Helping members make informed decisions about MRP policy

In our regular feature, Ask The Auditor, Graham Liddell from Grant Thornton UK LLP challenges finance professionals to do more to demystify local authority capital financing regulations and the setting of MRP policies. To ask Graham a technical query, email editor@room151.co.uk

Capital financing isn’t really that complicated. But sometimes it is convenient for us to tell everybody else that it is. I believe that we must all do much more to demystify capital financing. A good place to start is to provide members with much better support when they consider the MRP policy. So here is my three-step approach to help members make an informed decision.

1. Explain the difference between accounting and funding:

Local authorities follow international financial reporting standards (IFRS). These set out how to account for capital items such as property, plant and equipment and include concepts such as charging for capital costs as depreciation. However, if local authorities were required to meet IFRS capital costs, many would be unable to balance their general fund without raising significant additional funds from taxpayers. This is not indicative of poor decision-making in previous years: it is a consequence of accounting charges relating to capital projects encouraged by central government when it operated on a cash basis.

As a result, local authorities are required to follow a regulatory framework for charging for capital costs. This means that although a local authority income and expenditure statement includes accounting entries for items such as depreciation, these are removed from reserves and replaced with statutory capital accounting and financing entries.

2. Set out the key principles of the local authority statutory framework for capital accounting and financing:

– capital grants and capital receipts cannot be used to fund revenue: a local authority cannot, for example, sell land to fund the running costs of the Town Hall. Local authorities place income from capital grants and receipts into specific capital reserves that can only be used to fund capital expenditure.

– local authorities can spread the funding of capital expenditure over more than one year – where a local authority incurs capital expenditure it funds the costs from a combination of its capital grants, receipts and reserves and the general fund. It is allowed to spread this funding over several years taking on board the impact on current and future taxpayers.

– each year members must approve the authority’s policy on how much capital expenditure to charge to the general fund – it is up to each local authority to decide how to fund its capital expenditure. However, each year it must charge an amount to the general fund that it considers to be prudent. This is known as the Minimum Revenue Provision (or MRP). The MRP Policy must be approved by full council or (if an authority does not have a council) the nearest equivalent.

3. Explain how members might go about approving a prudent MRP policy:

– Consider the Capital Financing Requirement (CFR) – this sets out how much capital expenditure still needs to be funded by the local authority. Authorities must set an MRP policy that charges this balance to reserves on a prudent basis.

– Consider guidance on setting an MRP policy – local authorities are required to ‘have regard’ to statutory guidance on MRP published by the Department of Communities and Local Government (CLG). This means that an authority must consider what the statutory guidance says. It does not mean that a local authority is obliged to follow the guidance. However, if an authority does decide to depart from the guidance, it must be able to show good reasons for doing so.

– Apply judgement – members are not expected to be financial experts but they are required to make an informed decision as to whether the MRP policy is prudent. Questions for members to consider include:

– does the MRP policy follows CLG’s statutory guidance? If not have officers prepared a report that explains clearly the basis for any departure from the guidance?

– does the MRP policy charges the CFR to the general fund over a prudent period? For example, if the length of time is excessive (more than 60 years, say) then the policy is unlikely to be prudent: tax-payers will be funding the cost of assets long after they have been scrapped.

– are there are any warning signs? For example, has the MRP policy changed? If so, why? Is this part of a well-thought out capital financing strategy or a knee-jerk reaction to short-term financial pressures? Borrowing to invest in capital projects at historically low interest rates may very well be the right approach for the authority but has the authority received advice from external consultants? If so, have officers critically assessed the advice received or have recommendations been accepted without scrutiny?

I am not claiming that all aspects of capital accounting and financing are simple. But we can explain the principles. Furthermore, I believe the onus is on all of us to explain these principles to members to help them gain sufficient understanding to discharge their responsibilities.