Ask the Auditor: Schools, subsidiaries, associates & JVs

The CIPFA/LASAAC Code of Practice on local authority accounting for 2014/15 includes some important changes from previous years. In our regular feature, Ask The Auditor, Graham Liddell from Grant Thornton UK LLP discusses new accounting requirements for schools, subsidiaries, associates and joint ventures and the practical implications for local authorities. To ask Graham a technical query, email editor@room151.co.uk

The 2014/15 Code brings in two big changes:

• the Code now requires all maintained school assets, liabilities, income and expenditure to be accounted for in local authority single entity accounts. Although this should help achieve greater consistency across the sector, the application of the new policy will still require the application of judgement and may raise some significant challenges in the first year
• the Code has adopted a new suite of standards for accounting for subsidiaries, associates and joint arrangements. These changes affect how local authorities account for services delivered through other entities and joint working with partners.

In both cases, carrying out some preparatory work now should help local authorities to avoid major headaches later.

Accounting for schools

CIPFA/LASAAC has concluded that under IFRS 10, maintained schools (but not free schools or academies) meet the definition of entities controlled by local authorities and so would normally be consolidated in group accounts. However, the 2014/15 Code requires local authorities to account for all maintained schools within their single entity accounts instead. This includes school income and expenditure as well as assets and liabilities.

There are some potential complications:

• where school buildings are provided at no charge by a religious body and can be taken back by their owners at any point, CIPFA considers that the buildings are not assets of the school and so should not be included in local authority accounts
• for authorities who didn’t previously recognise PPE assets for some classes of maintained schools (church and foundation schools, for example) this will be a change in accounting policy in 2014/15. As such this will require restatement of 2013/14 comparatives and also the presentation of a third balance sheet as at 1 April 2013.

Local authorities need to prepare for these changes by:

• identifying those schools where school buildings are owned by third parties (such as church dioceses) and determining under what circumstances the buildings could be taken back by the third party
• obtaining valuations for school land and buildings for each of the three balance sheet dates (1 April 2013, 31 March 2014, 31 March 2015)
• obtaining sufficient information to enable the authority to restate its revaluation reserve and capital adjustment account.

Services delivered through other entities and working in partnership

The key changes for 2014/15 are to:

• the definition of control over other entities. This is set out in IFRS 10 and determines which entities are treated as subsidiaries
• the accounting for joint arrangements. This now follow IFRS 11 and includes changes to the definition of joint ventures and how joint ventures are consolidated in group accounts
• disclosures in relation to subsidiaries, joint arrangements, associates and unconsolidated entities as set out in IFRS 12.

Changes to the definition of control over other entities

Control was previously defined in terms of power to govern the financial and operating policies of an entity. IFRS 10 sets out three elements for an investor to be considered as controlling an investee (all of which must be met):

• the investor has the rights to direct the relevant activities of the investee (relevant activities being the ones that determine the return for the investors – the return could be in the form of a service rather than money)
• the investor has exposure, or rights, to variable returns from its involvement with the investee
• the investor has the ability to use its power over the investee to affect the amount of the investor’s returns.

In the commercial sector, this is generally thought to have resulted in more entities being treated as subsidiaries. However, the change is in both directions: some subsidiaries have been redefined as associates.

Local authorities with investments in other entities will need to consider whether:

• they control any entities using the new definition. Local authorities will need to pay particular attention to special purpose vehicles and any other entities where there was a close judgement call under the old IAS 27
• there is a need for a prior period adjustment.

Changes to accounting for joint arrangements

Joint arrangements are contractual arrangements between two or more parties where there is joint control. IFRS 11 makes three key changes from IAS 31:

• there are now only two types of joint arrangements: joint operations and joint ventures
• Under IAS 31 joint ventures were legal entities. IFRS 11 bases its definition of joint ventures on the substance of the arrangement rather than legal status. In a joint operation the investing parties have rights and obligations in relation to the arrangement’s assets and liabilities, whereas in a joint venture the parties have rights to the arrangement’s net assets
• local authorities are still required to consolidate joint ventures in their group accounts but must now do so using the equity (single line) method. The option for proportionate (line-by-line) consolidation has been removed.

The key challenge for most local authorities will be determining whether their joint arrangements are joint ventures or joint operations. The difference should be clear from the contract but in some cases judgement may be required.

Local authorities that have previously used the proportionate consolidation method will need to account for the move to equity accounting as a prior period adjustment.

Disclosure of interests in other entities

IFRS 12 makes consistent the requirements for disclosures in relation to subsidiaries, joint arrangements, associates and unconsolidated entities. It includes the need for transparency about the risks to which the reporting entity is exposed as a consequence of its investment in such arrangements.

Graham Liddell is Grant Thornton UK LLP’s national technical lead for the public sector. No responsibility or liability is accepted by Grant Thornton UK LLP towards any person or organisation in respect of the use of, or reliance on, information contained in this column.