valuation is considered necessary, LHB’s and NHS Trusts should approach their local District Valuer.

9.13 Land and any retained building elements held as assets in the course of construction are subject to periodic revaluations.

9.14 Land and buildings held for operational use are valued at their depreciated replacement cost, unless the open market value for existing use can be clearly established.

9.15 Land and buildings surplus to requirements are valued at open market value for alternative use.

9.16 Land and buildings which have not been formally declared surplus to requirements will be assumed to be in operational use at the date of valuation.

9.17 Land and buildings which are donated assets should be identified as such and included in periodic revaluations.

9.18 Equipment held for operational use is valued at depreciated replacement cost. This is calculated to be the gross replacement cost at current valuations less the depreciated to date.

9.19 Equipment surplus to requirements is valued at net recoverable amount.

Annual Prospective Indexation

9.20 The asset base to which annual prospective indexation should be applied will

include assets in the course of construction and assets acquired through finance leases. Estimated asset valuations for a financial year, derived by applying prospective indexation, will form the basis of asset valuations and associated capital charges to be included within the statutory accounts for that year.

9.21 Separate indices will be issued for land, Buildings and Equipment. These indices will be related to publicly available index figures, including the Building Cost Information Service Indices (BICS), the Health Service Price Indices (HSPI) and the Valuation Office Property Market Report (PMR).

Buildings

Buildings Depreciated Replacement Cost

9.22 For most buildings the District Valuer will use (and make available) a separate valuation figure for each of the following 26 categories to derive the buildings



depreciated replacement cost. The value of the building will then be the sum of these separate valuation figures.

1 Substructure 4 Fittings 2A Frame 5A Sanitary Appliances 2B Upper Floors 5B Services 2C Roof 5C Disposal 2D Stairs 5D Water Installation 2E External Walls 5E Heat Source 2F Windows and External Doors 5F Space Heating and Air Treatment 2G Internal Walls and Partitions 5G Ventilation Systems 2H Internal Doors 5H Electrical Installations 5I Gas Installations 3A Wall Finishes 5J Lift and Conveyor Installations 3B Floor Finishes 5K Protective Installations 3C Ceiling Finishes 5L Communications Installations 5M Special Installations

As part of the valuation, the District Valuer will provide subtotals as follows:

1 Substructure 4 Fittings 2 Structure 5 Engineering Services 3 Finishes

9.23 In some health bodies, the asset register will show each building analysed into

these five subtotals rather than the 26 constituent building elements. In these cases the subtotal valuation figures would be entered on the asset register and used to calculate depreciation.

9.24 For certain small or temporary buildings, such as workshops and portacabins, District Valuers will give values divided into:

1 to 4 Building Structure 5 Engineering Services

9.25 For accounting and capital charges purposes this division (between building

structure and engineering services) is the minimum acceptable detail for any building in operational use.

Existing Use Value

9.26 Where an existing use value will be provided for some buildings of a commercial nature, such as office blocks, and most domestic living accommodation. The value will be apportioned between land, building structure and engineering services.



9.27 An open market value will be given for land and building assets surplus to requirements. This value is not apportioned.

9.28 Covered Ways are defined above as being part of Roads and Services Areas. Some Trusts or authorities have treated Covered Ways as separate building blocks and this is acceptable.

External Works

External Works Large Sites

9.29 The definition of a large site may vary and is currently “a site of more than 1 hectare”.

9.30 For these sites external works are grouped into eight categories and each category is given a value. Each of the eight categories is reported in a similar manner to building blocks and are not further aggregated by the District Valuer.

9.31 The eight categories are defined as follows:

1. Roads and Service Areas

Various Constructions Kerbs Footpaths Covered Ways Pedestrian Subways 2. Vehicle Parking Surface Parking Multi – storey Parking Underground Parking Controls 3. Lighting External Lighting All Signage Floodlighting 4. Boundaries Walls and Fences Various Constructions Retaining Walls 5. Drains and Sewers



Drains Inspection Chambers Sewers Drainage Pumps Treatment Plant 6. Distribution Pipework Non Ferrous Ferrous Pressurised Steam Insulation 7. Sundries Underground Service Walkways Wells Helicopter Landing Areas 8. Other Piped and Wire Services Overhead Electrical Overhead CommunicationsRadio Masts Underground Electrical Underground Communications Gas Supplies 2. External Works Small Sites The definition of a small site may vary and is currently “a state of 1 hectare or less”. For these sites, in the absence of the above full details, the District Valuer will adjust the valuation by a percentage addition to the value of the building and engineering elements on the site.

Assets Under Construction

Land Purchased for Building

9.32 This is valued at open market value. The interest element of capital charges is

payable until the date of commencement of construction.

Commencement of Construction



9.33 The date construction commences is defined as the date at which the site is

handed over to the contractor.

9.34 Capital charges are payable at a rate of 3.5% on assets under construction.

9.35 Assets under construction will be valued at the total of:

i. the value of land; ii. any retained building elements within the site under the control of the

contractor; iii. any capitalised expenditure incurred to enable the construction work to

commence; iv. any capitalised expenditure incurred on preliminary works, to enhance the

prospects of a disposal ; v. invoices received for work carried out (whether paid or otherwise); vi. the estimated value of work carried out but for which an invoice has not yet

been received (which should be treated as capital creditors); vii. retentions (which should be treated as creditors until settled). 9.36 Assets under construction will be revalued using indices at the start of each

financial year.

Cessation of Construction Before Completion

9.37 For a formal cessation (i.e. documented instructions received by the contractor), the site, together with the value of construction to the date of cessation, is revalued by the District Valuer at alternative use value and capital charges are payable on that value.

9.38 For informal suspension or delay, the site and part construction continue to be valued as assets under construction.

Removal of Building from Operational Use for Refurbishment

9.39 Provided the following conditions are met, the building will be classed as an

asset under construction:

i. it is planned to be out of operational use for at least three months; and ii. there is evidence of refurbishment or upgrading activity on the site; and iii. it must be sufficiently self contained to allow alternative use, ie disposal or

rent. Assets Made Available For Use

9.40 The valuation to be given to the asset should be its current value on the date on

which it is made available for use. This should be calculated on the basis set out in paragraph 2 above.



9.41 An asset may be revalued by the District Valuer as at the date on which it becomes available for use.

9.42 Alternatively, in cases where the value has not been formally assessed by the District Valuer, the remaining life of the asset which is being made available for use should be taken to be 35 years. Where the work involved is of a particularly specialist nature a shorter period may be chosen at the discretion of individual LHBs or NHS Trusts.

9.43 In cases where only part of the asset is made available for use, eg if a building is brought into use on a staged basis, the proportion of the current value which is attributable to that part of the asset should be transferred to the appropriate tangible assets accounts.

Second – hand Assets

9.44 Second – hand equipment assets should be entered in the asset register as follows:

Purchase price

9.45 The value of the asset should equal the purchase consideration and will not be considered to have any depreciation attached to it.

Standard Asset Life

9.46 The standard life for the category of asset, ie the fact that the asset is second hand is irrelevant.

Annual Depreciation

9.47 Replacement cost divided by standard life.

9.48 This method means that assets are valued at full replacement cost. It also recognises that assets purchased second hand are likely to have a remaining life that is less than standard life for that category of asset.

9.49 The following example illustrates the method to be used for second hand assets:

9.50 An asset is purchased second hnad for £3,000. The cost if it were new would be £5,000. The asset’s standard life is five years.

9.51 It would be included in the books as follows:

Net Book Value (Replacement Cost less accumulated depreciation): £3,000 Capital charge for quarter following purchase:



Depreciation (replacement cost divided by standard life) ie £5,000 / (5 * 4) £250 Rate of return (Net Book Value at 3.5% pa)

I.e. £3,000 * 0.06 / 4 £45

Enhancements Altering Value

9.52 Repair and maintenance expenditure is designed to keep assets in good repair.

This expenditure should be charged as revenue.

9.53 On an exceptional basis, expenditure can be capitalised where expenditure on renovation or upgrading has enhanced the value of the asset.

Land & Buildings

9.54 Enhancement expenditure to land and buildings should generally be added to the book value of the asset at the time it is incurred. The remaining life of the asset should not be extended. It should be depreciated and indexed in common with the original asset until the next revaluation by the District Valuer.

9.55 Enhancement expenditure must be treated as an addition to the net book value of the asset and not as a revaluation of the asset., within both the annual accounts and the asset register. For LHBs, enhancement expenditure should be represented by an addition to the capital account.

9.56 Exceptionally, where a building is planned for replacement or disposal (section 6.4) and capital expenditure is incurred on preliminary works to enable the prospects of a disposal to be enhanced, such expenditure should not be added to the net book value of the asset. The expenditure may be regarded as an enhancement to the open market value of the asset rather than an enhancement to its existing use value. In such cases, the expenditure should charged to the assets under construction account (section 5.4) until the sooner of:

i. the date the building is taken out of use prior to the disposal of the asset; ii. the next revaluation by the District Valuer.

9.57 When the asset is taken out of use prior to its disposal, it will be valued at its

open market value. When the asset is next revalued by the District Valuer the enhancement will be included within the overall valuations of the site as appropriate. In either case the expenditure should not continue to be treated as an asset under construction.

Equipment



9.58 In some cases the enhancement may be sufficiently independent to justify the creation of a new asset.

9.59 In most cases, however, the expenditure should be added to the current replacement value and net book value of the asset. The resulting totals should be indexed and revalued, as appropriate, and depreciated over the remaining life of the original asset.

9.60 The remaining life of the asset can be extended where the enhancement expenditure has significantly extended the remaining life of the asset. The extended life must not exceed the standard life of the asset.

Modern Equivalent Asset

9.61 Modern equivalent assets are assets where:

• An existing asset would be replaced by assets of a significantly different specification;

• The cost of the modern equivalent asset is at least £100,000; • The difference between the replacement cost of the existing asset and the cost

of the modern equivalent asset is at least 25%. 9.62 In practice, modern equivalent assets are likely to be those where technological

advances mean likely replacements have significantly improved quality or quantity of outputs.

9.63 Where these circumstances apply, the replacement value of an existing asset should be the cost of a modern equivalent asset and not the cost of replacing the current asset.

9.64 The assumptions used must be recorded and agreed with the auditors. This is particularly necessary where those assumptions relate to differences in quality rather than quantity.

9.65 The modern equivalent asset calculation, which is likely to be exceptional, is demonstrated in the following example:

Current cost of original asset £150,000 (indexed historical cost) Cost of modern equivalent asset £220,000 Output of existing asset 20,000 units pa Output of modern equivalent asset 40,000 units pa Replacement cost calculation:



£220,000 * 20,000 / 40,000 = £110,000

9.66 This simple example assumes no difference in operating costs and standard

lives between the existing and modern assets.

9.67 The result of the calculation is to reduce the cost of the modern equivalent asset to what it would be if it had an output comparable to the existing asset.

Surplus Assets

Definition

9.68 Land and buildings which have not been formally declared surplus to requirements by the health authority or NHS Trust will be assumed to be in operational use at the date of valuation.

9.69 Where buildings have been formally planned for disposal or closure, the District Valuer may be asked to reassess the valuation of the buildings and their remaining life .

9.70 On closure of the building, prior to disposal, the property must be revalued as a surplus asset.

9.71 In most situations it will be relatively clear when an asset has been removed from operational use. In particular, buildings prepared for demolition, and declared surplus to requirements, would cease to be available for operational use.

9.72 In cases of doubt, it should be assumed that an asset has not been taken out of operational use except when the complete asset is capable of independent disposal.

9.73 Partial closure, eg during a rundown period, will not be regarded as making an asset capable of independent disposal.

Basis of Valuation

9.74 Surplus land and building assets should be revalued by the District Valuer at their open market value as at the date they are taken out of operational use.

9.75 Equipment surplus to requirements is valued at net recoverable amount but revaluation will not be necessary when a standard life asset has been fully depreciated.

Capital Charges



9.76 Capital charges are payable on surplus assets, but these are charged on the new valuation, and they are payable as follows until (and including) the quarter of disposal:

• Land: interest only; • Buildings: interest and depreciation • Equipment: interest and depreciation

Educational Use Assets

9.77 In practice, problems regarding the definition of NHS assets are most likely to arise regarding teaching hospitals and other educational bodies.

9.78 This means that capital charges are payable on all educational use assets except where the asset was originally funded by another body such as the Welsh Funding Councils (formally the University Funding Council). Where identifiable elements of a building were NHS funded, the capital charges should relate to a valuation of those elements, otherwise a valuation of the whole building should be apportioned on the basis of the original contribution.

9.79 Service Increment for Teaching and Research (SIFTR) payments will be increased by the amount payable in capital charges on educational use assets. It is not therefore necessary to attempt to recover these capital charges through increased prices.

9.80 In some instances, there are rental agreements whereby NHS assets are leased to teaching hospitals. Capital charges will be payable by the lessor on these assets but the rental charge should not be increased accordingly since it is proposed to increase SIFTR by the amount of the charge.



10 References

10.1 The following publications are referred to in this Manual:

FRS 5 – Reporting the Substance of Transactions

1994 (and subsequent Application Notes), Accounting Standards Board. ASB Publications, PO Box 939, Milton Keynes, MK9 2HT (01908 230344)

FRS 11 – Impairment of Fixed Assets and Goodwill

1998, Accounting Standards Board.

FRS 15 – Tangible Fixed Assets 1998, Accounting Standards Board.

Guidance - Land and Buildings in PFI Deals

Via the NHS Web http://www.doh.gov.uk/pfi/land.htm

Leases – Implementation of a New Approach - Discussion Paper

1998, Accounting Standards Board.

NHS Trust Manual for Accounts

Local Health Boards Manual for Accounts

Royal Institute of Chartered Surveyors (RICS) – Appraisal and Valuation Manual

Royal Institute of Chartered Surveyors http://www.rics.org.uk

SSAP4 – Accounting for Government Grants

1990, ASC Available from ASB Publications – see above

SSAP13 – Accounting for Research and Development

1977, ASC

SSAP21 – Accounting for Leases and Hire Purchase Contracts

1984, ASC

Treasury Technical Note No 1 (Revised)– How to Account for PFI Transactions

1999, HM Treasury 0171 270 4558/4860/4870 http://www.ogc.gov.uk/pfi/series_3/technote/tech_contents.htm


http://www.rics.org.uk/





11 Useful Web Addresses

Finman Primary Care Trust, StHA, NHS trust, Funds Held on Trust Manuals and spreadsheets, Primary Care Trust, Capital Accounting Manuals, Clinical Negligence spreadsheets, and Financial Matters. www.doh.gov.uk/finman.htm Other Department of Health Information on Primary Care Trusts can be accessed at: http://nww.doh.nhsweb.nhs.uk/nhs/pricare/index.htm PFI and capital information can be found at http://www.doh.gov.uk/pfi/index.htm Reference cost information and the NHS Costing Manual can be found at http://www.doh.gov.uk/nhsexec/costing.htm Resource accounting and budgeting guidance can be found at: http://www.doh.gov.uk/allocations/rab.htm Wales Audit Office http://www.wao.gov.uk/ HM Treasury http://www.hm-treasury.gov.uk/ Accounting Standards Board http://www.asb.org.uk

http://www.doh.gov.uk/finman.htm

http://nww.doh.nhsweb.nhs.uk/nhs/pricare/index.htm

http://www.doh.gov.uk/pfi/index.htm

http://www.doh.gov.uk/nhsexec/costing.htm

http://www.doh.gov.uk/allocations/rab.htm

http://www.audit-commission.gov.uk/

http://www.hm-treasury.gov.uk/

http://www.asb.org.uk/



12 List of abbreviations used in the finance manual

ASB Accounting Standards Board

AVC Additional Voluntary Contribution

CBI Confederation of British Industry

CGA Central Government Accounts

CHC Community Health Council

NAW National Assembly for Wales

EFL External Financing Limit

ELS Existing [clinical negligence] liabilities scheme

FHOT Funds held on trust

FRED Financial Reporting Exposure Draft

FRS Financial Reporting Standard

GAAP Generally Accepted Accounting Practice

NBV Net Book Value

NHS National Health Service

NI National Insurance

NIC National Insurance Contribution

PAYE Pay As You Earn

PDC Public Dividend Capital

PFI Private Finance Initiative

PPA Prior Period Adjustment

RA Resource Accounts

RAB Resource Accounting and Budgeting

RTA Road Traffic Act



SAS Statement of Auditing Standard

SFS Summary Financial Statement

SSAP Statement of Standard Accounting Practice

UITF Urgent Issues Task Force

UK GAAP United Kingdom Generally Accepted Accounting Practice

VFM Value For Money

WGA Whole of Government Accounts

whc (2006) 068 welsh health circular - nhs wales2006)068.pdfwhc (2006) 068 parc cathays caerdydd...

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