ICAEW chart of the week: NZ government balance sheet

Our chart this week delves into New Zealand’s public finances, one of the very few developed countries to have a government balance sheet with positive net assets.

Step chart illustrating New Zealand government balance sheet.

Assets NZ$438bn = PP&E NZ$ 213bn + Other assets NZ$ 24bn + Financial assets NZ$ 201bn.

Liabilities NZ$ 281bn = Borrowings NZ$ 163bn + Insurance liabilities NZ$ 60bn + Other liabilities NZ$ 58bn.

Net worth NZ$ 157bn = Taxpayer funds NZ$ 20bn + Revaluation and other reserves NZ$ 137bn.

The signing of the UK-New Zealand Free Trade Agreement on 28 February 2022 prompted us to take a look at New Zealand’s public finances, one of the few developed countries with public assets in excess of public liabilities, and a pioneer of accruals accounting in government.

Our chart this week summarises the total crown balance sheet reported in the Financial Statements of the Government of New Zealand for the year ended 30 June 2021, comprising assets of NZ$438bn (£223bn) less liabilities of NZ$281bn (£143bn) to give net worth of NZ$157bn (£80bn).

New Zealand is a leading country in adopting accruals accounting for use in government, with the financial statements prepared in accordance with New Zealand-adopted accruals-based International Public Sector Accounting Standards (IPSAS), which are aligned with IFRS with some adaptation for the public sector. The New Zealand government not only uses IPSAS for financial accounting and reporting, similar to how the UK’s Whole of Government Accounts is based on IFRS, but they also use these standards for budgeting, management accounting and fiscal target setting. This contrasts with the UK, which uses a distinct UK-specific ‘resource’ accounting framework for budgeting and management accounting, and the statistics-based National Accounts system for fiscal target setting.

The asset side of the balance sheet includes NZ$213bn (£109bn) of property, plant and equipment, other non-financial assets of NZ$24bn (£12bn) and financial assets of NZ$201bn (£102bn). The latter includes marketable securities, student loans, residential loans and other financial investments in addition to receivables and cash.

Liabilities include NZ$163bn (£82bn) of borrowings, insurance liabilities of NZ$ 60bn (£31bn) and other liabilities of NZ$58bn (£30bn). Insurance liabilities are relatively high compared with many other countries as a consequence of New Zealand’s unique national no-fault accident compensation scheme that covers everyone in the country, including visitors.

Net worth is made up of taxpayer funds of NZ$20bn (£10bn) and reserves of NZ$137bn (£70bn), with the latter comprising a property revaluation reserve of NZ$134bn (£68bn) and minority interests of NZ$6bn (£3bn) less negative reserves of NZ$3bn (£1bn) principally relating to defined benefit retirement plans and veterans disability entitlements.

With a population of 5.1m, net worth on a per capita basis at 30 June 2021 is equivalent to approximately NZ$31,000 (£16,000) per person, comprising NZ$86,000 (£44,000) in assets per person less NZ$55,000 (£28,000) in liabilities per person. This compares with the approximate negative net worth of £37,000 per person based on the UK Whole of Government Accounts at 31 March 2019, comprising £31,000 in assets per person less £68,000 in liabilities per person.

While some caution needs to be taken in comparing these amounts given differences in accounting policies and the exclusion of local government from the New Zealand numbers, they do provide an insight into how on a proportional basis the New Zealand public sector is much better capitalised than the UK public sector.

While there are significant differences between the economies of New Zealand and the UK that no doubt explain the respective strengths and weaknesses of their public balance sheets, the presence of accountants in New Zealand’s highest office, most recently Sir John Key (prime minister 2008-2016), may also have something to do with it.

This chart was originally published by ICAEW.

IFRS 16: A lot of effort, but a great opportunity too

In an article for Room 151, ICAEW Public Sector Director, Alison Ring writes that bringing leases onto the balance sheet from 1 April provides council finance teams with a real “opportunity” to help councillors better understand the scale and scope of local authority finances.

The introduction of International Financial Reporting Standard 16 ‘Leases’ (IFRS 16) on 1 April 2022 will have a significant impact on many local authority balance sheets as well as require a huge effort from council finance teams.

Many finance officers will be glad just to get the work needed to comply with IFRS 16 done, but they should also grasp the opportunity to use the comprehensive review of contracts they are undertaking to educate council leadership teams and councillors on the scale and scope of the local authority finances they are responsible for.

Capturing lease contracts

IFRS 16 abolishes the distinction between off-balance sheet ‘operating leases’ and on-balance sheet ‘finance leases’ and brings almost all leases longer than a year onto the balance sheet. The deadline for public sector entities to become compliant with the standard is April this year, so local authorities need to ensure they are not caught out.

The purpose of IFRS 16 is to provide financial statement users with a better understanding of the resources available to an organisation by requiring assets utilised via contractual arrangements to be recorded on balance sheets alongside legally-owned assets. This will cover many leased office buildings, that will now need to be included in the primary financial statements, rather than being disclosed in the operating lease note towards the end of the accounts.

The standard captures most contracts that give the right to use an asset for a period of time of more than one year, as well as lease arrangements where that right is “embedded” into a larger contract. The latter was already the case for embedded rights that met the old criteria to be treated as finance leases, including many private-finance initiative contracts started a decade or two ago, but IFRS 16 means that other types of lease arrangement will need to be identified and—if they meet the criteria—capitalised as an asset and a related lease liability.

Identifying lease assets

In theory, finance teams should have all the information they need to calculate the amounts to record for both asset and liability sides of the balance sheet, as well as recording depreciation and interest in place of lease payments in the expenditure statement.

However, in practice there needs to be a thorough exercise to review thousands of contracts to see if they are leases or contain embedded lease arrangements that fall within the scope of IFRS 16.

In addition to office buildings, there will be a range of assets to identify, ranging from office equipment to vehicle fleets, to leased facilities and equipment. This is not just about reviewing the legal text of contracts, but also involves working with operating departments to understand whether there is a right to use an asset.

Fortunately, there are two main exemptions that should make this exercise easier, with contracts with a term of 12 months or less or below a de minimus value in the order of £3,500 excluded completely.

Unlike in the private sector, the requirement to revalue local authority assets within the balance sheet adds to the complications that finance teams face. This is in addition to the raft of information required for disclosure purposes, such as sub-leasing arrangements, sale and leaseback transactions and variable lease payments.

There will also be challenges in accounting for lease modifications, where a change to the original terms and conditions requires a reassessment of the carrying value for an asset and its associated lease liability, based on the new pattern of lease payments and discount rate.

Beefing up management controls

The good news is that this exercise, while onerous, has benefits too. Creating an inventory of contracts with key terms identified and understood provides a resource that can be used for other purposes, including controlling costs and monitoring financial exposures.

A more comprehensive understanding of the assets in use across the organisation will help in ensuring that resources are being fully utilised for the benefit of service users and council taxpayers.

Processes to vet new contracts for their accounting implications also provide an opportunity to beef up risk management controls. And there may be opportunities to renegotiate contract terms such as lease lengths and renewal options, or to identify contracts that are no longer needed and that can be dispensed with.

Just as importantly, IFRS 16 implementation provides finance teams with a real opportunity to educate council leadership teams and councillors on the finances of the organisations they are responsible for.

Not only is there a need to explain the accounting change and what this means for the financial statements, but the outputs of the implementation exercise can be used to help those charged with governance to better understand the scale and scope of contracting undertaken, the nature of the assets available to be utilised and, most importantly, the commitments and risks that have been made to suppliers and to service users.

There is a temptation to see IFRS 16 as a problem, and I can understand why yet another major compliance exercise may not be embraced with overwhelming enthusiasm. However, I believe that this particular problem is an opportunity – one that should definitely be grasped.

This article was originally published by Room 151.

Biggest peacetime deficit caps extraordinary year for UK public finances

Huge economic shock combined with unprecedented fiscal interventions results in a provisional fiscal deficit of £303bn or 14.5% of GDP for the year ended 31 March 2021.

The Office for National Statistics today published its first estimate of fiscal history, reporting a provisional fiscal deficit of £303bn or 14.5% of GDP for 2020-21 and a £344bn increase in public sector net debt from £1.8bn to £2.14tn at 31 March 2021, breaking peacetime records for the public finances. This compares with an official forecast for the deficit of £55bn presented by the Chancellor just prior to the start of the financial year last March, admittedly together with the first in a series of mini-fiscal announcements that saw spending soar to tackle the pandemic at the same time as tax revenues collapsed.

The damage is less than had been feared at some points during the past year, with the provisional deficit coming in below the £355bn estimated by the Office for Budget Responsibility (OBR) at the time of the Spring Budget 2021 last month and substantially below their forecast of £394bn in November 2020 at the time of the Spending Review. While some of this is down to better economic performance as lockdowns have been less harmful than anticipated, there has been an offsetting increase in the forecast deficit for the 2021-22 financial year starting this month to £234bn compared with the pre-pandemic projection of £67bn. The provisional deficit of £303bn also excludes somewhere in the region of £27bn for bad debts on covid-related lending that will need to be accounted for at some point.

The deficit is only part of the story, as the government has borrowed significant amounts to finance tax deferrals and lending to business to help them survive. As a consequence, public sector net debt has increased by more than the deficit, with an increase of £344bn to a provisional £2,142bn or 97.7% of GDP at 31 March 2021. Debt is expected to rise over the next couple of years to in excess of £2.5tn.

While the numbers for both the deficit and debt are likely to be revised up or down over the next few months, the big picture won’t change – debt as a proportion of GDP has increased from 35% in March 2008 before the financial crisis to around 80% of GDP a couple of years ago before climbing to in the region of 100% of GDP today. These numbers don’t include other significant liabilities in the government balance sheet such as public sector employee pension obligations, nor do they include future financial commitments such as for welfare benefits. Despite that they still provide an indication of just how significantly the UK’s fiscal position has changed over a period of less than a decade and a half.

Fortunately, interest rates have been coming down even faster than debt has been going up, enabling the Government to reduce its interest bill over the course of the year. However, higher leverage comes with a greater exposure to movements in interest rates going forward, a concern for the Chancellor in mapping out his plans for the next few years.

While the Spring Budget last month provided some indications on how the Chancellor aims to stabilise the public finances through a combination of higher investment spending, short-term economic stimulus and a corporation tax rise, there is as yet no indication of his longer-term fiscal strategy to address the unsustainability of the public finances identified by the OBR before the pandemic.

While the government has been taking steps to set the foundations for better management of the public finances, for example through the National Infrastructure Strategy released last year, the soon to be launched National Data Strategy and actions coming out of HM Treasury’s recent Balance Sheet Review, there is no clear plan for how the government intends to fund pensions, health and social care over the next quarter of a century. These costs will continue to grow as many more people live longer in retirement and the working age population shrinks, just at a time that huge investments are needed to achieve net zero and pressures on public spending are unlikely to disappear. At the same time the government needs to work out how it can ensure the public finances are more resilient and better prepared for future crises – from whatever corner they may come.

Alison Ring, ICAEW Public Sector Director, said: “Today’s numbers cap a dramatic year for the UK’s public finances, and show this is the biggest deficit since the end of World War Two. However, the damage is less than had been feared, with the shortfall lower than the OBR had forecast.

Ultra-low borrowing costs have provided the government with the room it needed to provide unprecedented spending to tackle the coronavirus pandemic, protect jobs and prevent the economy from crashing, as well as the opportunity to invest for growth in the coming years.

However, even as the economy starts to recover, the legacy of higher debt and a greater exposure to changes in interest rates will be with us for years, if not decades to come. The public finances were already on an unsustainable path before the pandemic, and the government will need a long-term strategy for rebuilding them.”

This article was originally published by ICAEW.

Plastic is the future for cash – one way or another

22 September 2020: Physical cash use is declining fast, leaving the fixed cost base for processing cash transactions at risk of stranding. As cards and digital forms of payment become more prevalent, what will happen to those who still need access to cash?

The National Audit Office (NAO) issued a report on 18 September 2020 on the production and distribution of cash. It looks at what the Bank of England, the Royal Mint, HM Treasury and financial regulators are doing in response to a 59% decline in the volume of cash transactions between 2008 and 2019, as well as efforts to improve the efficiency of cash production and reduce counterfeiting.

According to data from UK Finance, cash payment values fell from £267bn in 2008 to £141bn in 2019 and were (prior to the pandemic) forecast to fall to £59bn by 2028.

Coin production has fallen significantly, with 383m coins manufactured for circulation in 2019-20 compared with 1.1bn in 2010-11. Notes in circulation have continued to increase (to 4.4bn notes with a monetary value of £76.5bn in July 2020), but only around 20%-24% of these are used for cash transactions and 5% used for savings, leaving over £50bn whose location is uncertain – a point which the NAO believes deserves further investigation.

A key finding from the report is that there is no single body in government responsible for overseeing how well the cash system is performing, despite the establishment of a Joint Authorities Cash Strategy Group (JCAS) focused on access to cash for those that need it, in particular for the million or so UK adults who do not have a bank or building society account.

The UK’s entire cash infrastructure across the public and private sectors is estimated to cost around £5bn a year, with many of these being fixed costs that with declining usage are putting pressure on the cash system. 

The number of ATMs fell by 12% over the two years to December 2019 to around 60,000, with a fall of 17% in the number that were free-to-use to around 45,000. The Payment Systems Regulator (PSR) has been working with the industry to maintain free-to-use ATMs in geographic areas where provision is most limited, although the NAO recommends greater attention is given to more deprived areas.

Demand for notes and coins declined by 71% between early-March and mid-April 2020 during the COVID-19 lockdown but has since recovered. The NAO believes it is still too early to assess the longer-term impact on cash access and usage but moves amongst some retailers to suspend acceptance of cash during the pandemic could further accelerate the switch to non-cash forms of payment.

The NAO is positive about the steps the Royal Mint and the Bank of England have taken against counterfeiting. In 2016, about one in 30 £1 coins was a counterfeit, but surveys since 2018 have found very low counterfeiting rates for the new £1 coin. The introduction of the polymer £20 note, traditionally the denomination favoured by counterfeiters, should also help reduce the cost of fraud to consumers and businesses.

The Royal Mint reported a reduced loss of £3.9m on its coin-making activities in 2019-20, with actions to improve efficiency including a 22% headcount reduction within its currency division and the mothballing of two of its six plating lines. The Bank of England has also worked with De La Rue to improve efficiency, albeit each polymer banknote costs 60% to 80% more than a paper one, even if they are expected to last at least 2.5 times longer. 

The NAO recommends that HM Treasury takes another look at the roles and responsibilities of the bodies involved in the cash system, setting out more clearly the specific outcomes it wants to deliver for consumers and small businesses and how this should be balanced against the cost of doing so. It also believes that a plan is needed to take action if some groups become left behind as the cash system changes.

Martin Wheatcroft FCA, adviser to ICAEW on public finances, commented: “The NAO has provided some extremely useful insights into how the UK’s cash system is coping with declining usage and it makes a number of sensible recommendations for improvements. 

“However,” continued Wheatcroft, “the report does not answer the more fundamental issue of whether cash has a long-term future at all, and in particular whether the multi-billion costs of running cash and other legacy payment systems could be better deployed.

“Ultimately, is it now time to look beyond a managed decline of the cash system and explore more radical options?”

Front cover: NAO report 'The production and distribution of cash'. Click on the image to go to the NAO website.

This article was originally published on the ICAEW website.

Magnox contract exit cost: a small price to pay?

16 September 2020: The National Audit Office has issued a report on the £20m cost of exiting the failed Magnox contract to decommission nuclear research sites and power stations.

The National Audit Office (NAO) report covers the handling by the Nuclear Decommissioning Authority (NDA) of the failed Magnox contract to decommission two nuclear research sites and 10 Magnox power stations and the estimated £20m cost incurred on exiting the contract.

The NDA is a statutory body established in 2005 to take ownership of the decommissioning programme for the UK’s oldest fleet of nuclear power stations and other nuclear facilities. At 31 March 2020, the NDA had an estimated liability of £135bn in its accounts for the costs of decommissioning still to be incurred.

The NDA has awarded a series of contracts to clean up nuclear sites and deal with radioactive materials, including fuel. This includes the 14-year Magnox contract awarded in 2014 to Cavendish Fluor Partnership (CFP) which the High Court decided was wrongly awarded, with the NDA agreeing a £97m settlement with a bidder in 2017.

The NDA then decided to terminate the contract with CFP nine years early, and an earlier report by the NAO stated how £122m had been lost by that point. The Public Accounts Committee reported in 2018 that the NDA needed to improve its understanding of the state of the sites, its ability to monitor work carried out on them, and the capability and expertise of its executive team.

Since 2017, a revised contract has been agreed with CFP and further litigation avoided, with £2.7bn of decommissioning work completed before the contract ended in August 2019.

The NAO says there have been further costs to the taxpayer, including an estimated termination cost of £20m to negotiate the early exit from the contract and incentivise a smooth handover of sites without further legal challenge. This is a relatively small amount in the context of the £6.9bn to £8.7bn estimated cost for decommissioning the Magnox sites.

The NAO report stated: “With the NDA now taking more direct control over the management of its sites, it will be critically important that it builds and retains better knowledge of the condition of its sites to enable it to plan and deliver decommissioning work efficiently and effectively. The NDA considers that it will be better placed to achieve this under its revised delivery model, but it is too early for us to assess the effectiveness of these arrangements.”

Martin Wheatcroft FCA, adviser to ICAEW on public finances, commented: “The huge sums being spent on decommissioning nuclear facilities can hide many sins, but we are fortunate that the National Audit Office is able to dig around and analyse what is going on.

“On this occasion, the £20m cost of exiting the Magnox contract appears a relatively small price to pay for a second chance at getting the decommissioning of the Magnox fleet right. There are much larger sums – in the billions – riding on the as-yet unproven new delivery model being put in place by the Nuclear Decommissioning Authority.”

Image of front cover of NAO report 'Progress report: Terminating the Magnox contract'. Click on the image to go to the NAO website to download the report.

This article was originally published on the ICAEW website.

ICAEW chart of the week: Whole of Government Accounts

24 July 2020: Liabilities of £4.6tn exceeded assets of £2.1tn at 31 March 2019 in the latest set of consolidated financial statements for the UK public sector.

UK public sector balance sheet at 31 March 2019: liabilities £4,555bn, assets £2,099bn, taxpayer equity -£2,456bn.

The topic for the #icaewchartoftheweek is the Whole of Government Accounts (WGA) published on Tuesday. Despite taking 15½ months to prepare (way too long, even with the additional delays caused by the pandemic), this is still one the most important documents published by the Government each year.

The good news is that the UK is one of the leading countries in the world in providing fiscal transparency, with this being the tenth WGA, incorporating the financial results of over 9,000 public bodies for the 2018-19 financial year. While many countries are working to adopt accruals-accounting for their public finances, the UK is still the only major economy to publish a full set of accounts covering all levels of government in accordance with internationally recognised accounting standards.

The bad news is the financial position presented by those financial statements, highlighting the weaknesses in the public finances that existed even before the coronavirus pandemic. Total liabilities of £4.6tn at 31 March 2019 were substantially higher than the £1.8bn reported for the headline measure of debt in the National Accounts, prepared in accordance with statistical standards.

To find out more, ICAEW has put together a summary analysis of the Whole of Government Accounts 2018-19.

Alternatively, the full 200 pages of accounting and disclosure goodness that constitutes the WGA can be found here.

This chart was originally published by ICAEW.