Rob Whiteman: Far-reaching reporting changes
0Rob Whiteman reviews the dramatic changes over the past 12 months and looks ahead to the coming year.
Just as the 1960s are retrospectively seen as a period of social change, or the 1930s as a period of upheaval, the present epoch will most likely be seen as a turning point. However, amidst it all at the time we probably can’t recognise it. The loss of public trust? The rise of China? Social media as a weapon of war? Either way, there are bigger forces at play than even Brexit, which is in reality just a consequence of any combination of the above.
In that context, as public finance professionals our enduring role is to provide high quality and transparent information and advice that reports past activity, manages present services and ensures the best and most sustainable decisions for the future.
Our duty each year is to report on a world that never stands still, and, with significant changes to technical reporting standards, 2018 has been no different. Changes through IFRS 9, 15 and 16, which are a consequence of major changes to internal financial reporting standards, will bring further work.
Finance teams in local authorities have had a particularly challenging year, grappling with extremely challenging financial pressures across the organisation whilst making further efficiencies themselves. In truth, austerity creates more work for finance, and in the way central government is strategically putting more staff on the border for Brexit, then during austerity councils would sensibly make the finance teams bigger.
Financial resilience
Local government has faced unprecedented financial challenges in recent years that are likely to persist well into the next decade. Despite the financial strain, councils have been able to deliver core services and manage their balance sheets more actively than other parts of the public sector. But, unfortunately, financial management capabilities and sharing good practice have at times been hollowed out by the repeated need to cut budgets.
The difficult financial situation that many authorities find themselves in has also not been helped by the relative weakness of public audit systems in place.
It is against this background that CIPFA has taken a leadership role in the public interest and devoted resources to the development of a Financial Resilience Index, which will consolidate the information for CFOs in relation to their council’s adequacy of reserves and any growing proximity to s114 territory. And I acknowledge this is difficult territory for CIPFA. As a membership body we do not wish to act outside of all members’ wishes; but as a chartered qualification body, we are ourselves held to account to ensure our members meet the statutory duties placed on them as a regulated profession.
Loking forward, the new Financial Management Code – to sit alongside established treasury management and prudential codes – will set out good practice in the planning and execution of sustainable finances. We hope to continue to share practical advice via the Funding Advisory Service (FAS) and that a very good new resource planning tool will help finance teams.
Adoption of IFRS 9: Financial Instruments
The 2018/19 Code introduced a single approach to the classification and measurement of financial instruments. The standard requires authorities to hold financial instruments at fair value, with gains and losses charged to revenue as they arise. For certain categories of investments, authorities will now recognise these gains and losses in their revenue accounts. As a result, the changes in the value of these investments will impact the authority’s General Fund.
Similarly, the standard introduces a forward-looking ‘expected loss’ model for the impairment of financial assets. This approach is likely to result in an increase in the impairment allowance and will require authorities to recognise impairment losses earlier.
Just as IFRS 9 is substantial and technically complex, so are its potential consequences for local authorities. The standard will be applied by authorities for the first time next year and is expected to have far-reaching financial and practical implications. Specifically, IFRS 9 has been predicted to pose a challenge for authorities which hold complex financial instruments as part of their debt portfolios.
Issues around the accounting for complex financial instruments emerged during this year. During the 2017/18 statement of accounts closedown process, CIPFA was alerted to accounting issues relating to Lender Option Borrower Options (LOBO) loans.
This prompted CIPFA/LASAAC to issue a statement on contracts with LOBO clauses in May of this year. It clarifies that the Code requires that local authorities follow the provisions of IFRS 9 and IAS 39 respectively in relation to the accounting treatment of embedded derivatives in contracts where there are LOBO clauses.
It remains the case that the accounting for LOBOs will affect a limited number of authorities. In addition, feedback from auditors based on authorities’ 2017/18 financial statements indicates that auditors have been generally satisfied that in the majority of instances these loans did not require treatment as Fair Value through Profit or Loss,which could have had significant implications for the General Fund. However,enhanced disclosures about these loans and their impact on council finances were generally regarded as necessary.
Adoption of IFRS 15: Revenue from Contracts
The 2019/20 Code introduced a five-step model that authorities will apply to all contracts with customers. The standard requires revenue to be recognised in a way that depicts the transfer of promised goods or services to customers or service recipients in an amount that reflects the consideration that the authority expects to be entitled to, in exchange for those goods or services.
The new principles-based approach to revenue recognition clarifies when an authority should recognise revenue and how much should be recognised.
The implications of IFRS 15 on an authority’s current accounting practices will be dependent on the extent of its commercial activity and the type of contracts held. Where an authority has entered into long-term, high-value contracts for the sale of goods or services, consideration will need to be given to understanding the how the new five-step model will apply to these income streams. As a consequence, the authority may see changes in the profile of revenue recognised and cost recognition.
However, given non-exchange transactions do not fall under IFRS 15, authorities’ major income streams will be unaffected and no accounting changes will be required.
IFRS 16: Leases
IFRS 16 introduces a substantial change in accounting practice for local authorities that hold leases. The standard removes the distinction between operating and finance leases in current accounting standards. Under IFRS 16, entities are required to recognise assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value. The asset represents the holder’s right to use the underlying leased property, and the corresponding liability represents the lessee’s obligation to pay for that right.
Thechanges introduced by IFRS 16 are significant and signal the end of the existing ‘off-balance sheet’ treatment for operating leases. For authorities that hold large numbers of leased assets, the financial impacts may be significant. As a consequence of leased assets now being ‘on-balance sheet’,the standard may also impact on authorities’ budgets and capital finance arrangements, including their prudential indicators. On a more practical level, depending on authorities existing systems, the information required to implemen tthe standard will impact on authorities’ workloads and demand a considerable amount of input and resource from staff across a range of departments.
Earlier this month, CIPFA/LASAAC confirmed that authorities will be required to implement IFRS 16 in the 2020/21 financial year, together with the rest of the UK Public Sector. In their statement, CIPFA/LASAAC emphasised the substantial preparation time associated with applying the standard. In order to assist authorities, CIPFA will issue a project plan and application guidance during 2019.
And finally…
Like the three wise men, these standards have been on the horizon and followed from afar for some time. Each will bear different gifts come the new year, and CIPFA will endeavour to both expertly guide and support practitioners through working with them.
For the longer term there is a difficulty that will remain hard to manage. UK law is that international standards must be translated through to public services; but clearly we are hitting tensions where because we make use of commercial instruments we are seeking legal overrides to commercial accounting rules as they adversely affect councils. Ultimately, we run the risk of being questioned whether such instruments, and their risks, are suitable for local government if it cannot easily adopt the associated commercial accounting treatments.
Rob Whiteman is chief executive of CIPFA
