LAAP BULLETIN 73
Closure of the 2007/08 Accounts and
Use of Resources Assessments
Please address any queries to CIPFA Technical Enquiry Service for CIPFA members and students
020 7543 5888
The Chartered Institute of Public Finance and Accountancy
Registered with the Charity Commissioners of England and Wales Number 231060
1. Recent reports by the various audit bodies across the United Kingdom on the
2006/07 accounts have highlighted the fact that local authority accounting is
generally sound, with sustained improvements being made. However, the reports
also highlighted weaknesses in some authorities. In the light of these weaknesses
and the significant changes to local authority accounting introduced in the 2007
SORP, practitioners have expressed a desire for guidance on the key issues they will
encounter when closing the 2007/08 accounts.
2. The Local Authority Accounting Panel is issuing this bulletin to highlight areas that
may cause authorities difficulties when closing the 2007/08 accounts. The bulletin
does not include detailed guidance for all these issues; rather it aims to provide
sufficient information for authorities to identify issues they will need to address, and
indicates where further guidance can be found. The bulletin focuses on those areas
that are expected to be significant for most authorities. Inevitably, there will be
issues that are relevant to some authorities that are not covered in this bulletin.
The bulletin is not intended to replace authorities’ processes for identifying issues,
but to complement those processes.
3. The bulletin addresses issues that will generally be applicable to authorities across
England, Wales, Scotland and Northern Ireland. However, some issues will be more
relevant in some jurisdictions than others.
Authorities in England
4. The Audit Commission’s announcement of the 2007 Use of Resources scores
(January 2008) has once again thrown the spotlight on financial reporting in local
authorities. The report highlighted the fact that councils were demonstrating
sustained improvements in their Use of Resources scores. News items, however,
focussed (perhaps inevitably) on the slight increase in the number of councils
performing below minimum requirements, a particular problem with financial
5. Reasons suggested for the difficulties experienced by some authorities have included
the recent pace of change in the local authority Statement of Recommended Practice
(SORP) and the tougher criteria built into the User of Resources Assessments. The
pace of change in both the SORP and the criteria seems, as a rule, to have caused
more problems for smaller authorities that have fewer resources to deal with the
changes - although there are smaller authorities performing well, just as there are
some larger authorities whose performance is weak.
Authorities in Scotland
6. Audit Scotland's report 'Overview Of The Local Authority Audits 2007' (February
2008) stated that financial accounting and reporting remained generally sound, with
annual accounts and audits all being completed on time. There was only one audit
qualification which related to group accounts. It was noted however that in some
authorities there was scope for improvement in the quality of working papers.
7. This will clearly be an issue for Scottish local authorities in the 2007/08 closure
process. In particular the recent rate of change in the SORP requirements means
that continual review of working papers (including spreadsheets) is highly
recommended. Some local authorities elect to use the CIPFA 'Disclosure Checklist' in
order to assist in this process.
PROBLEM AREAS IN THE 2006/07 CLOSURE OF ACCOUNTS
BEST VALUE ACCOUNTING CODE OF PRACTICE (BVACOP)
8. A comment received from some English authorities is that their Use of Resources
score has been adversely affected where auditors identified areas within the
accounts that did not comply with BVACOP requirements.
9. Authorities should bear in mind that BVACOP has statutory backing in England and
Wales, and that compliance with the Code is therefore a requirement. Para 5.23 of
the SORP requires that the Service Expenditure Analysis (SEA) in Section 1 of the
Income and Expenditure Account should comply with BVACOP but permits a locally
determined SEA provided that a BVACOP-compliant SEA is disclosed as a note to the
10. Authorities in England and Wales should note that for the closure of the 2007/08
accounts, the BVACOP-compliant SEA should include sections for Adult Social Care
and Children’s and Education Services. These sections are not reflected in the
Guidance Notes as the Guidance Notes were prepared prior to the publication of the
2007 BVACOP. However, the 2007 BVACOP applies to the 2007/08 Statement of
Accounts, and should be followed.
11. BVACOP also sets out the definition of ‘total cost’ which underpins the accounting
requirements in the Income and Expenditure Account.
12. Authorities should review their accounting arrangements to ensure the requirements
of the 2007 BVACOP, which applies to the 2007/08 Statement of Accounts, are being
followed. The 2007 BVACOP was published in December 2007 (Section 3 - Service
Expenditure Analysis; published February 2008 for Northern Ireland) and February
2008 (all other sections).
STATEMENT OF TOTAL RECOGNISED GAINS AND LOSSES (STRGL)
13. The STRGL has lived up to its name – the Audit Commission reported that a
significant number of English authorities struggled to produce the Statement of Total
Recognised Gains and Losses in line with the requirements of the SORP in their
2006/07 accounts. Auditors will therefore be interested in how authorities manage
the process for the 2007/08 accounts.
14. A number of authorities had included additional lines in the STRGL that held
balancing items. Only in exceptional circumstances will lines other than those
detailed in the SORP be required in the STRGL; if additional lines are required to
balance the STRGL, this may indicate underlying problems elsewhere in the
15. The STRGL in effect reconciles the movement in the balance sheet from one
reporting period to the next. To illustrate this, an example of the net worth (equity)
section of a balance sheet is shown on the next page:
61 Capital Adjustment Account 76
0 Financial Instruments Adjustment Account 15
0 Revaluation Reserve 50
0 Available-for-Sale Financial Instruments Reserve 0
-50 Pensions Reserve -30
4 Capital Receipts Reserve 9
10 Major Repairs Reserve 25
5 General Fund Balance 20
5 HRA Balance 10
15 Earmarked Reserves 5
16. In the example, the net worth (equity) section of the balance sheet has increased
from £50 million to £180 million, an increase of £130 million. The STRGL should
therefore show a total gain of £130 million.
17. The surplus or deficit on the Income and Expenditure Account for the year is part of
the total recognised gains or losses in the year, and should be included in the
STRGL. Other items that will form part of the STRGL (please note this list is not
• Surplus or deficit arising on revaluation of fixed assets;
• Surplus or deficit arising on revaluation of available-for-sale financial assets; and
• Actuarial gains and losses on pension fund assets and liabilities.
18. Transactions such as the purchase of a fixed asset will not form part of the STRGL,
as these do not represent a movement in the net position on the balance sheet, but
rather the exchange of one asset (cash) for another (the fixed asset).
19. Billing authorities (English authorities only) will need to bear in mind that the
balance sheet includes amounts relating to the Collection Fund (and Business
Improvement District revenue accounts where BIDs are in place), and that these will
therefore need to be included in the STRGL.
20. Authorities will find that any restatement of 1 April 2007 balance sheet in respect of
financial instruments has implications for the STRGL. Restatements are made to
opening balances on 1 April 2007 and will not therefore appear in the Income and
Expenditure Account in either 2006/2007 or 2007/08. Any restatements will impact
initially on the General Fund, resulting in a change to the net worth of the authority
and will need to be included as a single line in the STRGL. The net worth will change
even where the authority is able to rely on the Capital Finance and Accounting
Regulations to ameliorate the impact upon Council Tax requirements because a
credit or a debit to the Financial Instrument Adjustment Account will be matched by
a contra entry to the General Fund. That transaction will therefore have a neutral
impact upon net worth.
21. Note that the net worth of the authority may include the Available-for-Sale Financial
Instruments Reserve, as in the example above. A credit or a debit to this reserve
would need to be reflected in the STRGL because it will not be reflected in the
Income and Expenditure Account, but will impact upon net worth.
22. Module 3, Section F of the 2007/08 Guidance Notes gives further advice on the
GOVERNMENT GRANTS DEFERRED ACCOUNT
23. Since 1994/95 the SORP has required that grants and contributions should be
matched with the assets which they are intended to finance, and to make releases
from the Government Grant Deferred Account (GGDA) in line with the depreciation
of the related assets once those assets come into use.
24. Where grants and contributions are received in advance of the completion of the
asset, they cannot be credited to the GGDA, because the asset is not yet in use.
Therefore grants and contributions received in advance should be credited to
accounts for Grants and Contributions Unapplied pending completion of the asset.
Upon completion of the asset and it coming into use the grant or contribution would
be transferred from the relevant Unapplied Account to the GGDA (or Contributions
25. Consequently authorities should be able to demonstrate that the balance on the
GGDA (and the Contributions Deferred Account) relates to particular assets. Both
authorities and auditors have reported that some authorities are finding this difficult,
as the authorities have grants and contributions that cannot be related to particular
26. Amounts of grants and contributions that cannot be matched with particular assets
could have arisen for a variety of reasons. For example, the new unitary authorities
created in the mid 1990s were exempt from the revenue accounting aspects of the
then new capital accounting regime. This would have led to those authorities
accumulating capital government grants in the Government Grant Deferred Account.
27. The SORP requires balances in this GGDA (and the Contributions Deferred Account)
to be credited to the Income and Expenditure Account in line with depreciation. This
cannot be achieved where the grant cannot be linked to a fixed asset.
28. Where authorities are unable to identify assets relating to a proportion of their
Government Grant Deferred Account due to events in the past, the grant (or
contribution) will need to be derecognised in the balance sheet.
29. Where the error is material, authorities will need to make the adjustments as prior
period adjustments. Assuming the balances arose prior to 31 March 2006, the
opening 2006/07 balance sheet could be adjusted by transferring the balances from
the Government Grants Deferred Account to the Capital Adjustment Account (or
Capital Financing Account as it then was). This would then be reflected in a revised
2006/07 balance sheet in the 2007/08 accounts. The adjustment should be made to
the opening 2006/07 balance sheet to avoid having to restate the Income and
Expenditure Account and STRGL in 2006/07.
30. Where the error is not material, the appropriate treatment would be to credit the
grant to the ‘general government grants’ section of the Income and Expenditure
Account. The credit will then need to be reversed in the Statement of Movement on
General Fund Balance by a transfer to the Capital Adjustment Account. Authorities
may wish to discuss the levels of materiality for these transactions with their
31. The two approaches detailed above are designed to correct past errors on the
Government Grants Deferred Account.
32. Scottish authorities should also note that for 2008/09, when existing ring-fenced
capital grants are largely replaced by the General Capital Block Grant, they will need
to identify the amount of this funding used for specific assets in order to comply with
33. Further guidance on accounting for grants and contributions deferred can be found
in Module 5, Section I of the 2007/08 Guidance Notes.
REVALUATION ON DISPOSAL OF ASSETS
34. The 2007/08 Guidance Notes (Module 5, paragraph G6) advise that “Where there is
a substantial difference between the carrying value of an asset in the Balance Sheet
and sale proceeds, the first accounting requirement would be to revalue the asset to
recognise the new evidence, which will normally (but not necessarily) involve
revaluation to the sale price (net of costs of disposal) as a measure of net realisable
35. Some auditors, particularly Audit Scotland, have expressed the view that the
practice of revaluing assets immediately prior to disposal is inconsistent with the
requirements of FRS 15, and have requested that a revision to the SORP be
considered. The fact that an amendment to the SORP would be required to prevent
the practice of revaluing asset immediately prior to disposal demonstrates that the
2007 SORP does not prohibit such revaluations, although neither does it require
36. The advice in the Guidance Notes is based on the underlying principle that the
current values of assets should be kept up to date (see paragraph 3.125 of the 2007
SORP). This would not be met where there was a substantial difference between the
carrying value of the asset and the sale proceeds, indicating a revaluation
immediately prior to disposal is required to correct the carrying amount. A policy of
revaluing assets when they were declared surplus (required as the basis of valuation
is likely to change when the asset becomes non-operational), and periodically
(perhaps every one or two years) thereafter, would prevent substantial differences
occurring and avoid the need for revaluations immediately prior to disposal.
POLICE PENSIONS AND TOP-UP GRANT (ENGLAND & WALES ONLY)
37. For England and Wales, the 2007 SORP anticipated that top-up grant and payments
to the Secretary of State in relation to the police pension would be paid directly to or
from the police pension fund. However, when the Police Pension Fund Regulations
2007 were introduced, they required the police pension fund to be balanced to zero
by means of a transfer from the police fund. Top-up grant and payments to the
Secretary of State were to be paid to or from the police fund.
38. Police authorities in England and Wales should follow the Regulations rather than the
provisions of the SORP. This treatment is covered in the 2007/08 Guidance Notes at
Module 3, Section V, and has been confirmed by LAAP Bulletin 70.
WHOLE OF GOVERNMENT ACCOUNTS (WGA)
39. 2006/07 was the first year that all local authorities provided Whole of Government
Accounts information, although a significant number of the returns were unaudited.
In general there are still problems with the quality of data being provided, with
some authorities performing better than others. This problem is not limited to local
authorities, but will need to be addressed.
40. The issues with the quality of data can be partly explained by authorities filling in
‘greyed out’ cells in the data collection packs; the packs should have prevented this,
and this issue will be addressed for 2007/08. This does not cover all the problems,
however, and local authorities will need to consider how to provide better quality
information in future.
41. 2007/08 was scheduled to be the last 'dry run' year for the Whole of Government
Accounts, until the announcement in the 2008 Budget Report that the first Whole of
Government Accounts to be published would be for 2009/10 (rather than 2008/09
as had originally been announced). It remains likely that an increasing amount of
emphasis will be placed on this area. Issues identified in relation to local authorities'
submissions in 2006/07 included the following topics:
• Transactions and balances with other bodies – the amounts reported by the
counter parties to transactions (e.g. grants given and received) were often
• 2006/07 opening balances different to 2005/06 closing balances
• Movement in reserves not consistent with opening / closing balance sheets
• Using the wrong version of the return. CLG issued a second version of the WGA
return in July 2006 following the discovery of errors in the first version
• Trying to complete the WGA return using authority accounts which did not fully
comply with the SORP. Authorities should consider using the validation routines
built into the WGA returns as a means of validating their own compliance with
NEW OR CHANGED REQUIREMENTS FOR 2007/08
MINIMUM REVENUE PROVISION (MRP)
42. In England and Wales, new regulations relating to MRP have come into force. These
require authorities to make a prudent provision for debt, and statutory guidance is
provided, outlining what this means in practice. For MRP in 2007/08, authorities
have the choice of continuing to use the previous methodology or of adopting the
options in the guidance (this choice will also apply in future years in relation to
supported borrowing and debt arising before 1 April 2008). A statement as to the
methodology used by an authority will need to be approved by the full Council as
soon as is practicable. This should cover the methodology to be used for the
2007/08 accounts. A statement covering the methodology to be used in 2008/09 will
also be required, and may be combined with the 2007/08 statement.
LOANS FUND REPAYMENTS (SCOTLAND ONLY)
43. The Scottish Government will shortly be consulting on plans to amend the periods
for repayment of Loans Fund advances. The intention is to improve alignment
between advance repayment periods and asset useful lives. The consultation should
take place during early summer and a new Finance Circular is expected to be issued
to take effect in 2008/09 for Scottish local authorities.
REVALUATION RESERVE AND CAPITAL ADJUSTMENT ACCOUNT
44. 31 March 2007 saw the replacement of the Fixed Asset Restatement Account and
Capital Financing Account with the Revaluation Reserve and Capital Adjustment
45. There are a number of points that need to be borne in mind when implementing
these new arrangements.
• Whilst the 2007 SORP does not require the prior period to be restated (i.e.
revaluations and other transactions in 2006/07 are brought forward as
comparative figures unchanged), paragraph 3.113 does require the balance
sheet at 31 March 2007 to be restated, and for this treatment to be disclosed in
the notes. The balance on the Revaluation Reserve as at 31 March 2007 should
be set to zero. The balances on the Fixed Asset Restatement Account and the
Capital Financing Account should be transferred to the new Capital Adjustment
Account as at 31 March 2007.
• Apart from impairments relating to a consumption of economic benefits, it has
previously been possible to write off revaluation decreases to the Fixed Asset
Restatement Account under all circumstances. From 1 April 2007, this is no
longer the case. Revaluation decreases will only be permitted to be written off to
the Revaluation Reserve where there is a balance on the reserve, in relation to
the specific asset, against which the decrease can be applied. Where there is no
such balance, or the decrease exceeds the balance, the difference must be
charged to the Income and Expenditure account. As legislation does not permit
revaluation losses to be charged to the General Fund, the charge will need to be
reversed by crediting the Statement of Movement on the General Fund Balance
and debiting the Capital Adjustment Account.
• The opening balance on the Revaluation Reserve will be nil at 1 April 2007.
Therefore it is likely that most (if not all) revaluation decreases will need to be
charged to the Income and Expenditure Account (and then reversed via the
Statement in Movement on the General Fund Balance to the Capital Adjustment
Account) in 2007/08.
• However some cases authorities will make entries in the revaluation reserve on 1
April 2007 where assets are revalued upwards on 1 April. Such authorities will
o Housing authorities in England where paragraph 13.13.2 of the ODPM Stock
Valuation Guidance requires HRA dwelling stock to be revalued annually as at
o Authorities with a revaluation date of 1 April for non-housing assets where
the relevant assets are revalued in 2007 either as a result of a rolling
programme of revaluation or because this is the date of the five-yearly
46. Authorities should be aware that these arrangements will require more detailed
record keeping than has previously been the case, with both current cost and
historical cost information being required for each revalued asset. The balance on
the revaluation reserve for that asset will be the difference between the carrying
amount and depreciated historical cost. Revaluation decreases that take the value
of the asset below its deemed historical cost (initially the carrying amount at 31
March 2007) will need to be recorded as an impairment to the historical cost. This
detail is required so that the losses can be reversed in future years should the
revaluation decrease be reversed.
47. More information on accounting for the capital reserves can be found in Module 5,
Section I of the 2007/08 Guidance Notes.
REVALUATION OF INVESTMENT PROPERTIES
48. Some authorities have reported that their auditors are considering whether there
would be negative balances on the revaluation reserve for investment properties.
This view is based on paragraph 13 of SSAP 19, which states that “changes in the
market value of investment properties should not be taken to the profit and loss
account … unless a deficit (or its reversal) on an individual investment property is
expected to be permanent …”. Under SSAP 19, gains and losses on revaluation are
taken to an investment revaluation reserve, and negative balances are allowed.
49. The 2007 SORP does not require authorities to maintain an investment revaluation
reserve, and requires any transactions that would otherwise result in a negative
balance on the revaluation reserve to be debited to the Income and Expenditure
Account. Authorities are therefore not permitted to maintain a negative balance on
the revaluation reserve for investment properties. The 2007 SORP does not prohibit
the use of an investment revaluation reserve, and authorities may choose to operate
such a reserve for investment properties; however, they are not required to do so.
50. Where authorities choose not to operate an investment revaluation reserve, they
should charge any revaluation losses that take the asset below depreciated historical
cost to the Income and Expenditure Account, as they would with similar revaluation
losses on other classes of asset. Module 5, Section F of the Guidance Notes gives
further information on accounting for revaluations.
51. If an authority chooses to operate an investment revaluation reserve, it should
create the reserve (with a zero balance) as at 31 March 2007, the same time as it
creates the new revaluation reserves. Movements on both reserves will be included
in the STRGL, and could be combined into a single line in the STRGL.
52. In deciding whether to operate an investment revaluation reserve, an authority
should be aware that asset management systems designed to implement the
requirements of the 2007 SORP may not support a negative investment revaluation
reserve balance. They are therefore advised to confirm the capabilities of their
particular software before making a decision.
53. The 2007 SORP's adoption of FRS 25, FRS 26 and FRS 29, which deal with the
recognition, measurement, disclosure and presentation of financial instruments, is
one of the most significant changes in local authority accounting in recent years.
This is a complex area, which has warranted its own chapter in the SORP (Chapter
4) and its own module in the 2007/08 Guidance Notes (Module 6). Consequently,
this bulletin cannot cover all the issues relating to financial instruments; instead it
focuses on those issues that are likely to be common to most or all authorities.
Inevitably this means that some of the more complex arrangements will not be
covered; however, those authorities with the resources to enter into these more
complex arrangements are expected to have the resources to deal with the
accounting issues that arise - indeed this is likely to have been a factor when
considering whether to enter into the arrangement.
54. In addition to the sections of the Guidance Notes referred to in each topic below,
guidance on transition to the new arrangements for accounting for financial
instruments can be found in Module 6, Section D.
PWLB (and similar) Loans
55. Most authorities will have undertaken some borrowing through the Public Works
Loan Board (PWLB). Some authorities have expressed concerns that the 2007 SORP
requirements will make the accounting for these loans more complex. There are
three factors that will need to be considered.
Premiums and Discounts
56. Premiums and Discounts being carried on the balance sheet at 31 March 2007
are subject to the transition arrangements in the 2007 SORP. This is an area
that has generated significant discussion, and is covered in detail in LAAP Bulletin
57. From 1 April 2007, where loans are repaid early and premiums and/or discounts
arise, the accounting treatment depends on whether the early repayment is part
of a debt restructuring exercise that meets the loan modification requirements of
the SORP set out in paragraphs 4.36 and 4.37. All the following three
requirements must be met for the restructuring to meet the modification test:
• The holder of the old debt and the new lender must be the same party;
• The terms of the new debt are not “substantially different” or “substantially
modified” from the old debt. Paragraph 4.37 defines this as being the case
where the present value of the net cash flows under the new/modified loan is
within 10% of the present value of the contracted cash flows over the
remaining life of the original liability (i.e. between 90% and 110%). The
present value is required to be calculated using the effective interest rate of
the original liability;
• The exchange must be conducted on the same day.
• Where this is not the case, the premium or discount must be posted in full to
the Income and Expenditure Account. Regulations or statutory guidance then
require the premium or discount to be transferred to the Financial
Instruments Adjustment Account, via the Statement of Movement on the
General Fund Balance. The premium or discount is then debited or credited
to the Statement of Movement on the General Fund Balance (or the
Statement of Movement on the HRA Balance where appropriate) over time,
as required by the regulations or statutory guidance.
• Where the premium or discount arises as part of a debt restructuring exercise
which meets the loan modification test, different accounting arrangements
apply. Premiums and discounts are not charged to the Income and
Expenditure Account, but modify the carrying value of the replacement loan.
The premium or discount is then amortised to the Income and Expenditure
Account over the life of the replacement loan. To achieve this, the effective
rate of the replacement loan is recalculated. Guidance on how this is
undertaken is included in the 2007/08 Guidance Notes in Module 6, Section
• The terms of a PWLB loan do not allow formal modifications or exchanges,
but (following substance over form) the same result is achieved where loans
are repaid early and replacement loans taken out on the same day.
• The treatment of premiums and discounts outlined above will also be
applicable to premiums and discounts arising on loans with other lenders.
58. Financial instruments are measured at fair value, adjusted for directly
attributable transaction costs. Whilst this implies that the value of loans
recorded in the balance sheet should be adjusted to account for transaction
costs, in practice the concept of materiality means that this will not be required
in most cases. For loans raised from the PWLB, transaction costs are not
material and could be charged directly to the Income and Expenditure Account
(in line with historic practice), rather than being taken into account when
assessing the fair value of the loans.
59. PWLB loans can therefore be recognised in the balance sheet at the outstanding
amount of the loan (subject to any modifications for premiums or discounts, as
discussed earlier). Other loans can also be recognised in the balance sheet on
the same basis, provided the transaction costs are immaterial. Where
transaction costs are immaterial, they should be charged to the Income and
Expenditure Account as they are incurred.
60. Where transaction costs are material, the carrying amount of the loan will need
to be adjusted to reflect the transaction costs. An effective rate of interest
calculation will be required, to ensure that the additional costs are amortised
properly over the life of the instrument. Otherwise, the costs will be left on the
Balance Sheet unfinanced.
61. Authorities may wish to discuss the levels of transaction costs that would be
viewed as material with their auditors, particularly where the transactions costs
are greater than those charged by the PWLB. Guidance on effective interest rate
calculations can be found in Module 6, Section B of the 2007/08 Guidance Notes.
Embedded Derivatives within PWLB and similar Loans
62. Some authorities have expressed concern that the provisions regarding
embedded derivatives contained within FRS 26 will increase the complexity of
accounting for PWLB and similar loans. The early repayment option contained
within the terms of such loans meets the definition of an embedded derivative.
Under certain circumstances, embedded derivatives have to be accounted for
separately from the underlying financial instrument, and the concern has arisen
because the guidance in the FRS in relation to early repayment options appears
to be contradictory.
63. FRS 26 was developed in parallel with the equivalent international standard (IAS
39), and the two standards are almost identical. The International Accounting
Standards Board (IASB) has issued a proposed clarification to IAS 39 that makes
it clear that the early repayment option in PWLB and similar loans is “closely
related” to the underlying loan, and does not need to be accounted for
64. LAAP's opinion, confirmed by the proposed clarification, is that the early
repayment option in PWLB and similar loans does not need to be accounted for
separately and that (unless there is a related premium or discount), a new loan
should be recognised on the balance sheet at the amount borrowed. This
treatment is the same as that covered in the 2007/08 Guidance Notes, and is
confirmed in this bulletin in view of the concerns that have been raised by some
65. A LAAP Bulletin on this matter has been prepared, containing further details of
this issue. This will be issued once the IASB have considered the proposed
clarification and issued a revised standard (which is expected to be at the end of
66. Previously, the SORP required authorities to show accrued interest on borrowing
within the current liabilities section of the balance sheet. This presentation was
based on the optional treatment allowed under FRS 4.
67. The 2007 SORP incorporated the requirements of FRS 25, FRS 26 and FRS 29.
Under these standards, the optional treatment allowed under FRS 4 is no longer
68. Authorities will therefore show the accrued interest associated with a loan as part
of the carrying value of the loan.
69. Loans are included on the balance sheet at amortised cost, based on the
Effective Interest Rate method. Paragraph 4.25 recognises that it will not always
be necessary to undertake a formal effective interest rate calculation where
transaction costs are insignificant, and where it is obvious that the nominal
interest rate equals the calculated effective interest rate. This will be the case
for many PWLB loans.
70. Where no EIR calculation has been undertaken, and the loan is carried on the
balance sheet at nominal value, accrued interest should be charged to the
income and expenditure account, and added to the value of the loan. The
entries will be Dr I&E, Cr Borrowing. This will increase the carrying value of the
loan until such time as the accrued interest is paid.
71. Where an EIR calculation has been undertaken, the balance sheet values and
charges to the Income and Expenditure Account will reflect the calculation. In
these circumstances, no further entries relating to accrued interest are required
as the EIR calculation takes accrued interest into account.
72. In either case, the total carrying value of the loan should be shown in either
current liabilities or long term liabilities depending upon when the loan is to be
repaid; there is no requirement to separate out the accrued interest and present
it within current liabilities.
Disclosure of fair value of fixed rate loans
73. Some authorities have queried the method for arriving at the fair value
disclosure of fixed rate loans (e.g. PWLB fixed rate loans) required under
paragraph 4.100 of the SORP as outlined in paragraph E13 of Module 6 of the
SORP Guidance Notes. Paragraph 4.100 requires that:
74. “For each class of financial assets and financial liabilities an authority should
disclose the fair value of that class of assets and liabilities in a way that permits
it to be compared with its carrying amount.”
75. Paragraph E13 states that “fixed rate debt will need to be assessed on the basis
of a present value for the future cash flows due under the instrument, discounted
at the rate available currently in relation to the same loan from a comparable
76. PWLB will be providing fair value information for outstanding loans, discounted
using the premature repayment rates, when they provide their usual
confirmation of outstanding balances as at 31 March 2008.
77. This disclosure will be required in the notes to the accounts, not on the face of
the balance sheet.
78. Authorities will sometimes make loans at less than market rates, where a service
objective would justify the authority making a concession. Examples include loans to
voluntary organisations to facilitate the authority’s own responsibilities for service
provision, loans to organisations for economic regeneration purposes, and loans to
employees (e.g. car loans). Where this is material, the 2007 SORP requires the
discounted interest rate to be recognised as a reduction in the fair value of the asset
when measured for the first time. Where the amounts are not material (as might be
the case, for example, where an authority has a small number of car loans, and the
discount on the interest rate is relatively small), authorities should discuss this with
79. The sum by which the amount lent exceeds the fair value of the loan calculated
using the discounted interest rate should be charged to the Income and Expenditure
Account. This charge should be made to the service revenue account(s) benefiting
from the advance being made. This will normally be the service approving the
advance, but authorities may identify other services that benefit in particular
80. Over time, the carrying amount of the loan will be written up to its full value by the
repayment date, resulting in credits to the Income and Expenditure Account in
excess of the amount received.
81. A question has arisen as to where in the BVACOP subjective analysis the debits and
credits to the Income and Expenditure Account should be recorded. Group 10 -
Capital Financing Costs may seem to be the most logical section given the
relationship of these transactions with loans. However, this group is not included in
the net cost of services. As BVACOP requires the amounts to be debited to the
service revenue account(s), group 10 is clearly not appropriate. The Local Authority
Accounting Panel recommends that these debits be recorded in Group 5 – Third
Party Payments, and credits recorded (as a corporate entry) in Group 9 - Income.
82. Regulations (in England and Wales) and statutory guidance (in Scotland) have been
put in place which reverse the impact on the General Fund of accounting for soft
loans, so that the General Fund is credited with the (contractual) interest receivable
(if any). The adjustments are made between the Statement of Movement on
General Fund Balances and the Financial Instruments Adjustment Account. In
Scotland, the guidance does not extend to loans made after 1 April 2007.
83. Further guidance on Soft Loans can be found in Module 6, Section A of the 2007/08
“Rolled Up” Debt and similar issues
84. Authorities may be allowing clients to defer payment for services, for example by
agreeing to “roll up” the cost of care (with or without interest) against a legal charge
on the client’s property. Where these arrangements form part of a voluntary
agreement between the authority and the user, for example deferred payments
under section 55 of the Health and Social Care Act 2001, they should be treated as
85. Authorities will need to account for these amounts as soft loans and charge the write
down arising from valuing the loans at fair value to the Income and Expenditure
Account. This amount can then be reversed out to the Financial Instruments
Adjustment Account through the Statement of Movement on General Fund Balances.
86. The nature of these loans means that it will be difficult to estimate the life of the
loan on an individual basis. The write down to fair value of the loans can therefore
be estimated on a portfolio basis.
87. To assess the loans as a portfolio, authorities will need to estimate the average
length of their arrangements, based on past experience. The average remaining life
of the loans can be assumed to be half that of the average life of the arrangements;
this will allow for the fact that some arrangements will be nearing their end whilst
others will have just started. This estimate will need to be carried out as at 1 April
2007 to enable the opening 2007/08 balance sheet to be restated, and for each
subsequent closing balance sheet.
88. The fair value of the portfolio can then be assessed using the effective interest
method. This method requires the prevailing market rate to be used; as there is no
market for these loans, a reasonable approximation would be the PWLB interest rate
for a maturity loan with the same period as the estimated average remaining life of
89. Where a legal charge is raised against a client’s property as a method of recovering
debt (for example, under section 22 of the Health and Social Services and Social
Security Adjudications Act 1983), this does not amount to a soft loan. Such
amounts should be accounted for as a debtor. Where a legal charge has been
raised, it may mean that the debt is impaired since the amount or timing of cash
flows is likely to be different from the originally contracted cash flows. Authorities
should consider whether such debts are impaired or whether any exiting impairment
write down (or allowance) needs to be reviewed. Guidance on impairment can be
found in Module 6 of the Guidance Notes, paragraphs C27 to C32.
90. Authorities should include the legal charges discussed above in their collateral
91. This issue is unlikely to arise in Scotland due to the policy of free care.
Recovery of Debt Arrears
92. Debtors fall within the definition of a financial instrument, and may therefore need
to be measured using the effective interest rate method. Paragraph 4.25(a) of the
SORP states that this is not necessary where “the instrument is a short duration
receivable or payable with no stated interest rate”. This would then be measured at
the original invoice amount. Some authorities have asked what period a “short
duration” covers. This is a matter that authorities may wish to discuss with their
auditors, but a period of up to one year (i.e. the normal operating cycle of a local
authority, used to define current assets) would not appear to be unreasonable.
93. Authorities typically give financial guarantees (such as guaranteeing a loan) to
voluntary bodies, usually for policy rather than financial reasons. In many cases, no
charge will be made for this guarantee. From 1 April 2007, authorities are required
to account for these guarantees when they are given, rather than only when it is
probable that the guarantee will be called.
94. Financial guarantees will need to be recognised at fair value, and charged to the
Income and Expenditure Account. The guarantee will then be amortised over its life.
Guarantees given during 2006/07 will need to be brought into the opening 2007/08
balance sheet as at 1 April 2007.
95. Guarantees given before 1 April 2006 would rarely, if ever, have been recognised on
the balance sheet when they were given. They may however have been recognised
later as provisions. Because the guarantee was not recognised on the balance sheet
prior to 1 April 2006, the 2007 SORP does not require them to be subsequently
recognised as financial instruments. Instead, guarantees given before 1 April 2006
will continue to be accounted as before under previous editions of the SORP,
namely, as either:
• Contingent liabilities; or
• Provisions where the guarantee has been called and all three criteria for
recognising a provision (set out in paragraph 3.92) are met.
96. In England and Wales, where the guarantee was given after 31 March 2006 but prior
to 9 November 2007 (England) or 21 January 2008 (Wales), the charge to the
Income and Expenditure account for the guarantee can be reversed through the
Statement of Movement on the General Fund Balance to the Financial Instrument
97. Guidance on estimating the fair value of a guarantee and accounting for guarantees
can be found in Module 6, Section C of the 2007/08 Guidance Notes.
Investments managed by Fund Managers
98. Many authorities will have investments that are managed by fund managers, and
different practices for accounting for these investments have arisen. Following the
introduction of the 2007 SORP, authorities have expressed uncertainty as to whether
these investments should be accounted for as available-for-sale financial
instruments, or as at fair value through profit or loss.
99. Paragraph 4.51 of the 2007 SORP states that “All financial assets that are not
required by the SORP to be classified in another category should be classified as
available-for-sale.” The other categories into which assets might be required to be
classified are loans and receivables, and financial instruments as at fair value
through profit or loss. Investments will therefore be classed as either ‘available-for-
sale’ or ‘fair value through profit or loss’.
100. FRS 26 (and therefore the 2007 SORP) requires financial assets that are ‘held for
trading’ to be classified as at fair value through profit or loss. The definition of ‘held
for trading’ is met if the asset:
• is acquired principally for the purpose of selling it in the near future;
• is part of a portfolio of identified financial instruments that are managed together
and for which there is evidence of a recent actual pattern of short term profit
• a derivative
101. Where investments are managed by a fund manager, they are likely to form a
portfolio of identified financial instruments. If there is evidence of a recent actual
pattern of short term profit taking, all financial instruments in the portfolio would be
classified as at fair value through profit or loss. If there is no such evidence, the
portfolio would be classified as available for sale.
102. Authorities, in consultation with their fund managers, will need to decide whether
their investments satisfy this requirement. Some guidance is contained in the
Application Guidance section of FRS 26, paragraph AG 14, and the Guidance on
Implementation section of FRS 26, paragraphs B11 and B12. The guidance in
paragraph B12 makes it clear that buying and selling financial instruments to
balance the risks in a portfolio does not equate to trading; buying and selling must
be aimed at generating profits from short-term fluctuations in price.
103. If an authority does decide that investments within the portfolio satisfy this
requirement, the SORP requires the portfolio to be accounted for as at fair value
through profit and loss – this is not an optional treatment.
104. Whether investments within a portfolio would meet the definition of ‘held for trading’
is likely to depend on the instructions given to the fund manager. If the fund
manager has instructions to buy and sell investments to balance risk alone, then it is
likely that investments will not meet the definition of ‘held for trading’, and that the
portfolio will be classified as ‘available-for-sale’. If the instructions to the fund
manager allow buying and selling to generate profits from short-term fluctuations in
price – even on part of the portfolio – then it is likely that there will be evidence to
allow some investments to be classed as ‘held for trading’. The portfolio would then
be classified ‘as at fair value through profit or loss’.
105. Authorities who have already given instructions to fund managers allowing them to
trade should have confirmed their legal powers to do so. Authorities considering
giving such instructions should confirm the position with their legal advisors.
106. Further guidance on accounting for financial instruments as at fair value through
profit or loss can be found in Module 6, Section F of the 2007/08 Guidance Notes.
Embedded Derivatives and PFI Contracts
107. Some authorities have raised the question as to whether they need to review their
PFI contracts for embedded derivatives. The answer to this question is likely to be
108. Embedded derivatives are clauses within a contract that can result in a modification
of cash flows. Such clauses can arise in any contract, not just those that give rise
to a financial instrument (see paragraph 11 of FRS 26). The terms and conditions of
a PFI contract could therefore give rise to an embedded derivative.
109. Where the terms of the contract do give rise to an embedded derivative, authorities
will need to consider whether the embedded derivative needs to be separated and
accounted for separately to the main contract. Three criteria need to be met for
there to be a requirement to separately account for an embedded derivative. These
are that the economic characteristics and risks of the embedded derivative are not
closely related to those of the host contract; that a separate instrument with the
same terms would meet the definition of a derivative; and that the host contract is
not already being accounted for at fair value through profit and loss.
110. Local authorities are unlikely to enter into contracts where the economic
characteristics and risks of an embedded derivative are not closely related to the
host contract, and this will include PFI contracts. The terms and conditions of PFI
contracts are likely to include embedded derivatives - i.e. terms and conditions that
will modify the cash flows of the PFI contract. However, these are likely to be
closely related to the PFI contract and will not need to be accounted for separately.
111. PFI contracts contain three elements - payment for the assets, interest charges and
payments for services. Provided any modifications to cash flows are closely related
to the relevant element of the PFI contract, any embedded derivative will not need
to be accounted for separately from the PFI contract.
112. Examples of closely related embedded derivatives within PFI contracts are:
• Increases in charges related to index such as RPI. Provided the index used is
related to the services covered by the contract, this will be closely related.
• Increases or reductions in charges due to varying levels of demand. As any
variations in cash flows would directly relate to the level of service provided
under the contract, this will be closely related.
• Reductions in charges due to poor performance. Again, any variations in cash
flows would be directly related to the services provided under the contract.
• Variations in interest charges. Where these are related to the underlying debt
within the contract (for example, changes in interest that arise as part of a
refinancing exercise), these will be closely related to the host contract.
113. Within the Application Guidance section of FRS26, paragraphs AG27 – AG33B give
guidance on embedded derivatives, including examples of those that are, and are
not, closely related.
114. Authorities should review PFI contracts for any terms and conditions that could
modify cash flows. Provided these terms and conditions are the standard terms and
conditions described above, they will be embedded derivatives that are closely
related to the PFI contract, and need not be accounted for separately from the PFI
115. If the terms and conditions are not the standard terms described above, authorities
will need to undertake further reviews to determine if the terms and conditions are
embedded derivatives that need to be accounted for separately from the PFI
116. Authorities should also consider if they have any other contracts which could give
rise to an embedded derivative, and review them accordingly. It is likely that any
such embedded derivatives will be closely related to the host contracts, but
authorities would be advised to confirm this as soon as possible.
117. The Audit Commission National Report on the Use of Resources scores can be found
118. The Audit Scotland report 'Overview Of The Local Authority Audits 2007' can be
119. The 2007/08 Guidance Notes and 2007 Best Value Accounting Code of Practice can
be purchased from the CIPFA Shop:
120. The Communities and Local Government statutory guidance on the Minimum
Revenue Provision can be downloaded from:
121. CIPFA members and students can address any queries to the CIPFA Technical
Enquiry Service, telephone number 020 7543 5888, email: