Capital Accounting Manual

DRAFT NHS Foundation Trust Capital Accounting Manual
5 January 2005 IRCP 01/05
05/01/05
NHS FT Capital Accounting Manual
CONTENTS 1 Introduction..................................................................................4
Purpose of the Manual .................................................................................................4 Accounting standards and guidance referred to in the Manual..............................4 Queries and contacts....................................................................................................5
The Capitalisation and Valuation of Fixed Assets....................6

Introduction.....................................................................................................................6 General principles and definitions...............................................................................6 Categories ......................................................................................................................6 Tangible fixed assets ....................................................................................................7 Tangible fixed assets - expenditure to be capitalised ..............................................8 Intangible fixed assets - capitalisation......................................................................14 Deferred assets in PFI schemes...............................................................................16 Fixed asset investments.............................................................................................16 Measurement and valuation ......................................................................................16 Valuations, review and impairments.........................................................................19 Indexation .....................................................................................................................22 Surplus assets and disposals ....................................................................................24 Impairments..................................................................................................................25 Annex 1 - Definitions...................................................................................................32 Annex 2 - Presentation and disclosure examples...............................................34
Depreciation and asset lives ....................................................36

Introduction...................................................................................................................36 Chargeable period.......................................................................................................38 Other considerations...................................................................................................39 Calculation of Depreciation........................................................................................41
Leases ........................................................................................43
Introduction...................................................................................................................43 Definitions.....................................................................................................................44 Determining the lease type - the 90% test...............................................................44 Determining the Lease Type Other Factors.........................................................45 Accounting for finance leases lessees..................................................................47 Operating Leases ........................................................................................................50 Accounting for leases lessors ................................................................................51 Hire purchase contracts .............................................................................................51 Future developments ..................................................................................................52 Accounting entries.......................................................................................................53
Public Dividend Capital Interest...............................................56

Introduction...................................................................................................................56 PDC dividend calculation of relevant net assets .................................................56
05/01/05
Prudential Borrowing Limit (PBR)............................................58

Introduction...................................................................................................................58 Protected assets..........................................................................................................58
Donated assets ..........................................................................59

Introduction...................................................................................................................59 Accounting for donated assets ..................................................................................59 Accounting entries for donated assets .....................................................................61
Private Finance Initiative ..........................................................64

Introduction...................................................................................................................64 FRS 5 and SSAP21 ....................................................................................................64 PFI Accounting ............................................................................................................64 Land and buildings in PFI schemes..........................................................................66
Asset registers...........................................................................85
05/01/05
1 Introduction
Purpose of the Manual
1.1 The Foundation Trust Capital Accounting Manual (CAM) is intended to complement the Foundation Trust Manual for Accounts (MFA). It focuses on fixed asset transactions in greater detail than is possible in the Manual for Accounts. The CAM interprets standard accounting practice for its application in the NHS context, and defines NHS Foundation Trust accounting policy as defined by Monitor with Treasury's agreement. In the rare event that NHS Foundation Trusts propose to set aside guidance in the CAM in order to present a true and fair view of their transactions, organisations must inform Monitor so that any further implications can be followed through with Treasury. Any such deviation from guidance in the CAM would need to be agreed with the NHS Foundation Trusts external auditor. Private Finance Initiative (PFI) transactions should also be accounted for in a manner consistent with the CAM and MFA. Chapter 8 outlines the key issues and accounting treatments around PFI.
1.2
1.3
Accounting standards and guidance referred to in the Manual

1.4 The Foundation Trust Manual for Accounts, HM Treasurys Resource Accounting Manual (the RAM) and the CAM follow UK Generally Accepted Accounting Practice (UK GAAP) to the extent that it is meaningful and appropriate in the NHS context. NHS Foundation Trusts will therefore prepare UK GAAP compliant accounts, and merit a "true and fair" audit opinion, if the Manuals for Accounts and CAM are followed. The NHS Foundation Trust Manual for Accounts outlines the application of Standards in the NHS context. Specific reference to the following Standards in the Capital Accounting Manual: FRS 5: Reporting the Substance of Transactions FRS 10: Goodwill and Intangible Assets FRS 11: Impairment of Fixed Assets and Goodwill FRS 12: Provisions, Contingent Liabilities and Contingent Assets FRS 15: Tangible Fixed Assets SSAP 4: Accounting for Government Grants SSAP 13: Accounting for Research and Development SSAP 21: Accounting for Leases UITF Abstract 24 Accounting for Start Up Costs UITF Abstract 28: Operating lease Incentives
1.5
05/01/05
Queries and contacts

1.6 NHS Foundation Trusts may also find it useful to refer to up-to-date guidance in the NHS Finance Manual on the "finman" website www.doh.gov.uk/finman.htm. While this guidance is not intended or written for NHS Foundation Trust use, it addresses NHS accounting developments that might be of interest to NHS Foundation Trusts.
05/01/05
2 The Capitalisation and Valuation of Fixed Assets

Introduction
2.1 FRS 15, Tangible Fixed Assets, has been applied in the NHS from 1 April 1999. In the NHS, particular issues around the application of FRS 15 include: 2.2 The fact that much of the NHS estate consists of specialised healthcare assets for which no true market exists; The use of a a capital charging system, which UK Generally Accepted Accounting Practice (UK GAAP) 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; and The importance of the distinction between finance and operating leases
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 Foundation Trusts future economic benefits relate to the contribution of assets in some way to the provision of services or other outputs. 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.
2.4
Categories
2.5 The RAM requires that fixed assets are reported, analysed at the following minimum level of detail:
05/01/05
Tangible fixed assets

Land Buildings (excluding dwellings) Dwellings Assets under construction and payments on account Plant and machinery Transport equipment Information technology Furniture and fittings
Intangible fixed assets

Software licences Licences and trademarks Patents Development expenditure
Fixed asset investments

Equity Loans
Tangible fixed assets

2.6 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 entitys activities 2.7 A tangible fixed asset will generally have a life in excess of one year.
Capitalisation threshold of fixed assets - de minimus limits

2.8 The RAM leaves discretion for individual government Departments to set their own capitalisation thresholds, having regard to practicality, flexibility, consistency and asset grouping considerations. The Department of Health 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. This threshold applies to
05/01/05
NHS Foundation Trusts, as consistency with other NHS bodies is required. The 5,000 figure includes VAT where this is not recoverable.
Grouped assets
2.9 "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: 2.10 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.
Assets acquired in the course of the initial setting up of a new building or on refurbishment are also to be treated as "grouped" for capitalisation purposes (see below, para 2.18).
IT assets
2.11 It is expected that IT hardware will 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 all IT equipment purchases, where the final three criteria above apply, will be capitalised. Where an NHS Foundation Trust adopts this firmer interpretation of interdependency with regard to IT assets, and has not capitalised such purchases before, auditors may consider that the change constitutes a Prior Period Adjustment. 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
2.12 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. Foundation Trusts will need to apply judgement and consult with their auditors where cases are not clear-cut.
Tangible fixed assets - expenditure to be capitalised

2.13 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.
05/01/05
Attributable costs
2.14 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 a Foundation Trusts 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
2.15 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.
Interest
2.16 FRS 15 permits capitalisation of finance costs at the entitys option. However, as a matter of Treasury policy, interest or finance costs may not be capitalised in the NHS and this policy also applies to NHS Foundation Trusts.
05/01/05
Initial equipping and setting-up costs of new building

2.17 Assets which are capital in nature but which are individually valued at less than 5,000 may be capitalised (at the NHS Foundation Trust's discretion) as collective, or grouped, assets where they are acquired as part of the settingup 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 subsequent expenditure in FRS 15 terms. It is therefore appropriate to capitalise the purchase of new furniture in a new build or refurbishment exercise, provided that assets thus capitalised can be subsequently identified for audit purposes. UITF Abstract 24 addresses a different issue. It deals with 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. The UITF abstract then does not affect the practice of capitalising setting up costs in NHS Foundation Trusts because the items so capitalised are capital in nature, but usually are taken to the I&E 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). UITF Abstract 24 is fully applicable to the NHS in those circumstances.
2.18
2.19
Demolition costs
2.20 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

2.21 The question of capitalisation of staff training costs associated with the introduction of new systems is occasionally raised. 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 2.22 2.23 In other words, repairs and maintenance expenditure cannot be capitalised and should be charged to the I&E account. FRS 15 permits capitalisation of subsequent expenditure when:
05/01/05
10
That expenditure provides an enhancement of the economic benefits of the tangible fixed asset in excess of its previously assessed standard of performance 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.
2.24
The last two 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 assets expected economic life is triggered. 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 rebuilding, so are analogous to the creation of a new asset. 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 I&E account. Maintenance expenditure would thus fall to be treated as revenue expenditure even if initially, and erroneously, treated as capital.
2.25
2.26
Equipment
2.27 Equipment (new and second-hand) is initially capitalised at its purchase price. This arrangement will apply when equipment assets are initially brought onto a NHS Foundation Trust balance sheet whether or not the acquisition was from a commercial 3rd party or from a NHS body. When a new or 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).
2.28
05/01/05
11
Leases
2.29 Finance lease assets (where the NHS Foundation Trust is the lessee) will be brought on to the balance sheet and accounted for as if that body owns the underlying asset. Chapter 4 below deals with leases.
Donated assets
2.30 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 the calculation of PDC dividend charges while a release from the reserve neutralises the revenue impact of the depreciation charge. (See Chapter 3 below on depreciation and Chapter 5 on PDC dividends). 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. 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).
2.31
2.32
2.33
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 transferors books). Assets financed by 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 developers business. Any asset provided as part of a PFI scheme by the developer cannot be considered as donated1.
2.34
Any restrictions imposed by the donor on the use of an asset must be disclosed in the annual accounts.
Generally all the assets provided in a PFI scheme are privately financed. Occasionally an element (often equipment / enabling works) is funded by charitable donations or publicly funded but are still part of the PFI scheme. If these come on balance sheet then theses elements would be classed as donated. Assets which are privately financed are not donated.
05/01/05
12
Assets movements between NHS Foundation Trusts and other NHS bodies
2.35 The term transfer is loosely used in the NHS, and care must be taken that the umbrella term "transfer" does not obscure the need for a purchase/sale transaction in most cases to effect the transfer of assets or liabilities. It is envisaged that assets or liabilities will transfer between NHS Foundation Trusts and other NHS bodies only by means of cash purchase/sale transactions (other than on establishment or on dissolution). There is no requirement to revalue assets to a market value and the the purchase price should be set to equal the carrying amount of the asset in the vendor's books. This ensures that (a) there is no need to undertake an expensive re-valuation and that (b) no profits/losses can be generated within the NHS simply by virtue of intra-NHS transactions. A NHS Foundation Trust will only transfer assets without a cash transaction in two circumstances: On initial establishment, the complete balance sheet of the NHS Foundation Trusts predecessor transfers intact to the Foundation Trust. On the dissolution of a NHS Foundation Trust, its assets and liabilities will pass to a successor organisation (unless, and this is preferable, those net assets have previously been purchased by the successor organisation, and the sale proceeds used to repay Public Dividend Capital).
2.36
2.37
2.38
Assets acquired from other Government Departments, Local Authorities, Housing Associations and other non-NHS bodies, should be purchased at fair (market) value. Where transactions are between NHS Foundation Trusts and non-NHS bodies, NHS Foundation Trusts are not required to revalue assets scheduled for disposal to market value (see definition), but should recognise any profits or losses on the disposal of these assets based on the net book value of the asset at the time of sale.
2.39
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 Government grants are defined in SSAP 4, "Accounting for Government Grants" 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. Assets provided by grant will be accounted for as any other asset, in terms of valuation, depreciation and so on. The asset will be carried at its current cost, and the value of the grant must not be netted off its carrying amount.
2.42
05/01/05
13
2.43
The amount of the capital grant should be credited to a government grant reserve (GGR) 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 assets depreciation charge will be debited to the government grant reserve and credited to the I&E account (any depreciation arising from capital expenditure in excess of the grant will thus, rightly, go unrelieved). There will be no PDC dividend charged 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. Details of the depreciation and capital cost absorption treatments can be found in Chapters 3 and 5 below.
2.44
Intangible fixed assets - capitalisation

Research and development
2.45 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: 2.46 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.
In most cases R&D expenditure will be charged to the I&E account in the year in which it is incurred. If capitalised, the asset must be amortised over the period in which the product or service will be sold or provided for use. Capitalised development expenditure must be indexed (as is the practice set out in the RAM. The index figure to be applied is that for equipment. 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 I&E account immediately.
2.47
05/01/05
14
Software - purchase of licence

2.48 2.49 A purchase of software is generally the purchase of a licence to use software code developed by, and which remains the property of, a third party. FRS 10 "Goodwill and Intangible Assets" requires that software that remains the property of, for example, Microsoft should be capitalised as an intangible fixed asset. This is in recognition of the fact that the user has bought the right to enjoy the economic benefits of the use of the software for more than one year. The provisions of this Manual on the capitalisation threshold 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. The Accounting Policies note to the Annual Accounts discloses that intangible assets are amortised over estimated lives.. It is believed that software assets will tend to have relatively short lives, but this is a matter for an individual bodys 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 NHS Foundation Trusts IT strategy.
2.50
2.51
Software - created in-house

2.52 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, licence or sell the application at its discretion. This applies whether the software is produced "in-house", or is developed by contractors on behalf of the NHS Foundation Trust. FRS 10 considers that such software is integral to hardware systems on which the owned software will run, and says that its development cost should be included with the cost of the IT hardware. However, the software itself is clearly a valuable and productive asset in its own right, even where it is running on leased IT hardware for example (i.e. there is no hardware asset to which the cost of software can be added.). Software code owned by a NHS Foundation Trust should therefore be carried as a tangible fixed asset, within the category "IT hardware", indexed at the rate appropriate to IT hardware (currently nil), and depreciated over the expected economic life of the software.
2.53
2.54
Goodwill
2.55 Goodwill may arise if a NHS Foundation Trust purchases a subsidiary undertaking or business. Please refer to the Manual for Accounts and FRS 10 Goodwill and Intangible Assets.
05/01/05
15
Deferred assets in PFI schemes

2.56 Some PFI transactions involve the disposal of assets to private partners (by lease, sale or otherwise as part of the deal). Unless a NHS Foundation Trust has in substance disposed of the asset at an undervalue or for no consideration (in which case a loss on disposal must be recorded in the I&E account) it is to be expected that some benefit will accrue to the Foundation Trust in return. This implies that an asset of some kind must have been created in return for the exchange of the original asset. Chapter 8 gives more detail on PFI accounting with reference to Department of Health guidance Land and Buildings in PFI Schemes (Version 2) issued in January 2003. 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. The value of the reduction in future payments should be recorded as a prepayment within debtors. This is written off to the I&E 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 I&E account in this case will be over the life of the lease. 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 fall to be included within net relevant assets for the purposes of calculating the cost of capital charge.
2.57
2.58
Fixed asset investments

2.59 Where a NHS Foundation Trust owns equity in another entity, including associates and subsidiaries, the investment (analysed between equity and loan stock) must be disclosed. Fixed asset investments should be valued at cost, less any amounts written off, or at valuation (See Manual for Accounts).
Measurement and valuation

General Principles
2.60 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. Tangible fixed assets should be valued at the lower of replacement cost and recoverable amount.
2.61
05/01/05
16
Valuation of Tangible Fixed Assets lower of:
Net current replacement cost (RC)
Recoverable amount (RA)

higher of:
Net realisable Value (NRV)
Value in use
2.62
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. For equipment assets, depreciated replacement cost is the appropriate measure. A modern equivalent asset calculation may be used in the circumstances described below. Recoverable amount is defined as the higher of net realisable value (NRV) and value in use, where value in use is the cost of replacing the assets service potential. For specialised property this can be taken to be the depreciated replacement cost (DRC) of the asset. Net realisable value (NRV) is the actual or expected sale proceeds realisable on the open market, net of selling expenses etc. Other (non-property) tangible fixed assets value in use will be DRC.
2.63
2.64
2.65
Surplus assets
2.66 Surplus non-operational property should be valued at market value (MV), less directly attributable selling costs, where material. District Valuers now provide valuations based on MV 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. For an asset to be treated as "surplus" two conditions must apply: 2.68 there is an explicit intention to dispose, and the asset is not in operational use.
2.67
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
05/01/05
17
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. The following considerations apply: 2.71 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%.
2.70
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. 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 I&E 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 section on impairments). The accounting entries are as follows:
I&E account (impairment) Fixed assets Provision for depreciation account I&E account With the reduction in the replacement cost of the existing asset With the amount of the reduction in the accumulated depreciation on the existing asset
2.72
2.73
Dr Cr Dr Cr
The net amount charged to the I&E account will, therefore, be the reduction in NBV of the existing asset
05/01/05
18
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 Accumulated depreciation, existing asset NBV existing asset Cost of MEA Calculation of MEA cost (for same output as the existing asset): 220,000*(20,000/40,000) 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 Revised accumulated depreciation on existing asset Revised NBV of existing asset 110,000 150,000 60,000 90,000 220,000
110,000 44,000 66,000
2.74
The reduction in the gross replacement cost of 40,000 is debited to the I&E account, while the written-back depreciation of 16,000 is credited to the I&E 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 assets 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. 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 good deal of freedom for public sector bodies to set their own revaluation policies, having regard to the costs involved. Equipment assets are also indexed to maintain a current cost (at depreciated replacement cost). 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. (It should be noted,
2.76
2.77 2.78
05/01/05
19
however, that deferred development costs are indexed (in-house software) see para 2.58). 2.79 Revaluations of individual assets will be required outside the 5-yearly cycle when: 2.80 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 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.
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 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 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 MV 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 (DV) 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 Foundation Trusts have the freedom to commission such work from other suitably qualified valuers if they so wish. The standard disclosure of accounting policies 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 five-yearly cycle the full disclosure provisions of FRS 15 (para 74) must be followed. The total NHS estate has been revalued effective from 31 March 2005. Some element of prospective indexation is therefore required for the DV to estimate 1 April 2005 values.
2.83
05/01/05
20
Non-specialised land and buildings

2.84 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 openmarket 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. 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.
2.85
Specialised land and buildings valuation at DRC

2.86 FRS 15 and the RAM 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. Certain assumptions inherent in the DRC valuation methodology may lead to DRC valuations 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. It is to be expected then that the very action of revaluing from cost to DRC will produce a fall in value (see the section on impairments re the treatment of this fall. Essentially, such a fall is deemed to be a by-product of valuation methodologies and not a true loss of economic value. The debit entry is therefore to the revaluation reserve and is not charged to the I&E account). The DRC valuation methodology employed by the DV 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. While NHS Foundation Trusts 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).
2.87
2.88
2.89
2.90
05/01/05
21
2.91
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
2.92 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 (para 2.74 et seq) 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
2.93 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. Separate national indices are issued for land, buildings and equipment. Indices for the years 1992/93 to 2004/05 are shown below. 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. 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. When a national revaluation exercise returns 1 April valuations it is, consequently, appropriate to immediately index those new values. All tangible 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. NHS Foundation Trusts should always ensure that assets are not sold to third parties at an 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 market 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
2.94
2.95
2.96
2.97
05/01/05
22
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. 2.98 When assets transfer by sale or on dissolution/establishment between NHS bodies on 1 April, the transfers should take place before indexation (for the sake of consistency). The principle is that indexation must be applied to the asset, and having it applied by the vendor reduces the opportunity for confusion. There is no net effect in accounting/funding terms whether the indexation is applied by the vendor or purchaser.
Applying indexation
2.99 The series of indices applied in the NHS to date is shown below:
2001/02
2002/03
2003/04
1992/93
1993/94
1994/95
1995/96
1996/97
1997/98
1998/99
1999/00
Land
100
(2)
101
(2)
102
102
104
108
131
100
100
(1)
2000/01
115 161
(3)
140
148
159
Buildings
113
(2)
105
(2)
109
128
133
137
147
158
160
184
202
218
Equipment
100
107
111
115
118
120
123
126
129
132
136
139
142
Notes to table:
1. The Valuation Office rebased the index figure for land for 1999/2000 to 100. The index the VO gave for 2000/2001 is also 100 (i.e. no general land inflation is predicted). For 1 April 2000 therefore no indexation uplift should have been applied to land values. The land indices for 1999/2000 and 2000/01 are therefore shown here as 100, whereas in earlier publications they were given as 141. 2. 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. 3. As an example, the uplift to be applied to building values on 1 April 2002 is: (184/161)*100 or 14.286%
05/01/05
23
2004/05
Surplus assets and disposals

General
2.100 Where an asset is disposed of, the following transactions should be treated as separate and distinct events: revaluation to the appropriate carrying amount recognition of impairment re-profiling of depreciation recognition of profit/loss on disposal.
2.101 The demolition or scrapping of a building or a piece of equipment is a disposal for no consideration. 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). 2.102 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). 2.103 Note: the final carrying amount of a building is its market valuation as assessed by the DV. 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. 2.104 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. 2.105 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 impairments below). 2.106 Surplus land and buildings not in operational use should be revalued to market value (DVs attach valuations based on the prevailing use concept, having regard to the likely use to which property sold in the locality could be put). 2.107 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. 2.108 Property thus classed as surplus, but still in operational use, must not be written down to MV. It should remain in the balance sheet at its normal
05/01/05
24
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). 2.109 The matrix below summarises the transactions:
In operational use Carry at DRC (if specialised) or carry at MV for existing use (if market value available) carry at DRC or OMVEU as above and revise depreciation profile to reach OMV for alternative use by disposal date Not in operational use If temporarily not in operational use treat as in operational use
Not surplus
Surplus
Revalue to MV for alternative use and consider economic impairment. Cease to depreciate
Impairments
Requirements of FRS 11
2.110 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. 2.111 Much of the detail of FRS 11 is concerned with the identification of "incomegenerating 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. 2.112 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
2.113 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. 2.114 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 over specified for its current use there is a fall in value on indexation or on 5-yearly revaluation
05/01/05
25
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.
2.115 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. 2.116 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 fall in value on revaluation of a new asset from cost to DRC will not be treated as an economic impairment, as the DRC valuation methodology itself gives rise to the fall in value. 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. 2.117 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 I&E account (see para 2.15). Further, care needs to be taken that only legitimate capital expenditure is capitalised in the first place: the incorrect capitalisation of revenue costs would (on revaluation to DRC) then result in revenue expenditure being taken straight to reserves. 2.118 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 reviews
2.119 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 above). 2.120 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. 2.121 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.
05/01/05
26
2.122 An impairment review of a NHS Foundation Trust 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.
Future disposals
2.123 When there are firm plans to dispose of a currently operational building asset, an impairment review should be carried out to determine the assets open market value for alternative use (OMV) (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. 2.124 Where there is uncertainty about the date an asset will be taken out of operational use, NHS Foundation Trusts may wish to maintain an assets life and depreciation profile unchanged, recognising an economic impairment in the year in which the uncertainty is resolved and firm plans for disposal are agreed. 2.125 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 it is to be expected that the OMV will be lower than the OMV at the actual date of disposal, and this may then give rise to a profit on disposal. NHS Foundation Trusts 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. 2.126 In the unlikely event that the actual 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.
Recognition of impairment losses

2.127 As in the application of all Financial Reporting Standards, impairment losses need only be recognised (i.e. accounted for) when they are material. What is material in a particular set of circumstances is a matter to be agreed with auditors. The following paragraphs relate to material impairment losses. 2.128 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 I&E account. The exception to this principle relates to newly constructed buildings that attract a first DRV valuation that is invariably lower than cost. 2.129 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:
05/01/05
27
those that are clearly caused by a consumption of economic benefits, and those caused by a general fall in prices.
2.130 The first type is similar to depreciation and is treated in the same way i.e. recognised in the I&E 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 I&E account. 2.131 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. 2.132 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 I&E account. 2.133 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 I&E account.
Losses of economic benefit

2.134 Impairment losses resulting from the indications listed above (para 2.122) are losses of economic benefits and should be recognised in the I&E 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 should be made equal to: The amount of the impairment, or The credit balance on the revaluation reserve for the asset, if lower.
Price falls
2.135 Fixed assets are indexed annually and property assets are professionally revalued every five years. Indexations purely reflect price changes and the 5yearly 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. 2.136 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 I&E account. This 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. 2.137 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 STRGL until the balance in respect of that asset in the Revaluation Reserve is used up, after which it should be recognised in the
05/01/05
28
I&E 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. 2.138 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.
2.139 If, subsequently, it is decided that any part of the downward price movement is in fact permanent, an adjustment between the I&E account and the revaluation reserve should be made in the current accounting period.
Newly constructed assets

2.140 On bringing a newly constructed (building) asset into use there is often a significant fall in value. If this is due to a loss of economic benefits it should be charged to the I&E 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). Recent changes in the valuation methodology have narrowed the gap between cost and DRC valuations, so such price falls in the 2005 national revaluation, for example, should not be as marked as in previous years. 2.141 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 (i.e. not charged to the I&E account as an impairment). Negative revaluation reserve balances will inevitably arise these are acceptable. 2.142 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 I&E 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.
Enhancement expenditure
2.143 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.
05/01/05
29
Revaluation reserve balances

2.144 It is important to be able to link balances taken to the Revaluation Reserve with their associated assets. NHS Foundation Trusts 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 2.96 above defines, as far as possible, an "asset" in the context of revaluation reserve apportionment and impairment calculations. 2.145 When an asset is disposed of, the balance on the Revaluation Reserve in respect of it should be transferred to the 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. 2.146 Further, UK GAAP requires a transfer to be made from the revaluation reserve to the 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 and Government Grants
2.147 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 STRGL in the first instance the balance of the loss should be recognised in the I&E account when the Donated Asset Reserve has been reduced to the value at which the asset was first taken on where an impairment loss is recognised in the I&E account, an offsetting transfer should be made to it from the Donated Asset Reserve or GGR.
2.148 As price movements impact on the donated asset reserve, and economic losses taken to the I&E account result in the transfer noted above, the donated asset reserve in respect of a particular asset will continue to equal its carrying amount. 2.149 Similar treatment is required for assets financed by Government Grants, where the transfers will be from the Government Grant Reserve.
Reversal of past impairments
05/01/05
30
2.150 A debit to the I&E 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 I&E account to the extent that it increases the carrying amount of the asset to what it would have been had the impairment not occurred. 2.151 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 I&E 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

2.152 Impairment losses recognised in the I&E account should be included in operating costs. Impairment losses recognised in the STRGL must be disclosed separately on the face of the statement. 2.153 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 I&E account should be shown in the depreciation (bottom half) part of the note.
Where (exceptionally) an impairment loss recognised in an earlier period is reversed, the financial statements should disclose the reason for the reversal.
05/01/05
31
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) (b) a willing seller; 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; 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; that no account is taken of any additional bid by a prospective purchaser with a special interest; that both parties to the transaction had acted knowledgeably, prudently and without compulsion; that the property can be used for the foreseeable future only for the existing use; and, that vacant possession is provided on completion of the sale of all parts of the property occupied by the business.
(c)
(d) (e) (f) (g)
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) (b) that the plant and machinery will continue in its present uses in the business 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 that the transfer is part of an arms length sale of the business wherein both parties acted knowledgeably, prudently and without compulsion.
(c)
Market value
05/01/05
32
"The estimated amount for which a property should exchange on the date of valuation between a willing buyer and a willing seller in an arm's-length transaction after proper marketing wherein the parties had each acted knowledgeably, prudently and without compulsion". Extracts from the Appraisal and Valuation Manual (Royal Institution of Chartered Surveyors).
05/01/05
33
Annex 2 - Presentation and disclosure examples

Examples below illustrate the recognition, and reversal, of impairments in accounts. The examples below are intended only to illustrate the principles.
1.
Impairment price change
In the example the impairment is 100 and the revaluation reserve stands at 20. Where: the recoverable amount exceeds carrying amount (the normal treatment for assets held at DRC and showing a price movement on 5-yearly revaluation)
Dr Cr
100 Revaluation reserve 100 Tangible fixed assets The loss is taken to the STRGL in full, and a negative revaluation reserve iro the asset arises (-80) Where: the price movement is likely to be long-term Dr Cr 20 Revaluation reserve 80 Income and expenditure account 100 Tangible fixed assets The loss can be offset first against the revaluation reserve associated with the asset.
2.
Impairment loss of economic benefits
Impairment 100, revaluation reserve 20. Dr 100 I&E account Cr 100 Tangible fixed assets With the total impairment, as an economic loss Dr 20 Revaluation reserve Cr 20 I&E reserve To eliminate the balance on the revaluation reserve (up to a maximum of 100)
3.
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 Where: the recoverable amount exceeds carrying amount (the normal treatment for assets held at DRC and showing a price movement on 5-yearly revaluation) Dr Cr 80 Tangible fixed assets 80 Donation reserve With the increase in value Dr 100 Donation reserve Cr 100 Tangible fixed assets To reflect the impairment Where: the price movement is likely to be long-term Dr 80 Tangible fixed assets
05/01/05
34
Cr Dr Cr Dr Cr
80 Donation reserve With the increase in value 80 Donation reserve 20 I&E account 100 Tangible fixed assets To reflect the impairment 20 Donation reserve 20 I&E account To neutralise the impact of the impairment on the I&E account
4.
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 I&E account Cr 100 Tangible fixed assets With the impairment Dr 100 Donation reserve Cr 100 I&E account To neutralise the impact of the impairment on the I&E account
05/01/05
35
3 Depreciation and asset lives

Introduction
3.1 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. Depreciation is not a measure of loss of value and so the argument 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. 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. Depreciation is not intended to provide a fund for replacement, as FRS 15 makes clear. However, as depreciation is a non-cash item that will generally be met by cash-income, the application of depreciation will tend to generate cash surpluses in NHS Foundation Trusts books.
3.2
3.3
Depreciation policy
3.4 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). As this policy is consistent with the RAM, other methods (e.g. reducing balance, sum of digits methods) are not permissible.
Land
3.5 Land is not depreciated, because it is considered to have an infinite life.
Buildings
3.6 Building assets are depreciated over the period of their assessed lives, as determined by an independent valuer. Property consists of land and building elements, and valuers will apportion the cost of the property between (depreciable) buildings and (non-depreciable) land elements. 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 MV for disposal value on the disposal date (see below re accelerated depreciation).
3.7
05/01/05
36
Equipment
3.8 Equipment is depreciated over its useful economic life. The expected life of equipment assets and residual values should be reviewed 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". FRS 15 states that: 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 assets remaining useful economic life, except to the extent that it has been impaired at the balance sheet date. 3.10 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 that NHS Foundation Trusts 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
3.9
Residual value
3.11 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
05/01/05
37
example, that holding gains cannot be anticipated. All other things being equal, in times of inflation an organisation will (if it reviews residual value in line with FRS 15 for assets other than those carried at OMV) over-provide depreciation in the assets life such that a valuation to OMV prior to disposal may well generate a profit on disposal.
Assets under construction

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

3.13 Intangible fixed assets are amortised over the period of the assets' expected economic lives.
Finance leases
3.14 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 a Valuer to its MV or DRC value. The residual value should then be depreciated over the remaining useful economic life of the asset.
Chargeable period
Availability for use
3.15 3.16 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. 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. 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

3.18 Depreciation ceases to be chargeable when an asset is disposed of. A 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; or
05/01/05
38
3.19
scrapped.
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
3.20 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.
Disposal of a surplus asset

3.21 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
3.22 Collective or grouped assets should be treated as single assets for the calculation of depreciation.
Fully depreciated assets

3.23 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. 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 Foundation Trust and further depreciated over their estimated remaining useful lives.
3.24
05/01/05
39
Long-life assets
3.25 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, apart from land, are depreciated as a matter of policy and NHS Foundation Trusts should follow this policy.
Infrastructure assets and renewals accounting

3.26 Infrastructure assets 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. The RAM gives motorway and trunk roads as examples of infrastructure assets and it is highly unlikely that NHS Foundation Trusts will have infrastructure assets.
3.27
Heritage assets
3.28 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 Foundation Trusts will have any heritage assets (as defined by the RAM). Characteristics of heritage assets are: 3.29 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.
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. Non-operational heritage assets should be valued and capitalised where possible. Any NHS Foundation Trusts holding what may be considered as non-operational heritage assets should o discuss their classification and accounting treatment with the external auditor.
3.30
05/01/05
40
Calculation of Depreciation
On revalued assets
3.31 3.32 Depreciation is calculated on a quarterly basis, starting in the quarter following the one in which the asset became available for use. UK GAAP is clear that all the depreciation chargeable on revalued assets must pass through the I&E account. This means that that the extra depreciation incurred because an asset has been indexed or revalued upwards is included in the depreciation charge for the year. NHS Foundation Trusts should, however, release an amount from the revaluation reserve to the I&E reserve in respect of this excess depreciation over historic cost. This transfer avoids the anomaly of the revaluation reserve remaining in perpetuity after an asset has become fully depreciated. It is also justified as it recognises a realised profit in Companies Act terms. The following example illustrates the transfers required from the revaluation reserve to the I&E reserve in respect of a revalued asset.
3.33
3.34
Example: Treatment of Depreciation in the Balance Sheet Depreciation charged on revalued amounts can be calculated:
Depr. Depr on historic cost basis Excess over HC depr Year 1 22 20 2 Year 2 24 20 4 Year 3 26 20 6 Year 4 29 20 9 Year 5 32 20 12
Applying the adjustment to the revaluation reserve:

Year 1 Opening Balance Net Indexation Depreciation (Transfer to I&E Reserve) Closing Balance 0 10 (2) 8 Year 2 8 9 (4) 13 Year 3 13 7 (6) 14 Year 4 14 5 (9) 10 Year 5 10 2 (12) 0
In year 2 the book keeping entries would be:

Dr Cr Dr Cr Dr Cr 9 9 Fixed assets indexation Revaluation reserve To record indexation
24 I&E account - deprecn for the year 24 Fixed assets 4 4 Revaluation reserve I&E reserve
Depreciation charge for the year
In respect of depreciation charge in excess of that on HC
05/01/05
41
3.35
On the disposal of revalued assets, profit or loss is the difference between the sale proceeds and the carrying amount (i.e. at the revaluation value). Any remaining balance on the revaluation reserve should be transferred to the I&E Reserve.
Historic Cost
3.36 Some NHS Foundation Trusts will not have records of historic cost (HC) of revalued assets. In such cases "HC" is the value at which the asset first appeared in the balance sheet. This will most likely be the date of the predecessor NHS Foundation Trusts establishment or at the time of the first 5-yearly DVs valuation. The historic cost and the life of the asset, once established, give a value for historic cost depreciation that remains constant. Thus a building valued at 1m 5 years ago and given a 20 year life at that point will be recorded as having a historic cost depreciation value of 1,000,000/20 = 50,000 pa for the next fifteen years. If this year it is revalued at 1.5m and given a 25 year life, the actual depreciation charged for the year will be 1,500,000/25 = 60,000 pa, giving a transfer for the year from the revaluation reserve to the I&E Reserve of 10,000. Subsequent expenditure (enhancement) on an asset will have the effect of increasing its historic cost. The historic cost depreciation figure can be recalculated by adding an element for depreciation on the enhancement (as if it were a separate, new asset) to the original figure.
3.37
3.38
05/01/05
42
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. For NHS Foundation Trusts the main impact of SSAP 21 is in the distinction between capital and revenue expenditure. The classification of a lease as finance or operating determines whether an asset is recognised in the balance sheet and counts as capital expenditure, or is simply a revenue transaction. 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. 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. NHS Foundation Trusts 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. In the meantime, purchase or lease decisions should remain based on value for money considerations.
4.2
4.3
4.4
4.5
Leasing arrangements between NHS bodies

4.6 There was 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 Secretary of State. 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.
05/01/05
43
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
4.7 A finance lease is a lease that transfers substantially all the risks and rewards of ownership of an asset to the lessee.
Operating lease
4.8 a lease other than a finance lease.
The lease term

4.9 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
4.10 The price at which an asset could be exchanged in an arms 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

4.11 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 Foundation Trusts 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. 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.
4.12
05/01/05
44
4.13
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.
4.14
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. 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.
4.15
4.16
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 lessees rate of incremental borrowing should be used. The Treasury discount rate of 3.5% + inflation may be used as a proxy for the lessees rate incremental borrowing, where no other measure is available. 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.
4.17 4.18
Determining the Lease Type Other Factors

4.19 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?
05/01/05
45
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?
4.20
Responsibility for maintenance, insurance etc can be an indicator, but the fact that a lessor bears these costs does not automatically mean the lease is operating e.g. if those costs are then recovered in the lease rental.
Property leases
4.21 The principles outlined above apply equally to property leases. Some specific considerations are noted below.
Statutory rights of renewal

4.22 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.
4.23
Break clauses
4.24 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
4.25 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
05/01/05
46
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

4.26 NHS Foundation Trusts will far more frequently be lessees rather than lessors.
Capitalisation
4.27 The leased asset should be first recorded in the lessees 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 lessees books and asset register at its fair value, i.e. at valuation (land and buildings), or replacement cost (equipment). 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.
4.28
Revaluation
4.29 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 Foundation Trust. 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. The Valuer should carry out a periodic revaluation of leased land and buildings, usually every five years. NHS Foundation Trusts 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.
4.30
Indexation
4.31 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
4.32 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
05/01/05
47
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. 4.33 The depreciation on leased assets should be charged to the I&E account, and is separately identified in the tangible fixed assets note. 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. 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. 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 I&E account as normal, but matched by a transfer from the revaluation reserve to the I&E Reserve (where any positive revaluation reserve still remains in respect of the asset).
4.34
4.35
Finance lease creditor

4.36 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
4.37 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: 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. 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
4.38
4.39
05/01/05
48
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. 4.40 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. 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.
4.41
Rental payments
4.42 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. 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.
4.43
4.44
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.
Improvements to leased assets
05/01/05
49
4.45
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 I&E 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 (paras 2.23 et seq: subsequent expenditure). Under English law, 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.
4.46
Termination of lease
4.47 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
4.48 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 preexisting lease commitment of the lessee). Alternatively, initial periods of the lease term may be agreed to be rent-free or at a reduced rent. 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
4.49
05/01/05
50
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 lessees benefit from the use of the leased asset.
PFI refinancing gains

4.50 Renegotiation of off balance-sheet PFI contracts may involve a reduction in overall costs in recognition of lower finance costs available in the current economic conditions. In general, such cost savings should be allocated to the period over which the contract runs. This is consistent with the practice of allocating all the other contractors costs to the life of the arrangement there is little justification for treating a cost reduction as lump-sum in-year income. Early discussion with auditors is recommended, in view of the material sums often involved.
Accounting for leases lessors

4.51 NHS Foundation Trusts 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 Foundation Trusts 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. 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 Foundation Trusts freehold interest will be assessed, by the Valuer, to reflect the existence of the tenancies. 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 Foundation Trust that granted the lease should not continue to record the asset as an operational fixed asset within its accounts and will not have to charge 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. In cases where a Foundation Trust leases out assets at low or peppercorn rent, there is a net cost to the NHS, not least in terms of opportunity cost. Foundation Trust should weigh this cost against the overall benefits received from the lessee. These benefits may be of a non-financial nature.
4.52
4.53
4.54
Hire purchase contracts

4.55 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 fulfilment of certain conditions.
05/01/05
51
4.56
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 instalment 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 instalments. They will, however, forfeit the right to have any of the previous instalments 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.
4.57
Future developments
4.58 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. As stated previously, NHS Foundation Trusts 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.
4.59
05/01/05
52
Accounting entries
Capitalisation of leased asset
Dr Cr Tangible fixed assets Creditors With the present value of total minimum lease payments (or fair value of asset)
Depreciation of leased asset Dr Cr I&E account 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 Cr Dr Cr I&E account Finance Charges Finance Charges Cash/bank With the finance charge element of rental payment With the finance charge element of rental payment
Payment of rental to lessor capital element Dr Cr Creditors Cash/bank With the capital element of rental payment
Revaluation of leased asset Dr Cr Dr Cr Tangible fixed assets Revaluation reserve Revaluation reserve Provision for depreciation account With increase in value (no adjustment of finance lease creditors) With backlog depreciation
Indexation of leased assets Dr Cr Dr Cr Tangible fixed assets Revaluation reserve Revaluation reserve Provision for depreciation account With increase in value (no adjustment of finance lease creditors) With backlog depreciation
Expiry of lease Dr Cr Provision for depreciation 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 Cr Tangible fixed assets Revaluation reserve With residual value, calculated or on valuation
Depreciation in secondary lease term Dr Cr Revaluation reserve Provision for depreciation account With depreciation for the period
Rental payment in secondary lease term
05/01/05
53
Dr Cr
I&E account Cash/bank
With total rental payment (all finance charge as capital element now fully discharged)
Finance lease example calculation

4.60 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

YEAR 1 Opening RC Indexation 4% Indexed RC Opening AD Backlog Depreciation Depn. of indexed RC Closing AD Closing NBV
Lease Creditor Movements in Year
Fin. Lease Obligations at Balance Sheet Date
15000 600 15600 0 0 (1560) (1560) 14040
Opening Creditors Total Rental Payment Finance Charge Capital Repayment Closing Creditors
15000 2000 (909) (1091) 13909
Within 1 Year Between 1 and 5 years After 5 Years Subtotal Future Finance Charges Outstanding Obligation
2000 10000 6000 18000 (4091) 13909
05/01/05
54
YEAR 2 Opening RC Indexation 5% Indexed RC Opening AD Backlog Depreciation Depn. of indexed RC Closing AD Closing NBV YEAR 3 Opening RC Indexation 3% In-Year Revaluation Indexed Revalued RC Opening AD Backlog Depn (index) Backlog Depn (reval) Depn. of indexed RC Closing AD Closing NBV
15600 780 16380 (1560) (78) (1638) (3276) 13104
13909 2000 (818) (1182) 12727
2000 10000 4000 16000 (3273) 12727
16380 491 337 17208 (3276) (98) (66) (1721) (5161) 12047
12727 2000 (727) (1273) 11454
2000 10000 2000 14000 (2546) 11454
etc...
05/01/05
55
5 Public Dividend Capital Interest

Introduction
PDC Interest charges
5.1 Legislation requires that NHS Foundation Trusts should be charged PDC interest on the same basis as the cost of capital charge. A charge of 3.5% is therefore made on average relevant net assets held in the year.
Capital charges estimates (CCEs)

5.2 The Department of Health needs estimates of Foundation Trust relevant net assets for vote purposes. In addition, NHS Foundation Trusts themselves will also need to estimate their future PDC dividend figures in order to manage their budgets. Predecessor NHS Foundation Trusts will have provided such data via Strategic Health Authorities for the year 2004-05. The mechanism for collecting this data from NHS Foundation Trusts will be advised in due course.
PDC dividend calculation of relevant net assets

5.3 Average relevant net assets (RNAs) are calculated 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, any assets transferred from other NHS bodies on 1 April must be included as opening balances in the calculation. Closing relevant net assets are normally those reported at the balance sheet date, after all the years transactions and valuations have taken place.
PDC dividend - calculation of RNAs

5.4 The calculation of net relevant assets now reflects the Resource Accounting Manual provisions. The calculation of average relevant net assets in 2004-05 is as follows:
Total capital and reserves (total assets employed) less donated asset reserve less government grant reserve less cash balances in Paymaster accounts
X (X) (X) (X) X/(X)
05/01/05
56
Changes in calculation
5.5 In 2003-04 NHS Trusts were required in the Capital Charges Exercise for that year to report estimated assets-under-construction (AUC) CCs, but continued to exclude AUCs from the calculation of their cost of capital charge. The Department funded these CCs centrally. For 2004-05 NHS Foundation Trusts are required to include AUCs in their calculation of net relevant assets. The calculation of PDC dividends is therefore simpler in that all assets and liabilities (with the three exceptions above) fall to be included in the calculation.
05/01/05
57
6 Prudential Borrowing Limit (PBR)

Introduction
6.1 6.2 NHS Foundation Trusts are not subject to the controls on capital introduced by Resource Budgeting, nor have External Financing Limits. They must, however, restrict their total borrowing to an amount determined by Monitor (the Prudential Borrowing Limit (PBR)), which is derived from ratios similar to liquidity and gearing ratios commonly applied in the private sector. They must also comply with the Code of Practice on Prudential Borrowing issued by Monitor
Protected assets
6.3 Monitor designates certain assets as protected. These are assets that are central to the core provision of NHS services by the NHS Foundation Trust, and broadly speaking will be the assets with which the NHS Foundation Trust was established. A NHS Foundation Trust may only dispose of such assets with Monitors agreement. Further, a NHS Foundation Trust may not give a third party any charge over protected assets. For this reason, a NHS Foundation Trust cannot give a floating charge, as this would permit protected assets to be considered as debt security. Non-protected assets subsequently acquired by the NHS Foundation Trust may be used as security for the debt that financed their acquisition.
6.4
6.5
05/01/05
58
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. Assets provided from National lottery funds are to be treated as donated.
7.3
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 partdonated 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.
PDC Dividends
7.6 As shown in the note on calculation in paragraph 5.4, 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
05/01/05
59
I&E account in respect of donated assets (a transfer from the donated asset reserve is made to the I&E account to match the I&E 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 on impairments apply. Donated assets are analysed with purchased assets in the Fixed Asset note 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 I&E 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 I&E account, as it would be for a purchased asset. However, an equal sum is debited to the donated asset reserve and credited to the I&E 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 I&E account. The carrying amounts of donated assets continues to equal the value of the donated asset reserve
Depreciation is charged to the I&E 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 I&E account to match the depreciation charged. No release is made in respect of revalued amounts to the I&E Reserve (as for purchased revalued assets) as the full credit is required in the current year I&E 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. Surplus land and buildings not in operational use should be revalued to open market value for alternative use. 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
7.10 7.11
05/01/05
60
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 I&E account. 7.12 The profit or loss on disposal is calculated in the normal way, as the difference between the carrying amount and net sale proceeds, and credited or charged to the I&E account. A transfer from the donated asset reserve to the I&E account is made to match the profit/loss. 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 I&E Reserve.
Realised donation reserve

7.13 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 I&E Reserve. Final balances transferred in this way should equal the sale proceeds. 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. Where a NHS Foundation Trust 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.
7.14
7.15
Accounting entries for donated assets

Acquisition of donated asset
Dr Cr Tangible fixed asset (donated) Donated asset reserve With cost, DRC, or market valuation (equipment at cost)
Depreciation of donated asset

Dr Cr Dr Cr I&E account Provision for depreciation account Donated asset reserve I&E account With full depreciation charge for period, including on revalued amount With the same amount as charged to I&E account above
05/01/05
61
Revaluation of donated asset (price change)

Dr Cr Dr Tangible fixed assets (donated) Donated asset reserve With increase in value
Donated asset reserve With backlog depreciation Provision for depreciation Cr (buildings and equipment) account Entries reversed if there is a fall in value on revaluation (and see impairments)
Indexation of donated asset

Dr Cr Dr Tangible fixed assets (donated) Donated asset reserve With increase in value
Donated asset reserve With backlog depreciation Provision for depreciation Cr (buildings and equipment) account Entries reversed if there is a fall in value on indexation
Impairment of donated asset (price change)

Dr Cr Donated asset reserve Tangible fixed assets (donated) With fall in value
Impairment of donated asset (economic loss)

Dr Cr Dr Cr I&E account Tangible fixed assets (donated) Donated asset reserve I&E account With fall in value
With the same amount
Disposal of donated asset closure of asset account

Dr Cr Asset disposals account Tangible fixed assets (donated) Cumulative depreciation account Asset disposals account With asset valuation
Dr Cr
With the accumulated depreciation
Disposal of donated asset sale proceeds, profit/loss on disposal

Dr Cr Dr Cr Dr Cr Dr Cash Asset disposals account Asset disposals account I&E account I&E account Donated Asset Reserve With sale proceeds With profit on disposal (entries reversed for loss on disposal) With the same profit as posted above to OCS (entries reversed for loss on disposal) With the remaining balance this now
Donated Asset Reserve
05/01/05
62
Cr
I&E Reserve
equals the same proceeds
05/01/05
63
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. The various transactions that comprise a PFI project differ from routine NHS Foundation Trust 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 NHS Foundation Trusts Manual for Accounts, apply in full to PFI transactions. Specific relevant PFI accounting guidance is also 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) (TTN 1); Land and Buildings in PFI Deals (Version 2) Website: http://www.doh.gov.uk/pfi/
8.2
The specialised and complex nature of PFI accounting is addressed in detail in guidance issued by HM Treasury. In general queries on PFI transactions and accounting should be addressed to Monitor. The purpose of this Chapter is to highlight the key accounting issues arising from PFI and outline their accounting treatment.
FRS 5 and SSAP21

8.3 In the PFI context, lease or lease-type transactions will often be part of a wider inter-related series of capital and revenue transactions and so it will not always be possible to apply SSAP21 in isolation to individual transactions. Under these circumstances, FRS 5 should be applied and the substance of the transactions as a whole considered. Similarly, if a PFI contracts elements are separable such that service elements can be identified and valued, the remaining property element can be subjected to SSAP21 analysis.
PFI Accounting
Separation of contract elements
8.4 The first stage of the accounting analysis is to determine if the PFIcontract 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.
05/01/05
64
8.5
TTN1 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
8.6 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). Service-related variations in costs and revenues are irrelevant to determining which party has the asset of property. Thus, penalties related to belowstandard food quality will not be relevant in considering the holding of a catering facility asset. In quantitative risk analyses the private sector should be treated as one single entity (so the contractors 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%). TTN1 discusses the following types of risk in quantitative terms: 8.10 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
8.7
8.8
8.9
The following are qualitative indicators of asset holding: Termination for operator default Nature of operators financing Who determines the nature of the property
05/01/05
65
Land and buildings in PFI schemes

8.11 This section is extracted in full from Department of Health guidance published in January 2003 and addresses the following issues: the overriding principles governing the inclusion of land and buildings in PFI deals; the criteria for judging whether or not to include land in a PFI deal; the sale of surplus NHS land to the private sector for subsequent sale in exchange for a reduction in annual unitary payments; land or buildings leased to the private sector; the use of assets donated by third parties to effect a reduction in annual unitary payments; accounting for residual interests; and tax and other issues.
Overriding principles
8.12 8.13 Unless there are strong supporting commercial reasons, surplus land not integral to the development should be excluded from PFI procurements. Where surplus land is included in PFI procurements (to be sold in exchange for a reduction in service payments) NHS Foundation Trusts should ensure that: they own the land prior to sale; the land is sold to the consortium for at least open market value - the VFM test; they take all reasonable steps to maximise the value of the land prior to disposal; for example, by obtaining enhanced planning permission; consideration is given to whether arrangements to share in the future benefits, which the consortium or other parties may derive from the land, will improve the value for money of the PFI deal; parent company guarantees are obtained to enable the NHS to recover the full cost of the land in the event of the private sector partner being unable to complete the building project and deliver services; the timing of the sale is appropriate; the accounting treatment of land is considered fully when determining the affordability of the project.
8.14
Before deciding to include surplus land in PFI transactions, NHS Foundation Trusts should consider from the outset the potential disbenefits. PFI transactions are highly complex and experience to date has shown that inclusion of surplus land in deals adds further complications. As a consequence there may be delays in the PFI process which can prove costly. Other possible disbenefits may include:
05/01/05
66
potential tax liabilities; potential timing problems if transactions are not back to back; and cost implications, such as the requirement to pay 6% capital charges on the reducing debtor balance associated with the unitary payment reduction.
8.15
Where the new hospital is to be built on a site that the NHS Foundation Trust already owns, NHS Foundation Trusts should ensure that: they retain their freehold interest in the land rather than sell this to the project company; the arrangements for land on expiry of the primary period are sufficiently flexible; the accounting treatment of land is considered fully when determining the affordability of the project.
8.16
Occasionally, an NHS Foundation Trust may wish to sell land which is integral to the scheme to the private sector. Any decision to sell the site on which the hospital is to be built should first take into account the requirement that an NHS Foundation Trust should not enter into any contractual arrangement where assets essential for its functions are put at risk. If it is deemed appropriate to sell rather than lease, the primary considerations should then be of a commercial, value for money nature. If the buildings have an alternative use and the private sector is constructing the property with this in mind, then there may be an argument for selling the freehold. This is more likely to be a valid reason for some small community-type schemes. If the situation arises where there is a real commercial justification for an NHS Foundation Trust to sell the freehold to the project company, they should only do so in exchange for at least open market value, subject to overage as discussed further below. Asset changes to an NHS Foundation Trust's balance sheet as a result of entering into a PFI contract must be set out clearly as part of the schemes business case. Depending on the size of the scheme, these changes will have to be agreed with at least the Trusts StHA and possibly the Department of Healths Private Finance Unit prior to inclusion in the balance sheet, capital charge estimates and hence pricing.
8.17
8.18
Criteria for judging whether to include land in a PFI scheme

8.19 Unless there are strong supporting commercial reasons, surplus land not integral to the development should be excluded from PFI procurements. The criteria listed below should be considered in determining the suitability of surplus land for inclusion in a PFI procurement.
8.20
Before commencing a PFI scheme, NHS Foundation Trusts should explicitly review what parcel(s) of land/buildings might be associated with a particular scheme and ascertain into which of the following categories it/they would fall: (a) land/buildings that would remain in operational use within the proposed development
05/01/05
67
(b)
land/buildings that would become surplus to requirements as a consequence of the proposed development (and by implication would not become surplus if the proposed development did not proceed land/buildings with the potential to release development gain (i.e. enhanced value or more valuable planning consent) on either itself/themselves or other land/buildings if they were to be disposed of by the NHS;
(c)
8.21
In the case of (a) then such land/buildings are clearly integral to the overall deal and the economic assessment of the overall PFI scheme would also suffice for the economic assessment of any such land transactions. In the case of (b) and (c) two tests of value for money would be required: - the economic assessment of the overall PFI scheme, and - the economic assessment of the land disposal;
8.22
Surplus land should only be considered for inclusion within a PFI scheme if the NHS Foundation Trust considers that the alternative of conventional sale and reinvestment of the proceeds in another scheme that has not secured private finance would not command a higher priority. NHS Foundation Trusts should agree explicitly what proportion of the proceeds arising from the disposal of surplus land will be included in the PFI scheme in order that any implications for affordability can be assessed early. NHS Foundation Trusts should also consider whether improved value for money and affordability can be achieved by reinvestment of the proceeds in equipment or in publicly funding the refurbished elements of the scheme; Consideration should be given to whether the inclusion of any surplus land would facilitate achievement of other national/local priorities and objectives Reference should also be made to the NHS Foundation Trust's estate strategy in making decisions on whether to associate surplus land with a PFI scheme. The absence of an NHS Foundation Trust estate strategy would tend to favour a decision not to associate land with a PFI scheme. In assessing both the relative returns and relative priority between inclusion in a PFI scheme and conventional disposal, StHAs should also take into account: - the levels of risk and ease of disposal; - the potential timing of disposal; - the opportunities for securing planning permission; - the holding costs of the land (egg continuing capital charges, security, essential health and safety expenditure etc) prior to its disposal; and - the impact of any delay and/or uncertainty in realising disposal values arising from inclusion within the PFI scheme that would be associated with each option;
8.23
8.24
8.25
Legal advice should be obtained to ensure that proper title to the land exists and that there are no impediments or reversionary clauses (e.g. the Crichel Down rules) that would prevent the proposed disposal route or impose restrictions on the future use of the land. The Crichel Down rules, for example, require that the original owner of land acquired under compulsory purchase should be given the first option if the land is to be sold. Particular
05/01/05
68
care should be taken where the actual conveyancing of the land to the NHS Foundation Trust, although intended, is not complete.
Disposal of surplus land

8.26 Surplus assets must be sold or disposed of for at least open market value (OMV). It is not sufficient that the NHS Foundation Trust achieves a value which simply makes the scheme affordable. The private sector partner must be prepared to pay at least the OMV for the asset at the point of sale. NHS Foundation Trusts should also note that protected assets cannot be sold as part of a PFI Scheme without the agreement of Monitor. Identification of OMV requires relevant professional advice. It is recommended that a suitable land valuation is sought from the DV. NHS Foundation Trusts may seek an additional valuation from a suitably qualified and independent valuer and discuss any differences with the DV. Trusts may also wish to obtain professional advice regarding the marketing of land in order to help maximise disposal proceeds. Where the land included in a PFI scheme represents only part of the total available estate, steps should be taken to ensure that the item of land sold does not adversely affect the value of the remainder. This could be achieved through DV valuations or market testing the entire site as a single disposal and comparing the likely figure obtained with the actual cost of sale plus an equivalent market test for the remainder of the land. The NHS Foundation Trust should also consider whether the value to be derived from land disposals will be improved by the NHS Foundation Trust obtaining enhanced planning permission for the land prior to disposal. The advantage of this approach is that the NHS Foundation Trust will receive the full benefit of any uplift in value from the enhanced planning permission. NHS Foundation Trusts should consider whether overage arrangements are necessary. Overage occurs when the proceeds realised at the actual time of sale of the land by the PFI consortium are in excess of the minimum underwritten value in the project agreement and the excess is shared between the NHS Foundation Trust and the Project Company. Hence, the total agreed price for the land would be the minimum of OMV at the time of signing the project agreement plus overage. For example, this may be appropriate where enhanced planning permission is likely to increase the market value of the property. The affordability of the scheme for the purposes of FBC approval should be based on the minimum underwritten value. Overage arrangements will ensure that the NHS Foundation Trust receives best value for money from the inclusion of surplus land in PFI schemes in respect of valuation risk and the forward sale of land. The anticipated benefits for any overage arrangements should be compared with any increase to the contract price which the consortium requires in return for agreeing to such arrangements. The NHS Foundation Trust should also consider whether other arrangements to share in the future benefits which the consortium or other parties may derive from the land will improve the value for money of the PFI deal. For example, the Trust could negotiate for share of future revenue streams in the event that the consortium realised opportunities for developing the land or acting as a building contractor on any development by a third party.
8.27
8.28
8.29
8.30
8.31
05/01/05
69
8.32
As with all claw back arrangements, the NHS Foundation Trust will need to assess whether such arrangements will improve the value for money of the PFI deal, taking into account any price adjustment which the consortium may seek for agreeing to these arrangements. The formula for the overage arrangements should take into account the risk and effort that the private sector has taken in enhancing the value of the land. Where the risk taken by the Project Company is insignificant, a higher share of overage should accrue to the NHS Foundation Trust. Conversely, where the Project Company underwrites proceeds in excess of market value, a smaller share of overage may be appropriate. Irrespective of risk transfer, underage should not be agreed as this would cause difficulties in obtaining value for money If any surplus land is put into a scheme the resulting benefits, including overage, must be protected in the event of early termination. Protection may include requiring a parent company guarantee to be provided by the Project Company. Disposal of the land to the project company should occur prior to the operating phase of the contract only when there is real commercial justification for the sale and there are appropriate safeguards to the NHS Trust by way of appropriate parent company guarantees.
8.33
8.34
8.35
Accounting for land sold to the private sector

8.36 PFI schemes may include surplus land in the deal in order to reduce project financing costs and thereby reduce the unitary payment paid to the private sector partner and increase the potential affordability of the project. Where land is sold to the private sector for subsequent resale, the sale must be accounted for in the following stages:
Stage 1: Revaluation of the land from net book value in the NHS Foundation Trust's accounts to OMV
8.37 The land should be valued by the DV in order to verify that the guaranteed minimum price in the deal is at least OMV for alternative use. Where a reduction in future payments forms the economic benefit, the net present value (NPV) of the reduction in the value of the annual service payments must be greater than or equal to the OMV of the asset. The NPV should be calculated using the Treasury discount rate. As a matter of course, NHS Foundation Trusts should seek professional advice to assess whether the benefit of including the land in the bidder's financial model is actually reducing the unitary payment by the amount required. The land should be revalued at OMV. The treatment of a downward revaluation is considered in Chapter 2 of this Manual. An upward revaluation (OMV higher than book value) should be taken to the revaluation reserve. The revaluation should take place when the land is declared surplus.
8.38
Stage 2: Disposal of the fixed asset

8.39 The sales price is the NPV of the annual reduction in payments when discounted at the Treasury Rate. Where the actual price obtained in the deal exceeds the OMV then the difference should be accounted for as a profit in
05/01/05
70
the NHS Foundation Trust's income and expenditure account. Worked examples can be found in Annex 1 to this chapter. Example A shows the accounting entries for a nil profit on disposal. Example B shows the relevant entries where the price obtained exceeds the OMV and a profit on disposal is realised. 8.40 It should be noted that where buildings are to be disposed of in the PFI deal, they may not be available immediately for disposal, for example, where they become vacant and surplus once the new site is redeveloped and operational. Up to that point, the buildings may remain operational. These buildings should be written down to their OMV in accordance with paragraphs 2.123 to 2.126 of the Manual. NHS Foundation Trusts should only make such an adjustment when the scheme has reached financial close, thereby providing certainty that the disposal is taking place.
Stage 3: Creation of a debtor

8.41 The disposal of land in exchange for a long-term reduction in service payments creates a debtor (prepayment) in the NHS Foundation Trusts accounts. This is because the benefit of placing the land in the deal is realised over a future period and effectively constitutes a prepayment. The debtor asset should be created at the point at which the scheme reaches financial close, i.e. when the transfer of economic benefit becomes reasonably certain. The value of the debtor is equivalent to the economic benefit obtained from including land in the PFI deal, i.e. the NPV of the reduction in the value of the annual service payment when discounted at the Treasury Rate. This initially would be the underwritten value (guaranteed minimum price) but may change as a result of overage arrangements. Debtors should not be indexed over the life of the contract where the prepayment is a fixed monetary amount, not linked to inflation. The debtor should be treated as a prepayment within current assets in the NHS Foundation Trusts financial statements. The amount due after more than one year must be separately disclosed in the accounts in order to meet the requirements of Urgent Issues Task Force Abstract 4.
8.42
8.43
05/01/05
71
Stage 4: Subsequent write-off over the contract life

8.44 The write-off of the debtor should be over the period of the service payment reductions. This will normally be the primary period (the period up to the first break clause in the contract). However, if the period agreed for making the discounted or reduced service charges is shorter than the primary lease period, then the release of the prepayment should take place over the shorter period.
Stage 5: Finance charge (Interest receivable)

8.45 In accordance with TTN 1, a book entry is required in the NHS Foundation Trusts income and expenditure account in order that the undiscounted reduction in the annual payment is fully recognised (interest receivable). The amount in question is calculated as the difference between the undiscounted total annual payment reductions and the NPV of the payment reductions. This should be recorded over the same period as the write-off of the debtor.
Effect of overage
8.46 If the value of the land increases in the future due to the operation of overage provisions, the debtor will be increased and the resultant balance written-off over the remaining contract life. The increase in the debtor will be matched by a credit adjustment to the NHS Foundation Trust's income and expenditure account (profit on the sale of fixed assets) at the point when the consortium recognises the disposal of the land for an increased value. The situation may arise where the proceeds from the land sale exceed the annual payments. In such a case, the accounting principles are no different; however, the NHS Foundation Trust should consider whether it would prefer a lump sum for the excess or a future income stream, based on whichever option delivers value for money.
8.47
Where the land does not become available until later in the contract period
8.48 In some circumstances, the surplus land may become available later in the contract (for example, where the vacation of the site is dependant on the new hospital being built) and the NHS Foundation Trust may wish to put a "cash injection" into the deal in the meantime in return for a reduction in service payments. The NHS Foundation Trust itself may undertake to sell the surplus land and to put all or some of the proceeds into the deal. In these circumstances, the NHS Foundation Trust would be expected to market the site conventionally, i.e. the sale could be to any buyer so long as at least OMV is obtained. Effectively the relationship between the sale of the land and the reduction in the unitary fee is divorced. Prepayments of this sort should only be made if they are justifiably value for money. Bullet payments should not be made ahead of service commencement and the NHS Foundation Trust Board should take advice on the legality of the proposed transaction. The FBC should fully explain the rationale for the bullet payment and its use should be cleared with Monitor. A debtor is created at the point the cash is injected in the deal and write-off is, as before, over the shorter of the primary lease period or the period over which the reduction in
8.49
8.50
05/01/05
72
payments is obtained. The NPV of the reduction in service payments should at least equal the cash injected in the deal. The debtor is included within net relevant assets for the calculation of the capital cost absorption. 8.51 The land should be revalued in the NHS Foundation Trust's books at OMV at the date it becomes available and is put up for sale. Any difference between the OMV and proceeds actually realised will form a profit or loss on disposal.
Land or Buildings leased to the private sector which subsequently form part of the PFI scheme
8.52 Three different scenarios are possible: only land is leased to the private sector; land and existing buildings are leased to the private sector. These buildings then may or may not be refurbished by the private sector and become inextricably linked with the PFI scheme; land and buildings are leased to the private sector and the buildings become the responsibility of the consortium to demolish in order to make way for new build. Such buildings are written-off in the normal way.
8.53
Where the NHS Foundation Trust owns the land on which the hospital is to be built, the NHS Foundation Trust generally should retain its freehold interest in the land rather than sell this to the project company. It is usual for the NHS Foundation Trust to lease the land to the private sector under a head lease and for the private sector to lease the hospital site back to the NHS Foundation Trust using an underlease. It may be the case that the head lease is at a peppercorn rental. The lease terms should be coterminous although, where good reasons exist, different lengths of term can be considered.
Options for land on completion of the primary period

8.54 In these cases, the contract should be drafted to provide for sufficient flexibility of arrangements on completion of the primary period. For example, it could include an option for the private sector to purchase the land for at least OMV if the NHS Foundation Trust no longer wishes to use the facility. In the event of early termination or expiry of the contract (including the expiry of the primary concession period), the head lease to the Project Company should automatically fall away. Any decision that an NHS Foundation Trust takes with regard to the property at the end of the primary period should be made after consideration of the NHS Foundation Trust's overall estate holdings. A sale should never prejudice the best interests of the NHS Foundation Trust's overall estate holding.
8.55
05/01/05
73
Lease of land only

8.56 Where the NHS Foundation Trust has granted a project company a head lease on land only, the accounting treatment of the land should follow the accounting standard FRS5 - Reporting the substance of transactions. Usually the lease will have the characteristics of an operating lease and the land should therefore continue to be recorded as an asset on the Trusts balance sheet. The economic assessment of the overall PFI deal is sufficient for the economic assessment of any such land transactions.
8.57
Land and existing buildings are leased but buildings not integral to the PFI scheme
8.58 Where existing buildings are not being refurbished by the private sector and the private sector do not take on the risks or rewards of ownership, the buildings should continue to be recognised in the NHS Foundation Trust's balance sheet in accordance with FRS5. It is then advisable not to lease the underlying land but rather to restrict the land lease only to the land on which the buildings are integral to the PFI scheme and which are on the project companys Project Companys balance sheet.
8.59
Land and existing buildings are leased and buildings are integral to the PFI scheme
8.60 Where the existing buildings are refurbished, and the private sector, has taken on the risks and rewards of ownership, they become inextricably linked with the PFI scheme. As a result, the accounting treatment of the buildings should follow FRS5 and depend on the overall terms of the contract. Where the economic substance of the transaction is that the private sector owns the buildings, the NHS Foundation Trust will need to account for their disposal. Where a disposal takes place, a deferred asset (i.e. a benefit realised in future periods) will arise on at the point the NHS Foundation Trust ceases to have access to the risks and rewards arising from the existing estate. This is usually taken to be the commencement of the lease. The valuation of the deferred asset depends on the nature of the PFI Scheme. For example, where the Scheme involves the complete refurbishment of the buildings, then the Trust is in effect handing over a building shell, whose value is in all likelihood substantially less than the and the deferred asset will simply be equivalent to the existing use value of the buildings as a hospital site. It is therefore advisable to seek a DV valuation (OMV) prior to handover. Any change in valuation should be accounted for as accelerated depreciation or an impairment, depending on timing. The deferred asset should be written-off through the income and expenditure account over the life of the lease. The deferred asset is included within net relevant assets for the calculation of the capital cost absorption. At the end of the primary concession period, buildings integral to the PFI Scheme will revert to the Trust. As such, their estimated fair value on reversion represents a residual interest.
8.61
8.62
05/01/05
74
8.63
The economic assessment of the overall PFI scheme is sufficient for the economic assessment of any such transactions.
Worked Examples
8.64 Worked example C in Annex 1 demonstrates accounting for leases of land and buildings in PFI deals.
Injection of donated land, buildings or other assets into a PFI Scheme

8.65 Prior to considering the incorporation of donated land, buildings or other assets in a PFI Scheme, NHS Foundation Trusts should ensure that donors have not placed restrictions on the assets which would preclude such use. The treatment of a donated asset depends on whether it is: The disposal of a donated asset in order to obtain a reduction in the unitary charge; The injection of cash or other assets from parties other than those directly connected with the PFI scheme in order to obtain a reduction in the unitary charge.
8.66
For the avoidance of doubt, Trusts should note that once a previously donated asset passes out of the control of an NHS Foundation Trust, it is treated as a disposal. The required accounting treatments therefore follow the examples given earlier. Adjustments to the donated asset reserve will complement those to the donated asset account. The above treatment for general donated assets which the Trust has decided to incorporate into the PFI Scheme can be contrasted with the treatment of funds raised and donated by third parties specifically to the Scheme below. Cash or other assets may be donated for use in a PFI Scheme by a third party, such as the National lottery, business sponsors, or raised through public appeal. For the avoidance of doubt, cash injections of this nature must satisfy the NHS definition of a donated asset being: a disinterested transfer of economic benefit from an organisation or individuals to the NHS. Where cash donated by a third party to the NHS Foundation Trust has the effect of reducing the unitary charge, a prepayment should be recognised.
8.67
8.68
8.69
05/01/05
75
Residual Interests Recognition and initial valuation

8.70 In some transactions all or part of the property will pass to the NHS Foundation Trust 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 NHS Foundation Trust. Alternatively, where the contract specifies the amount (including zero) at which the property will be transferred to the NHS Foundation Trust 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. For example, the standard form contract provides that assets constructed as part of the PFI scheme should revert to the Trust on expiry of the primary concession period. Primary concession periods are generally of the order of 25 30 years and yet the assets on reversion may have a remaining useful economic life of between 30 35 years. This residual useful economic life constitutes an asset which the NHS Foundation Trust has paid for during the concession period. In accordance with TTN 1, any difference (the residual interest) 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 interest. The estimated fair value on reversion (EFVR) of the residual interest dictates the proportionate split of the annual unitary payment between revenue and capital. It is essential that this initial valuation is performed in accordance with common guidance and standards. Valuations should therefore only be sought from the DV, rather than alternative, qualified valuers as permitted for other capital assets. The valuation of the residual interest can only be performed with any reasonable accuracy once the precise specifications and lifecycles of the buildings components are known. NHS Foundation Trusts and their advisers should assume that the value of the residual interest at reversion will approximate to the buildings depreciated replacement cost at reversion. The value at which the residual interest is recognised in NHS Foundation Trusts financial statements should only be based on the DV valuation. The residual interest should be recognised in the appropriate heading within tangible fixed assets in the balance sheet.
8.71
8.72
8.73
8.74
8.75
05/01/05
76
Revaluation, indexation and impairment

8.76 The estimated fair value on reversion of the residual interest is based on the DVs professional estimate at the start of the concession period. Trusts asset bases are reviewed and revalued by the DV on a five-yearly cycle. As a result of revaluation, it is possible that the value of the residual interest may increase, in which case: 8.77 8.78 The NPV of the increase in value should be debited to Tangible Fixed Assets; There should be corresponding credit to the Trusts revaluation reserve.
In the periods between cyclical revaluations, residual interests should be subject to indexation. If, during the life of the contract, expectations conditions change so that the expected value of the residual falls (but there are no changes to payments scheduled under the contract), then consideration should be given to whether there has been an impairment. The accounting treatment for the impairment of a residual interest depends on whether it is the result of the consumption of economic benefits associated with the residual interest or whether the fall in value has been the result of price changes. The alternative accounting treatments are as follows: If a fall in value results from the consumption of economic benefits then it should be charged to the I&E account. It is unlikely that such an assessment can be made with any degree of confidence until late in the primary concession period; A more likely scenario is that an impairment results from a price fall, in which case it is charged against the revaluation reserve to the extent that it reverses previous increases in valuation. Any excess impairment should then be charged to the I&E account, unless it can be shown that the recoverable amount of the asset in question is higher than its revalued amount, in which the entirety of the impairment is charged to reserves. This creation of a negative reserve is permissible if the impairment is judged to be: Not the result of the consumption of economic benefits; Short-term and likely to reverse in the medium term.
Other issues Tax

8.79 Where land is included in a PFI scheme, a tax liability may be incurred by the project company. The tax liability is a potential additional cost to the NHS Foundation Trust. It is important that the accounting treatment and contract terms are such that the tax liability of the SPV is minimised (and hence the PFI tariff), whilst ensuring that the Trust can fully reclaim VAT on the unitary charge. The project company may need to take financial advice on the tax treatment of land. The affordability of the scheme should reflect appropriate professional advice on the tax treatment.
Equipment
05/01/05
77
8.80
The same principles apply to equipment as those outlined for land and buildings above.
Disclosure requirements
8.81 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 I&E account in respect of PFI transactions; The payments which the NHS Foundation Trust is committed to make during the next year, analysed between those in which the commitment expires: 8.82 within one year in the 2nd to 5th year inclusive in the 6th to 10th year inclusive and so on in five year bandings
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 NHS Foundation Trust 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. The following information is also required for those schemes assessed as off balance sheet: A description of the scheme The estimated capital value, and contract start and end dates.
8.83
8.84
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.
8.85
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.
05/01/05
78
Annex 1 LAND SOLD TO THE PRIVATE SECTOR FOR SUBSEQUENT SALE IN EXCHANGE FOR A REDUCTION IN ANNUAL PAYMENTS EXAMPLE A: DISPOSAL AT OPEN MARKET VALUE
The accounting entries are shown below. Figure 1 (Worked Example A) shows the impact on the NHS Foundation Trust's accounts over the entire contract period. Assumptions Land at Book Value DV valuation at OMV NPV of reduced payments Profit / (loss) on disposal Primary period Annual payment Reduction for land value Actual amount payable Accounting entries (1) When the decision to dispose is taken: 000 2.000 2.000 12m 10m 10m Nil 25 years 15m (before reduction for land value) 782,267 pa 14,217,733 pa
Debit: I&E Credit: Fixed Assets
Revaluation to open market value
(2) On disposal: Debit: I & E disposal account Credit: Fixed Assets Disposal of the asset Debit: Debtors - prepayment Credit: I & E disposal account Creation of the debtor 000 10.000 10.000 000 10.000 10.000
05/01/05
79
(3) At the end of year 1: Debit: Credit: I&E Debtors - prepayment 000 0.400 0.400
Write-off of the debtor over 25 years (4) Recognition of annual service charge: Debit: Credit: Credit: I & E service charge I & E interest receivable Cash 000 14.600 0.382 14.218
Being the recognition of the annual service charge due.
The underlying effect is that the total service expense of 15 million is represented by cash consumed of 14.2 million, the consumption of the prepayment of 0.4 million and the unwinding of the discount.
05/01/05
80
VALUE FOR MONEY TEST Annual Payment Reduction (a) 0 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 782,267 19,556,675 (a) (b) (c) (d) (e) (f) (g) (h) (i) Discount Rate 6% (b) 0 1.06 1.1236 1.191016 1.262477 1.338226 1.418519 1.50363 1.593848 1.689479 1.790848 1.898299 2.012196 2.132928 2.260904 2.396558 2.540352 2.692773 2.854339 3.0256 3.207135 3.399564 3.603537 3.81975 4.048935 4.291871 Net Present Value (c) 0 737,990 696,215 656,806 619,629 584,555 551,467 520,252 490,804 463,023 436,814 412,088 388,763 366,757 345,997 326,413 307,936 290,506 274,062 258,549 243,915 230,108 217,083 204,795 193,203 182,267 10,000,000
I & E EFFECT Profit Deferred Total On Asset PFI charge I&E Disposal Write Off Charge (d) (e) (f) (g) 0 0 0 0 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 400,000 14,217,733 14,600,000 0 10,000,000 355,443,325 365,000,000 I & E EFFECT WITHOUT LAND (h) 0 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 375,000,000 (h) less (g) DIFFERENCE
between the nomina and real benefit of th
(i) 0 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 400,000 10,000,000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Notes
derived from the financial model discount annual reduction in payments at 6% npv of annual reduction is 10m profit on disposal is NIL : 10m (npv) less 10m (OMV) write off of the deferred asset over the primary lease period annual payment 15m less 0.782m reduction total impact on I & E charge without reduction the deferred asset is based on the NPV of future savings i.e. real savings the actual saving of 0.782m is based on the nominal saving over and above the 15m payment
81
EXAMPLE B: AN UPWARDS REVALUATION TO OMV AND REALISATION OF PROCEEDS IN EXCESS OF OMV The accounting entries are shown below. Figure 2 (Worked Example B) shows the impact on the NHS Foundation Trust's accounts over the entire contract period. Assumptions Land at Book Value DV valuation at OMV NPV of reduced payments Profit / (loss) on disposal Primary period Annual payment Reduction for land value Actual amount payable 12m 14m 18m 4m 25 years 15m (before reduction for land value) 1,408,081 pa 13,591,919 pa
Accounting entries (1) Debit: Fixed Assets Credit: Revaluation Reserve m 2 2
Revaluation to open market value (2) Debit: I & E disposal account Credit: Fixed Assets 14 14
Disposal of the asset (3) Debit: Debtors -prepayment Credit: I & E disposal account 18 18
Creation of the debtor
At the end of year 1: (4) Debit: I & E Credit: Debtors - prepayment 0.720 0.720
Write-off of the debtor over 25 years (5) Debit: I & E service charge Credit: Interest receivable Credit: Cash 14.280 0.688 13.592
Being finance charge / interest receivable (i.e. the annual reduction in the tariff 1.408m less the written-off debtor 0.720m)
82
WORKED EXAMPLE : B VALUE FOR MONEY TEST Annual Payment Reduction (a) 0 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 1,408,081 35,202,025 (a) (b) (c) (d) (e) (f) (g) (h) (i) Discount Rate 6% (b) 0 1.06 1.1236 1.191016 1.262477 1.338226 1.418519 1.50363 1.593848 1.689479 1.790848 1.898299 2.012196 2.132928 2.260904 2.396558 2.540352 2.692773 2.854339 3.0256 3.207135 3.399564 3.603537 3.81975 4.048935 4.291871 Net Present Value (c) 0 1,328,377 1,253,187 1,182,252 1,115,332 1,052,200 992,642 936,454 883,447 833,441 786,265 741,760 699,773 660,163 622,796 587,543 554,286 522,911 493,312 465,389 439,046 414,195 390,750 368,632 347,766 328,081 18,000,000 I & E EFFECT Profit Deferred Total On Asset PFI charge I&E Disposal Write Off Charge (d) (e) (f) (g) -4,000,000 0 0 -4,000,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 0 720,000 13,591,919 14,280,000 -4,000,000 18,000,000 339,797,975 353,000,000 I & E EFFECT WITHOUT LAND (h) 0 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 15,000,000 375,000,000 (h) less (g) DIFFERENCE
between the nominal and real benefit of the land
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
(i) 4,000,000 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 688,081 21,202,025
Notes
derived from the financial model discount annual reduction in payments at 6% npv of annual reduction is 18m profit on disposal 18m (npv) less 14m (OMV) write off of the deferred asset over the primary lease period annual payment 15m less 1.408m reduction total impact on I & E charge if no land in the deal the diference between annual cash saving and NPV of total saving, equivilent to interest receivable
83
EXAMPLE C: LEASE OF LAND AND BUILDINGS TO THE PROJECT COMPANY WHICH FORM PART OF THE PFI SCHEME Assumptions NBV of buildings to be refurbished by the NHS Foundation Trust NBV of buildings to be refurbished by the private sector NBV of land leased to the private sector Primary period Deferred asset (NBV of buildings to be refurbished by the private sector) 3m 8m 5m 25 years 8m
Accounting entries m 8 8
(1)
Debit: I&E disposal account Credit: Fixed assets - buildings
Disposal of the head lease (2) Debit: Deferred asset Credit: I&E disposal account 8 8
Recognition of the benefit of entering into the lease
At the end of year 1: (3) Debit: I & E Credit: Deferred asset 0.32 0.32
Write-off of the deferred asset over 25 years
84
9 Asset registers
Maintenance of an asset register
9.1 Each NHS Foundation Trust must maintain an asset register. Asset registers support the annual accounts and so are subject to audit. The benefits arising from keeping a comprehensive asset register are: 9.2 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 Foundation Trusts.
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 Whether the asset is designated protected or un-protected by Monitor.
85
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 Foundation Trust 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 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. 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.
9.6
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 9.9 9.10
The asset register may itemise the different building elements. The asset register must also be designed so as to allow the allocation or apportionment of depreciation charges to the appropriate cost centre. Where assets are desegregated for the purpose of applying separate depreciation regimes to different components, registers must facilitate this.
86

Capital Accounting Manual

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Capital Accounting Manual

Uploaded by

Copyright:

Available Formats

DRAFT NHS Foundation Trust Capital Accounting Manual

5 January 2005 IRCP 01/05

NHS FT Capital Accounting Manual

The Capitalisation and Valuation of Fixed Assets....................6

Depreciation and asset lives ....................................................36

Public Dividend Capital Interest...............................................56

NHS FT Capital Accounting Manual

Prudential Borrowing Limit (PBR)............................................58

Donated assets ..........................................................................59

Private Finance Initiative ..........................................................64

NHS FT Capital Accounting Manual

Accounting standards and guidance referred to in the Manual

NHS FT Capital Accounting Manual

Queries and contacts

NHS FT Capital Accounting Manual

2 The Capitalisation and Valuation of Fixed Assets

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

General principles and definitions

NHS FT Capital Accounting Manual

Tangible fixed assets

Intangible fixed assets

Fixed asset investments

Tangible fixed assets

Capitalisation threshold of fixed assets - de minimus limits

NHS FT Capital Accounting Manual

Tangible fixed assets - expenditure to be capitalised

NHS FT Capital Accounting Manual

NHS FT Capital Accounting Manual

Initial equipping and setting-up costs of new building

Staff training costs

NHS FT Capital Accounting Manual

NHS FT Capital Accounting Manual

NHS FT Capital Accounting Manual

Assets funded from National lottery funds

NHS FT Capital Accounting Manual

Intangible fixed assets - capitalisation

NHS FT Capital Accounting Manual

Software - purchase of licence

Software - created in-house

NHS FT Capital Accounting Manual

Deferred assets in PFI schemes

Fixed asset investments

Measurement and valuation

NHS FT Capital Accounting Manual

Valuation of Tangible Fixed Assets lower of:

Net current replacement cost (RC)

Recoverable amount (RA)

Net realisable Value (NRV)

NHS FT Capital Accounting Manual

Modern equivalent asset

NHS FT Capital Accounting Manual

Example: modern equivalent asset (MEA) calculation

110,000 44,000 66,000

Valuations, review and impairments

NHS FT Capital Accounting Manual

Valuers and Disclosures

NHS FT Capital Accounting Manual

Non-specialised land and buildings

Specialised land and buildings valuation at DRC

NHS FT Capital Accounting Manual

NHS FT Capital Accounting Manual

NHS FT Capital Accounting Manual

Surplus assets and disposals

NHS FT Capital Accounting Manual