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					The Accounting Treatment of Schools PFI
Projects
The Accounting Treatment of Schools PFI Projects – Discussion Draft


Contents

                                                                                  Page

Part 1   Introduction and Process

Part 2   Guidance for Determining the Accounting Treatment for Schools
         PFI Projects

         I      Introduction

         II     Overview of FRS 5 approach

         III    Separation of the contract

         IV     Qualitative indicators

         V      Demand risk

         VI     Design risk (including obsolescence)

         VII    Residual value risk

         VIII   Third party revenue risk

         IX     Penalties for under-performance and non-availability

         X      Potential Changes in Relevant Costs

         XI     Factors Not Capable of Meaningful Quantification

         XII    The Overall Judgement

         XIII   What do we do if our scheme is assessed as on-balance sheet?

Part 3   Data collection forms

Part 4   Standard risk ranges




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                           1


Part 1        Introduction and Process

Objective

1.1    The objective of this document is to provide practical guidance to Local Education
       Authorities (LEAs) on how to address the accounting treatment of schools PFI
       schemes. The aim of this guidance is to promote consistency in the application of the
       relevant accounting standards, and to reduce the costs incurred by individual LEAs by
       standardising the approach as far as possible. In particular, the guidance aims to
       provide, wherever possible, a standard interpretation on issues common to school
       schemes, together with guidance on the reasonableness of individual risk ranges.

1.2    DfEE also has a need to ensure that the accounting analysis is considered at the
       earliest stages of the scheme, in order to provide greater certainty when allocating its
       capital resources. If a scheme has a significant risk of being considered „on-balance
       sheet‟ then DfEE needs to be aware as early as possible in order to consider the
       funding implications. For DfEE‟s purposes, it is desirable that they are aware at
       Project Review Group (PRG) approval stage whether a scheme is likely to be on- or
       off-balance sheet.

1.3    To this end, this guidance also includes an early warning mechanism for LEAs to
       apply to their schemes to identify those schemes that have a higher risk of being
       considered on-balance sheet.

Process

1.4    The first stage of DfEE‟s approval process requires LEAs to submit an initial
       application focusing on how their scheme meets the DfEE‟s prioritisation criteria.
       LEAs are required to consider the accounting issues for the scheme and include a
       commentary in this application.

1.5    Those projects that score highest against the prioritisation criteria receive provisional
       support from DfEE for recommendation towards final approval from the PRG. DfEE
       provides assistance to the LEAs in developing the Outline Business Case for
       submission to PRG.




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What will LEAs have to do, and when?

1.6      DfEE will expect LEAs to have considered the accounting issues for their schemes as
         follows:

         Initial application to DfEE

1.7      LEAs should consider the likely demand risk, reflecting the nature of the scheme as
         discussed in section V of the attached guidance. A commentary on the risk should
         then be provided within the initial application document, and can include measures
         that LEAs might take to manage the demand risk. LEAs are not expected to undertake
         detailed calculations to quantify the risk at this stage, but where the scheme features
         indicate that demand risk is likely to be higher, they may wish to do so in support of
         their application.

         Outline Business Case (OBC)

1.8      At OBC stage LEAs should be in a position to meaningfully quantify their demand
         risk, and consider likely ranges on the other risks.


[Early warning mechanism – some options for DfEE:

1 Qualitative analysis of the risks – particularly demand risk, to identify the inherent
demand risk in the scheme and the LEA‟s proposals/options for managing it.

2     Quantitative analysis of demand risk, based on:

            LEA‟s assessment of demand risk for the scheme;
            Capital expenditure and lifecycle costs generated for the PFI Credit toolkit; and
            Indicative risk ranges.

          This quantitative assessment could be done by, for example:

            LEAs;
            DfEE using a standard model provided by PwC; or
            External supplier under contract to DfEE e.g. PwC

         Any analysis done at this stage would be indicative, and a further analysis would need
         to be performed at a later stage based on the operator‟s financial model and chosen
         design solution.]

Prior to appointment of preferred bidder [?]

[DfEE to consider value/need for „final‟ analysis prior to appointment of preferred bidder.]




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Summary of requirements

What do LEA’s have to do?                       How do we do this?

Initial Application stage

   Assess the demand risk inherent within         Use the guidance provided in Section V
    the scheme.                                     of this document.

   For grouped schemes only, consider the         Use the guidance provided in Section III
    extent to which schools will need to be         of this document.
    assessed individually.

Outline Business Case

   Consider separability of services.             Use the guidance on section III of this
                                                    document. Adopting the Model contract
                                                    in unchanged form will substantially
                                                    address the separability concerns.

   Initial analysis of risks [option for          Use the guidance in sections V to X of
    quantitative modelling at this stage?]          this document.

   Consider the qualitative indicators:

    -   Termination for operator default; and   -   Adopting the model         contract in
                                                    unchanged form will       address this
                                                    indicator.

    -   Who determines the nature of the -          Use the guidance provided in section IV
        property?                                   of this document.


Prior to Appointment of Preferred Bidder

   Undertake [or consider need to update]
    quantitative analysis of the risks

   Consider the qualitative indicator:            Use the guidance in section IV of this
    „Nature of the operator‟s financing‟.           document.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft         4




                                      Part 2



  Guidance for determining the accounting
        treatment for PFI Schools




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I      Introduction
Background

1.1    Regulation 16 of the Local Authority (Capital Finance) Regulations 1997 defines a
       Private Finance Transaction (PFT). Schemes which meet this definition are credit
       arrangements and the Local Authority (LA) is required to provide credit cover to the
       value of the initial cost of the scheme.

1.2    Prior to 31 March 2000, if a scheme satisfied the „contract structure test‟ requirements
       of Regulation 40 of the Local Authority (Capital Finance) Regulations 1997 then the
       initial cost of the credit arrangement would be nil. With effect from 1 April 2000,
       Regulation 40 was changed, with the contract structure test being replaced by an
       accounting-based test to determine if the initial cost of a PFT was nil:

1.3    “A credit arrangement which is a private finance transaction shall be excluded from
       section 49(2), and the initial cost and the cost at any time of the arrangement shall be
       nil, if the authority determine that in accordance with proper practices no item…… is
       required to be recognised as an asset in any balance sheet they are required to
       prepare.”

1.4    Effectively this means that if a PFT is judged to be „off-balance sheet‟ for the LA, the
       initial cost of the credit arrangement will be deemed to be nil and the LA will not
       have to provide credit cover or set aside resources from revenue each year.
       Conversely, if a PFT is judged to be „on-balance sheet‟ the LA will need to provide
       credit cover to the value of the initial cost.

1.5    DfEE provides funding to LEAs for PFI schemes through the mechanism of PFI
       credits. However, these PFI credits can only be provided where a scheme is judged to
       be off-balance sheet. If a scheme is judged to be on-balance sheet, DfEE would need
       to provide funding to the LEA through issuing a Supplementary Credit Approval
       (SCA) which it would have to find from its block capital budget.

1.6    The Local Authority SORP defines proper practices as:

             ASB Application Note F to FRS 5 „Reporting the Substance of Transactions -
              Private Finance Initiative and other contracts‟ (September 1998) (the
              „Application Note‟); and

             SSAP 21 Accounting for leases and hire purchase contracts.




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1.7     The Application Note seeks to determine whether a PFI scheme is, in substance:

                a financing transaction for a property, with an accompanying service contract;
                 or

                the provision of services, in which an underlying property is used.

1.8     In June 1999, HM Treasury Taskforce issued Technical Note No. 1 (Revised) „How
        to Account for PFI Transactions‟ (the „Technical Note) to promote consistency across
        the public sector when interpreting the Application Note (AN). The Technical Note
        does not replace the Application Note, but is complementary to it, providing further
        guidance in areas where there is scope for variations in interpretation. The Accounting
        Standards Board has stated that the Technical Note is „not inconsistent‟ with the
        Application Note. The Technical Note therefore represents „best practice‟ for the
        public sector when interpreting the relevant parts of the Application Note.

1.9     The Local Authority SORP provides that the Technical Note is „influential‟ but not
        mandatory for LAs.

1.10    This guidance document provides assistance in the following areas:

Content of the AN                                       DfEE additional                   Heading
                                                           guidance
Features                                                          
Overview of the basic principles                                  
Separation of the contract *                                                      Application to the
                                                                                   Model Contract
                                                                                   Group schools schemes
SSAP 21 v. FRS 5                                                  
How to apply SSAP 21                                              
How to apply FRS 5 *                                                              Qualitative indicators
                                                                                   Quantitative indicator
                                                                                   Unquantifiable risks
Required accounting (Not relevant to LAs**)                       
* additional guidance provided in the Technical Note
** the required accounting is set out in the Local Authority SORP Guidance Notes

1.11    It is important to note that this guidance supplements the relevant accounting
        standards, described above, and should be applied in conjunction with them. In any
        cases of uncertainty, the accounting standards should be referred to for definitive
        guidance.




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DfEE Model Contract

1.12   The DfEE Model Contract for school PFI schemes will standardise many aspects of
       school schemes, including:

             the overall allocation of risks;

             the separability of the scheme (driven by the payment mechanism, and
              benchmarking provisions); and

             other factors, for example, the compensation payable on contractor default.

1.13   Where LEAs adopt the contract without changes, certain aspects of the accounting
       analysis will have been addressed already. This will leave LEAs to assess those
       factors that are driven entirely by local factors, for example, demand risk, or that are
       dependent upon the operator‟s specific solution, for example, design risk.

1.14   This document provides guidance to LEAs, based on the assumption that they adopt
       the Model Contract, on approaching the analysis of the local and solution-specific
       factors. The principles and methodology in this guidance similarly apply where LEAs
       adopt alternate contract arrangements to those in the Model Contract, but in these
       circumstances LEAs will need to consider, taking advice as necessary, on the
       resulting implications for the detailed application of the accounting assessment.

Value for Money

1.15   As the Technical Note observes, “The objective of PFI procurement is to provide high
       quality public services that represent value for money for the taxpayer. It is therefore
       value for money, and not the accounting treatment, which is the key determinant of
       whether a project should go ahead or not. Purchasers should focus on how
       procurement can achieve risk transfer in a way that optimises value for money and
       must not transfer risks to the operator at the expense of value for money.”

Terminology

1.16   The Application Note and the Technical Note use the term „Property‟ when referring
       to the underlying capital elements in a scheme, rather than the term „asset‟, which is
       reserved for items that are recognised in the balance sheet. This is because the
       accounting tests seek to establish which party has an asset of the property.

1.17   This guidance document follows this convention. It is important to note that the term
       „property‟ applies to each of the capital elements in the scheme including, for
       example, plant and IT equipment, and is not just restricted to land and buildings.




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Determining the accounting treatment

1.18   This document seeks to promote consistency by LEAs in applying the relevant
       accounting standards to schools PFI schemes. Ultimately, however, the responsibility
       for determining the appropriate accounting treatment for the purposes of Regulation
       40 and the LEA‟s annual financial statements, rests entirely with LEAs in
       consultation with their auditors.




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II         Overview of FRS5 Approach
Background

2.1        The first stage in the analysis involves identifying whether any elements of the
           contract are separable. Guidance on separability of the scheme is provided in
           Section III of this document.


      Do any elements of the PFI payments operate            •Separate payment streams
      independently from each other?                         •Separate terminations/different periods
                                                             •Separation renegotiations


                      yes

           Exclude                                                              Distinct properties?
                                               no


      Are the only remaining elements payments for the property?


                                                                              yes
                         no

                                                           SSAP21 analysis

        FRS 5 analysis




2.2        Having determined any separable elements, consideration needs to be given as to
           which accounting standard to apply, as follows:

Contract components that comprise:                                     Accounting treatment

Payment for services only                                              Expense as a revenue cost as incurred

Payment for property and services                                      Determine in accordance with FRS 5

Payment for property only                                              Determine in accordance with SSAP 21


2.3        Where, as a result of separability, elements fall to be considered under SSAP 21, it is
           highly likely that those elements will be assessed as on-balance sheet.




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FRS 5 Approach

2.4       The diagram below sets out the formal approach under the Technical Note, however
          the principles are consistent with the Application Note.


      Is it obvious, after an initial assessment of the risks                  No further work required
      which party has an asset of the property?                          yes


                                        no


      Further work required which involves weighing up all relevant indicators




      (a)Qualitative indicators              (b)Quantitative indicator         (c)Other indicators

      •Who determines the nature of          Undertake a quantitative          Those risks, if any, which are
      the property?                          risk analysis for those risks     not capable of meaningful
      •Termination for operator              which are capable of              quantification for inclusion in
      default                                meaningful quantification         (b) due to level of uncertainty
      •Nature of operator’s financing                                          surrounding them




       Form a judgement on the accounting treatment based on (a), (b) and (c)




QUALITITATIVE INDICATORS

2.5       Detailed guidance on how to assess the qualitative indicators is provided in Section
          IV of this document.

QUANTITATIVE ANALYSIS OF THE RISKS

Key principles

2.6       Under the general principles of FRS 5, whichever party has the greatest access to the
          benefits of the property, and exposure to the risks inherent in those benefits, should
          recognise an asset of the property. In other words, the accounting treatment follows
          the commercial allocation of the risks. This should be determined by examining the
          extent to which each party bears potential variations in property profits or losses.

2.7       The Application Note highlights that a range of factors will be relevant in determining
          the extent of property profits and losses and it will be necessary to look at the overall
          effect of these factors when taken together. It further notes that any potential
          variations that relate purely to a service should be ignored.

2.8       The principle here is to distinguish potential variations in costs and revenues that flow
          from features of the property from those that do not.



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2.9     The Application Note also notes that greater weight should be given to those features
        that are more likely to have a commercial effect in practice. Where there is no genuine
        possibility of a particular scenario or cash flow occurring it should be ignored.

2.10    In applying this, the Application Note highlights that it is necessary to consider both
        the probability of any future profit variation arising from a property factor and its
        likely financial effect.

Initial analysis of the risks

2.11    The first stage of the analysis is to undertake an initial assessment of the risks. If it is
        obvious from this assessment which party bears the majority of the risks, then no
        further work would need to be done.

How should we assess the key risks?

2.12    There is a need to ensure that all risks are identified and assessed in a consistent way.
        The following sections of this document provide guidance on how to assess each of
        the key risks as follows.

Key risk                                                Further guidance provided in Section:
Demand risk                                                               V
Design risk (including obsolescence)                                     VI
Residual value risk                                                     VII
Third party revenue risk                                                VIII
Penalties for under-performance and non-                                 IX
availability
Potential changes in relevant costs                                         X

2.13    Whilst other approaches to assessing the risks may be equally valid, DfEE is
        promoting the approach set out in this document in order to ensure consistency and to
        aid evaluation.

2.14    Based solely on the Model Contract, the risks appear to be allocated as follows :

 Risk/Principal Factor                                 Borne by the LEA    Borne by the Operator
 Demand risk                                                  
 Third party revenues                                                                
 Design risk                                                                         
 Penalties for under-performance or non-availability                                 
 Potential changes in relevant costs                                                 
 Obsolescence                                                                        
 Residual value risk                                          

2.15    From this analysis, it is not clear which party bears the majority, by value, of the risks,
        and further analysis will, therefore, generally be required.



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Practical considerations

Do we need to do further work?

2.16   LEAs need to perform the above initial analysis, based on the actual risk allocation
       within their schemes. Only if all of the risks were with one party would no further
       analysis be required. In practice, however, this is unlikely to be the case since value
       for money considerations will usually militate against demand and residual value risk
       being passed to the operator.

Do we need to do a quantitative analysis?

2.17   The Application Note highlights that a range of factors will be relevant in determining
       the extent of property profits and losses and it will be necessary to look at the overall
       effect of these factors when taken together.

2.18   It also notes that greater weight should be given to those features that are more likely
       to have a commercial effect in practice and that it is necessary to consider both the
       probability of any future profit variation arising from a property factor and its likely
       financial effect.

2.19   The Application Note does not, however, provide guidance on how this assessment
       should be carried out. The Technical Note supplements the Application Note, and
       requires the use of appropriate quantitative techniques when considering the
       combined impact of the risks.

2.20   It notes that a range of modelling techniques can be used to perform the risk analysis,
       depending on the size and complexity of the project. Such techniques include
       sensitivity analyses, scenario analyses or a Monte Carlo simulation. Care, however,
       needs to be taken when considering the results of any quantitative analysis to avoid
       spurious accuracy, given that any such analysis involves a high degree of subjectivity.
       The potential variations in profits or losses should be taken at the 95% confidence
       level to reduce the effect of any outliers, but the overall results will still be driven by
       the risk range inputs to the model.

2.21   While the use of quantitative techniques is a matter for individual LEA judgement, in
       accordance with their accounting policies and practices, DfEE‟s view is that the use of
       quantitative modelling techniques – specifically monte carlo analysis - provides the
       best evidence when considering the combined effects of the individual risks.

2.22   Experience suggests that the overall quantum of risk in schools schemes, for
       accounting treatment purposes, is often closely balanced. Consequently, it is
       important to undertake risk modelling on all relevant, meaningfully quantifiable, risks
       including those that might otherwise be considered as de-minimis.




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2.23   The accounting analysis substantially follows the underlying commercial allocation of
       the risks and, therefore, the quantitative modelling should reflect the anticipated
       commercial reality of the proposed scheme.

2.24   The risk-adjusted Public Sector Comparator (PSC) prepared for the Outline Business
       Case will reflect the key risks within the scheme. It is important to remember,
       however, that comparatively few of these risks are relevant to the accounting analysis
       and that the PSC is based on the public sector‟s design solution, whereas the
       accounting analysis is based on the bidder‟s design solution. This document does not
       prescribe how risks should be assessed for the PSC and hence it is possible that the
       same risks may be assessed, and modelled, slightly differently for the PSC and
       accounting analysis. This does not invalidate either analysis, but LEAs should take
       care to ensure that the two are, at least, not inconsistent.

2.25   To promote consistency of approach to the quantitative analysis, Part 3 of this
       document builds on the guidance on assessment by providing a common format for
       recording information on the key risks for modelling purposes. Additionally, Part 4 of
       this document provides indicative risk ranges for those risks where the underlying
       factors are likely to be common to all schemes.


UNQUANTIFIABLE INDICATORS

2.26   Guidance on these is provided in section XI of this document.


THE OVERALL JUDGEMENT

2.27   The overall judgement cannot be done in a mechanistic way and requires professional
       judgement, however some guidance is provided in section XII of this document.




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III Separation of the contract
Introduction

3.1    This section provides guidance on how to determine whether elements of the contract
       are separable and should, therefore, be considered further on an individual basis.
       Separability is examined from two perspectives:

          Separation of services – examining the extent to which the contractual provisions
           of the Model Contract may result in the separation of services; and

          Grouped schemes – examining the extent to which individual properties within
           multi-school schemes may need to be considered separately.

3.2    For each of these sections, the guidance describes:
        The key principles;
        Practical considerations; and
        Key messages for LEAs.


SEPARATION OF SERVICES

Key Principles

3.3    The first stage of the accounting analysis is to determine if the PFI contract is
       separable (i.e. the commercial effect is that individual elements of the PFI payments
       operate independently from each other).“Operate independently” means that the
       elements behave differently and can therefore be separately identified

We are making a single unitary payment for the delivery of services, how can there be
separable elements?

3.4    Although PFI schemes involve the use of a Unitary Charge, the separability tests seek
       to establish whether there are, in substance, underlying elements that behave
       differently or are driven by different commercial factors and whether these feed
       through into the Unitary Charge independently.

3.5    For example, where the Unitary Charge is adjusted as a result of a market testing
       exercise or the termination of an individual service, then these elements could be
       judged to be separable.

3.6    Paragraph F10 of the Application Note, which is elaborated upon in the Technical
       Note, provides that a contract may be separable in a variety of circumstances,
       including, but not limited to, the following three situations.




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Situation 1 - the contract identifies an element of a payment stream that varies according to
the availability of the property itself and another element that varies according to usage or
performance of certain services.

Situation 2 - different parts of the contract run for different periods or can be terminated
separately. For example, an individual service element can be terminated without affecting
the continuation of the rest of the contract.

Situation 3 - different parts of the contract can be re-negotiated separately. For example, a
service element is market tested and some or all of the cost increases or reductions are passed
onto the purchaser in such a way that the part of the payment by the purchaser that relates
specifically to that service can be identified.

Practical considerations

Is the scheme separable under Situation 1?

3.7      The Model Contract includes, in Part 1 of Schedule 7, the indicative payment
         mechanism during the operational period of the contract, extracted below. If LEA‟s
         do not use this payment mechanism, then they will need to seek appropriate advice
         from their PFI accounting advisors.

UC = [BUC – AD – PPD] +/- AO – IA

Where:

UC       =     Unitary Charge
BUC      =     Base Unitary Charge [determined in accordance with Part 5 of Schedule 7]
AD       =     Availability Deductions [determined in accordance with Part 4 of Schedule 7]
PPD      =     Performance Points Deductions [determined in accordance with Part 3 of
               Schedule 7]
AO       =     Any other amounts which are required to be added to or subtracted from the
               Unitary Charge in accordance with paragraph 2.6 of Part 5 (Availability of
               Indices)
IA       =     Any amounts to be deducted from the Unitary Charge under paragraph 3 of
               Part 5 (Incentive schemes)

3.8      For the purposes of the accounting analysis, we are principally concerned with how
         the Base Unitary Charge is calculated, and the way in which deductions for poor
         performance or non-availability are applied.

3.9      [Based on principles in 4P‟s Payment mechanism paper] Deductions for poor
         performance will be applied to a proportion of the Base Unitary Charge.

3.10     [Based on principles in 4P‟s Payment mechanism paper] Deductions for non-
         availability will be applied to the whole Base Unitary Charge.




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3.11   The Unitary Payment does not, therefore, appear to comprise separate payment
       streams for availability of the property and provision of services, and consequently
       does not appear to be separable between these two elements.

Is the scheme separable under Situation 2?

3.12   There appear to be no provisions in the Model Contract for partial termination of
       individual services, for example, as a result of continued poor service performance.

Is the scheme separable under Situation 3?

3.13   Clause 28 of the Model Contract provides for the benchmarking of „Operational
       Services‟. Any identified variations in excess of 95% - 105% of the base cost will
       result in an adjustment to the unitary payment, or in the market testing of those
       services. Where market testing is carried out, any price variations will result in an
       adjustment to the unitary payment, and consequently will be separable.

3.14   The Model Contract does not list the individual services which fall within the
       benchmarking and market testing provisions, since this may vary between schemes. If
       all services are subject to benchmarking or market testing, then they will all be
       separable. Once eliminated, this will leave a payment stream that represents payment
       solely for the property, and SSAP 21 will need to be applied to determine the
       accounting treatment, with the likely result of an on-balance sheet treatment for
       the LEA.

3.15   For the purposes of the FRS 5 analysis, only risks that flow from features of the
       property are relevant. For practical purposes, this means that the key services are
       likely to be the Hard Facilities Management (FM) services – principally lifecycle
       replacement and building and equipment maintenance. Consequently, it is important
       that, for accounting purposes, that benchmarking and market testing provisions do not
       cause the Hard FM services to be separable from the payment for the property. This is
       consistent with the advice issued by HM Treasury PFI Taskforce in „Standardisation
       of PFI Contracts‟ and with the „Payment Mechanisms for Local Authority PFI
       Schemes - Schools‟ issued by 4Ps which both note that only Soft FM services should
       be subject to benchmarking or market testing.

3.16   A feature of schools schemes is that a significant element of building maintenance is
       often performed in the first instance by the school janitors. Therefore, it is important
       that janitorial services also are not separable. Further references in this guidance
       document to building maintenance services should also be taken to include janitorial
       services.




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       Indexation

3.17   The Unitary Charge is usually indexed to reflect the commercial reality that some of
       the operator‟s costs - relating to services - will increase over the course of the
       contract. However, the operator‟s capital financing costs represent a large element of
       its overall costs and will usually be fixed over the life of the contract.

3.18   Thus when, for example RPI, is used as an index, value for money considerations
       usually mitigate against applying the full effect of the indexation to the whole unitary
       charge. One solution to this is to split the unitary charge into an indexed element and
       an unindexed element with the latter broadly equivalent to the operator‟s annual debt
       repayment costs. However, since indexation of payment streams can be seen as a
       basic form of benchmarking, this can sometimes lead to these two elements being
       seen as separable under situation 3.

3.19   When deciding how indexation should be used within the payment mechanism, LEAs
       should have regard to the possibility of separation. Possible solutions include:
        Ensuring that annual maintenance and lifecycle costs are included in the
          unindexed element; or
        Indexing the whole unitary payment by a fraction of RPI.

3.20   In the first of these cases, any separability would not matter as the relevant costs are
       in the same payment stream as the property. In the latter case there would be no
       separability of the elements.

KEY MESSAGES

LEA’s should use the payment mechanism in the Model Contract to avoid separability
under situation 1.

LEAs should ensure that Hard FM services are not subject to benchmarking or market
testing to avoid them being considered separable for accounting purposes. This is
consistent with Treasury PFI Taskforce and 4Ps guidance.

LEAs should be careful to ensure that any indexation provisions do not result in
separability of Hard FM services.

If LEAs do not follow the terms of the Model Contract, then they will need to seek advice
from their PFI accounting advisors on the extent to which their schemes are separable.

If all services are separable, then SSAP 21 will need to be applied to the remaining
property payment stream and will likely result in an on-balance sheet assessment.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                          18


GROUPED SCHOOLS SCHEMES – assessing the extent to which there
are distinct properties

Key principles

3.21   When considering the extent to which a PFI contract can be separated into individual
       elements, the Application Note/Technical Note focus on separability of services from
       the underlying „property‟, rather than separability between properties. For grouped
       schools schemes, however, there may be two or more distinct properties which need
       to be assessed separately for accounting purposes. The factors that need to be
       considered in determining whether there are any distinct properties and whether, or
       not, they need to be assessed separately are discussed below.

Are there any distinct properties?

3.22   Factors to consider include:

          are there any schools which are physically or geographically distinct? (this is
           likely to be the case);
          do the schools have different economic lives?
          do they have individual notional unitary charges to which deductions for
           unavailability and poor performance are applied, so that, in effect, there is a self-
           contained payment stream for each school or set of schools in the group? and
          are the schools capable of being terminated separately without affecting the rest of
           the contract?

Are the distinct properties material?

3.23   Having determined that there are, say, two groups of “distinct properties”, one also
       needs to consider if one of these groups is immaterial. If yes, then the analysis could
       be done on a contract wide basis. In assessing materiality, one will need to look at the
       level of capital expenditure involved for each of the two groups of distinct properties.

Do the distinct properties have different risk profiles?

3.24   If the different groups of distinct properties have similar risk profiles, then for
       practical and efficiency reasons, the analysis could be done on a contract wide basis.
       This assessment will need to consider the following risks:

              demand;
              residual value;
              design;
              third party revenues;
              obsolescence and technology;
              potential changes in relevant costs; and
              penalties.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                          19


3.25   For example, demand risk may well be different between primary and secondary
       schools and design risk may be different between new build and refurbishment

Practical considerations

How do we approach the risk analysis when dealing with separable or distinct properties?

3.26   The general principle is that each distinct property will need to be considered
       separately. However, if it can be demonstrated that there are one, or more, properties
       that have substantially the same risk profile in substance, then for convenience they
       can be considered together since the conclusion drawn from the analysis of the
       combined properties will be the same as that drawn for each property analysed
       separately.

3.27   A simple analysis of the risks will not be sufficient to determine whether the risk
       profiles are the same in substance, since demand risk will vary by a multiplicity of
       factors as described in the Demand risk section of this document. Additionally, for
       example, design risk may be different for new build schemes when compared to the
       refurbishment of existing schools.

3.28   LEAs must, therefore, consider the risks for each property in practice, as described in
       the rest of this document, before determining whether properties can be considered
       together for quantitative analysis purposes. The extent to which properties can be
       grouped for analysis purposes is a matter of professional judgement.

Although we have a number of distinct properties, our deduction regimes cut across the
whole contract and are not simply applied to each school – does this make a difference?

3.29   If substantial non-availability or poor performance at one site can result in deductions
       to the charge for other sites as well (i.e. the total deduction could be greater than
       100% of the notional availability charge or service charge for that site), then, if this
       risk is significant, this may override all of the above considerations regarding
       separability and different risk profiles. The reason is that, in substance, the contract
       might be seen as a whole, not distinguishing between different sites, but treating all
       properties together for availability and performance purposes. There is also a practical
       consideration here – when modelling the impact of deductions for the quantitative
       analysis, it might only be realistically performed by looking at the contract as a whole.
       When considering whether the impact of the deduction regimes can override the
       existence of distinct properties, professional judgement must be applied.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                     20


3.30   The approach to dealing with the analysis for grouped school schemes can be
       summarised in the diagram below:


             Does the contract involve         No        Do accounting
             any groups of distinct                      analysis on contract-
             properties?                                 wide basis
                              Yes

                                               No
             Is more than one of the
             'distinct properties' material?

                              Yes

             Do the groups of 'distinct        No
             properties' have different
             risk profiles
                              Yes

             Does the deduction regime         Yes
             cut across all schools and is
             it a significant risk?
                              No


             Assess the groups of 'distinct
             properties' separately for
             accounting purposes




KEY MESSAGES

For grouped schools schemes, individual sites may well need to be considered separately,
as described above.

However, it may be possible to consider some properties together, but this will only be
possible where they have, in practice, substantially the same risks, or where the deduction
regimes treat the contract as a whole and do not distinguish between individual properties.
When determining the extent to which properties can be considered together, professional
judgement is required.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                          21


IV QUALITATIVE INDICATORS
4.1    The Application Note states that in determining which party has an asset of the
       property, it will not be appropriate to focus on one feature in isolation (para. F49). It
       adds that it will often be useful to consider other factors to assess whether the scheme
       is, in substance, a financing transaction, for example, an assessment of the operator‟s
       financing and the extent to which the senior debt will be paid out under all events of
       contract default (para. F50). The Technical Note expands these considerations into
       formal qualitative indicators, and provides some further guidance on their assessment:

          Nature of the operator‟s financing;
          Termination for operator default; and
          Who determines the nature of the property?

4.2    This section provides guidance on how to evaluate each of these indicators and
       describes for each:

          The key principles in assessing the indicator;
          Practical considerations and how to deal with them; and
          Key messages for LEAs.

NATURE OF THE OPERATOR’S FINANCING

Key Principles

4.3    The Application Note provides that all aspects of the operator‟s financing
       arrangements should be taken into account e.g. the use of senior or sub-ordinated debt
       and the presence of any guarantees, and notes that a very high level of gearing is an
       indicator that the property is an asset of the purchaser. The Application Note does not
       give any indication as to what level of gearing would indicate a financing
       arrangement, other than to say that a „significant level of equity‟ is an indicator that
       the property is an asset of the operator, but without defining significant. The
       Technical Note also does not add any further guidance in this area.

4.4    However, experience of PFI schemes and their accounting analyses suggests that
       where bank financing (i.e. debt and debt-like instruments) represents greater than 90%
       of total financing, it would generally be considered as an indicator of a financing
       arrangement. However, there are no hard-and-fast rules, and a level of 90%-95% falls
       within a „grey area‟ and judgement must be exercised. Where the bank financing
       represents 95%, or more, of the total financing, this indicates a financing arrangement,
       unless further investigation into the existence of other factors e.g. parent company
       guarantees or contingent equity, overturns this presumption.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                                       22


Practical Considerations

What is included in ‘bank financing’?

4.5      The private sector generally deliver PFI schemes through a non-recourse financing
         structure using a Special Purpose Vehicle (SPV). There are many and varied
         combinations of capital financing in PFI schemes. The table below provides an
         indication of the common scenarios, but these will not always apply, and professional
         judgement will often be needed to assess the levels of bank financing (i.e. all debt and
         debt-like instruments) and equity (i.e. equity and equity-like instruments) in each
         scheme.

Type of finance    Who provides?            Payment committed        Funding provider     Order of payment
                                            annually?                has direct           in the event of
                                                                     influence over       SPV liquidation.
                                                                     SPV’s operations?
Senior Debt        Third party, usually a   Usually – principal      Not usually          Usually
                   bank                     and interest                                  immediately after
                                                                                          SPV preferential
                                                                                          creditors
Bond Finance       Bond issued, often       Usually - principal      Not usually          Usually
                   with monoline            and interest                                  immediately after
                   insurance                                                              SPV preferential
                   underwriter.                                                           creditors
Mezzanine debt     Often the senior debt    Yes, but usually only    Not usually          Usually a
                   lender, or where bond    to the extent that                            preferential creditor
                   finance, the bond        senior debt or bond                           after senior debt or
                   insurance provider       cover ratios are                              bond holders.
                                            maintained.
Subordinated       Usually the private      Yes, but only to the     Usually, if equity   Usually an
debt               sector parties to the    extent that both         holders are          unsecured creditor,
                   transaction – the SPV    senior debt/bond and     providing the        of equal rank with
                   equity holders.          mezzanine debt cover     subdebt.             other unsecured
                                            ratios are maintained.                        creditors.


                                                                                          Occasionally, sub-
                                                                                          ordinated to all
                                                                                          other creditors.


Equity             Usually the private      No but can pay           Yes                  Remaining funds
                   sector parties to the    dividends although                            after payment of all
                   transaction.             usually only to the                           creditors.
                                            extent that all debt
                                            cover ratios are
                                            maintained.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                           23


4.6    Mezzanine debt and subordinated debt are commonly described as either debt or
       „quasi-equity‟. Where these types of financing are included in a scheme, it is
       necessary to consider their nature in order to determine whether they are debt- or
       equity-like in nature. The table above describes three characteristics of each
       component which can be used – whether annual payments are made, the level of
       control that the provider has over the SPV‟s operations, and the preferential status of
       the component in the event of SPV liquidation.

4.7    Generally, if a component has a preferential status in terms of annual payment and
       redemption, then this is an indicator that it is more akin to debt than equity. Similarly,
       if the provider has no executive control or voting rights over management decisions,
       this is also an indicator that it is debt-, rather than equity-like in nature.

4.8    On this basis, it can be seen that Mezzanine debt is usually debt- rather than equity-
       like in nature. Subordinated debt is more problematic, and a key test can be the
       preferential status on SPV liquidation. If the debt is sub-ordinated to all other
       creditors, including unsecured creditors, then this is an indicator of an equity-like
       instrument.

How do we treat land sale receipts that have been netted-off the capital expenditure total?

4.9    In some schemes, LEAs may transfer surplus land to the operator for subsequent
       disposal. Where this occurs, the operator will usually use the receipt to fund partly the
       initial capital expenditure, thereby reducing the overall borrowing, and the LEA
       benefits from a lower Unitary Charge. For the purposes of this indicator, the capital
       structure should be examined after the deduction of these proceeds i.e. based on the
       lower capital expenditure total.

What are we looking for when considering Parent Company Guarantees?

4.10   Where a high level of gearing provides evidence to suggest a financing transaction, it
       is necessary to examine whether there are any financial guarantees from one, or more,
       of the parent companies over the liabilities of the SPV. This seeks to establish
       whether or not the parent companies‟ financial liabilities are merely restricted to the
       level of equity and quasi-equity. Very often parent companies will provide
       performance guarantees over, for example, the construction of the property, or the
       provision of FM services. The former are not relevant for this purpose as they relate to
       the construction phase, while the latter may only be relevant insofar as they relate to
       hard FM services. Parent company guarantees over the financial liabilities of the SPV
       provide evidence that overrides the non-recourse assumption of the arrangement by
       extending the parent companies‟ financial risk beyond the level of equity and/or
       subdebt. However, if an SPV has a high level of gearing, and there are no financial
       guarantees from the parent companies then this is an indicator of a financing
       transaction.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                         24


4.11   Although not an accounting issue, where there are no guarantees in place and little
       equity in the SPV, this should prompt the LEA to question the extent to which the
       SPV can, in reality, bear the commercial risks of the scheme, and whether ultimately
       those risks may come back to the LEA.

What if there is no SPV?

4.12   If no SPV is present, the operator will be funding the scheme from its own balance
       sheet. This often happens for IT-intensive schemes, but could, exceptionally, occur
       for accommodation-type schemes such as schools.

4.13   Ordinarily this would indicate that the operator is bearing a considerable degree of
       risk to its own equity and therefore would not provide contributory evidence of an on-
       balance sheet assessment. However, if the proposed financing involves the operator
       obtaining ring-fenced finance from a third party, or other complex arrangements, then
       professional judgement will need to be applied.

4.14   Where there is no SPV, a commercial consideration is the extent to which the operator
       is in a position to finance the scheme from its own resources. LEAs would need to
       consider the scheme obligations against the operator‟s financial resources, for
       example, the size of their balance sheet and the risks attached to the operator‟s other
       substantial activities.

KEY MESSAGES

It will not normally be possible to assess this indicator until the procurement process is well
advanced and the bidders’ financing structures are understood. [DfEE require LEAs to ask
bidders for their financing proposals at an earlier stage in the process]

Assessing this indicator involves professional judgement, although as a rule of thumb,
where bank financing represents more than 90% of the total financing, this would
generally be considered to provide an indicator of a financing arrangement. This however,
is one indicator and needs to be considered along with all of the other indicators in this
analysis.

This indicator is a ‘one-way’ test. It can provide evidence of an on-balance sheet treatment
for the LEA, or it can provide no evidence of which party should recognise an asset of the
property. It cannot, however, provide evidence of an off balance sheet treatment for the
LEA.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                                         25


TERMINATION FOR OPERATOR DEFAULT

Key principles

4.15   The Application Note states that where a contract is terminated early and the senior
       debt financing will be fully paid out by the purchaser under all events of default,
       including operator default, this is an indication that the scheme is a financing
       arrangement.

What compensation is payable under the Model contract?

4.16   Clause 45 of the DfEE Model Contract sets out the compensation payable in the event
       of operator default whereby the LEA has the option to re-tender the provision of
       services or to require an expert determination of the value of the remaining contract.

4.17   If the Authority chooses to re-tender, the objective will be to enter into a new contract
       with the Compliant Tenderer who offers the highest lump sum capital payment
       (representing the bid from the new contractor to take over the property and
       contractual commitments in return for the future income stream from the LEA). The
       Authority will then pay to the contractor the Adjusted Highest Compliant Tender
       Price, which will be calculated as:

       The Highest Compliant Tender Price, less the aggregate of:

       (a)      The Post Termination Service Amounts (if positive);

       (b)      The Tender Costs; and

       (c)      The amounts that the Authority is entitled to set off or deduct under clause 33.8,

       plus an amount equal to the aggregate of:

       (i)      all credit balances on any bank accounts held by or on behalf of the Contractor on the date that
                the highest priced Compliant Tender is received; and

       (ii)     any insurance proceeds and other amounts owing to the is entitled Contractor (and which the
                Contractor is entitled to retain) to the extent not included in (i) above; and

       (iii)    the Post Termination Service Amounts (if a negative number),

       to the extent that:

       1)       i), ii) and iii) have not been directly taken into account in that Compliant Tender; and
       2)       the Authority has received such amounts in accordance with the Agreement.



4.18   If the Authority chooses not to re-tender the contract, an expert determination of the
       contract value will be sought. The compensation payable to the contractor will be the
       Adjusted Estimated Fair Value, calculated as:



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The Accounting Treatment of Schools PFI Projects – Discussion Draft                                         26



       The Estimated Fair Value, less an amount equal to the aggregate of:

       (a)      the Post Termination Service Amounts (if a positive number);

       (b)      the Tender Costs; and

       (c)      amounts which the Authority is entitled to set off or deduct under clause 33.8,



       plus an amount equal to the aggregate of:

       (i)      all credit balances on any bank accounts held by or on behalf of the Contractor on the date that
                the Estimated Fair Value is calculated; and

       (ii)     any insurance proceeds and other amounts owing to the Contractor (and which the Contractor
                is entitled to retain), to the extent not included in (i) above; and

       (iii)    the Post Termination Service Amounts (if a negative number)

       to the extent that:

       1)       (i), (ii) and (iii) have not been directly taken into account in calculating the Estimated Fair
                Value; and
       2)       the Authority has received such amounts in accordance with the Agreement.



4.19   The compensation payable will, therefore, be based on the market value of the
       unexpired term of the remainder of the contract – measured by a competitive tender
       exercise or by an expert determination. Since this arrangement provides no guarantee
       that the bank financing will be fully paid out this indicator would provide contributory
       evidence that the property is an asset of the operator.

Practical Considerations

What if there is no bank financing?

4.20   This indicator links closely with the „Nature of the operator‟s financing‟ indicator
       above. Notwithstanding the above conclusion on the contractual provisions, if, from
       the review of the financing structure for the previous indicator, there is no bank
       financing, for example, where the capital expenditure is funded directly from the
       operator‟s reserves, then our understanding of the ASB‟s view is that this Termination
       for Operator Default indicator would be not relevant to determining which party has
       an asset of the property.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                    27


KEY MESSAGE

Provided that the LEA’s PFI contract complies with the Model Contract’s provisions for
Compensation on Termination for operator default, this indicator will provide contributory
evidence that the property is an asset of the operator.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                         28


WHO DETERMINES THE NATURE OF THE PROPERTY?

Key principles

4.21    This indicator is effectively identical to the assessment of which party bears design
       risk for the quantitative analysis. In most cases, where the operator has bid against an
       output-based specification, then it will be responsible for determining the nature of
       the property, and this indicator will provide evidence that the property is an asset of
       the operator.

Practical considerations

4.22   For the avoidance of doubt:

             the fact that features of the property may be recorded in the contract
              documentation does not necessarily indicate that the LEA has determined
              those key features;

             a process of acceptance testing during the commissioning phase does not
              necessarily result in the LEA assuming responsibility for the operator‟s design
              solution;

             where buildings, or part of them, are listed, this may impose constraints on the
              operator‟s design solution, however, these would not normally be considered
              as design constraints imposed by the LEA; and

             where a contract involves refurbishment of existing buildings, there are
              limitations on the scope of the operator‟s design solution, however, this does
              not necessarily mean that the LEA has determined the nature of the property.

KEY MESSAGES

For this indicator to provide an off-balance sheet view, the LEA should ensure that:

   The procurement process involves tendering against a genuine output specification,
    with bidders having freedom to develop their own design proposals;
   The LEA does not assume responsibility, at any stage in the procurement process or
    during the contract, for those aspects of the functioning of the property which were
    originally described in the output specification;
   The LEA does not, at any stage, prescribe, in whole or in part, how the property should
    be designed, built or operated; and
   The operator bears the cost implications of the key design and operating risks
    associated with the property.

The above features should be present in a normal PFI procurement process and contract,
and, therefore, reaching an off-balance sheet view for this indicator should not present
many difficulties.



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The Accounting Treatment of Schools PFI Projects – Discussion Draft                       29


V      Demand Risk
Introduction

5.1    Demand risk is, arguably, the most important risk in school PFI schemes, since it will
       usually be borne by the LEA and is often seen as difficult to quantify. This section
       describes how to meaningfully assess demand risk for the purposes of the accounting
       analysis and covers:

          The key principles;

          Who bears this risk;

          Evaluating demand risk:
           - Notional cost per pupil place;
           - Expected levels of demand;
           - Variations from expected demand;

          What are the components of demand risk?
           - Initial demand risk;
           - Operational demand risk;
           - Long-term demand risk;

          What factors influence demand for schools?
           - Primary school v. secondary school;
           - Refurbishment/replacement v. new school;
           - High growth areas v. low growth areas v. shrinking demand;
           - Single schemes v. grouped;
           - Urban v. rural;

          Practical considerations:
           - Sources of information;
           - Measures that an LEA might take to mitigate demand risk;
           - What if we cannot meaningfully quantify demand risk? and

          Key Messages.


Key principles

5.2    The AN defines demand risk as „the risk that demand for the property will be greater
       or less than predicted or expected.‟

5.3    For school schemes, the demand for the property is driven by the number of pupils,
       and hence the „unit of demand‟ is a pupil place. Demand risk is, therefore, the
       variation in pupil numbers against the expected number, and the value of demand risk
       is this variation multiplied by the notional „cost per pupil place‟.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                            30


Who bears this risk?

5.4    Schedule 7 of the Model Contract sets out the payment mechanism and provides for
       the LEA to make a fixed payment for the property regardless of usage. Demand risk is
       therefore likely to be borne by the LEA since it will pay a fixed amount to the
       operator regardless of whether, or not, the property is used. Similarly, the operator is
       guaranteed a fixed payment (subject to availability and performance) regardless of
       usage. The significance of this risk will depend on the likely variation in pupil
       numbers over the contract term.

Evaluating demand risk

5.5    There are three components to evaluating demand risk:

             notional cost per pupil place;

             expected levels of demand; and

             variations from expected demand.

Notional ‘cost per pupil place’

5.6    The notional cost per pupil place is calculated, simply, as the total relevant unitary
       payment divided by the capacity of the school, or schools.

5.7    The Relevant Unitary Payment is represented by the element of the total unitary
       payment that is attributable to the relevant costs for this analysis i.e. capital financing
       costs, building maintenance and lifecycle replacement. For simplicity, below, we refer
       to it as the availability charge, Separable and/or non-relevant services (as defined
       above) are not included in this charge.

5.8    The capacity of the school could be interpreted in a number of different ways:

             design capacity;

             maximum number of pupils that are expected to be accommodated (derived
              from operational requirements); and

             real (or absolute) capacity – based on the absolute maximum number that can
              realistically be accommodated within the school without providing additional
              facilities. This number will exceed the design capacity and be the same or
              higher than the expected operational maximum.

5.9    For the purposes of this accounting risk analysis, the capacity to be used is the real or
       absolute capacity, since this is the highest number that that school could (and may
       have to) accommodate. Therefore the Cost per pupil =         Availability Charge
                                                                        Real Capacity



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The Accounting Treatment of Schools PFI Projects – Discussion Draft                                                                         31


Expected levels of demand

5.10                    The diagram below shows the expected levels of demand for a typical new secondary
                        school over the first 15 years of a PFI contract. For simplicity, the usage profile
                        assumes that the school will only be filled through „natural class progression‟
                        commencing with the first year.
                                      Example forecast usage of a secondary school in years 1 to 15 of a PFI contract


                  600


                              Real capacity
                  500




                  400
  Pupil Numbers




                  300


                                                       Expected pupil numbers
                  200




                  100




                    0
                         1     2      3        4       5        6        7       8        9       10       11      12   13   14   15

                                                                         Year of contract




5.11                    In this instance, demand risk in, say year 4, is the variation around the expected usage
                        i.e. 240 pupils. Similarly in year 6, the variation is around the expected usage of 360
                        pupils. From year 7 onwards, the school is expected to be at its nominal maximum of
                        420 pupils and the demand risk thereafter is the variation around this amount.

5.12                    In the early years, the number of pupils in the school is substantially less than the real
                        capacity of 500, and indeed the expected maximum of 420. However the Unitary
                        Charge payable by the LEA does not vary according to pupil numbers and assumes
                        that the school will be full throughout the contract.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                                                                              32


5.13                    It is important to note that any potential „under-utilisation‟ is a value for money issue
                        and does not, of itself, represent demand risk to the LEA in accounting terms. As
                        noted, the LEA does not expect to fill the school in these early years, and therefore,
                        the demand risk is around the LEA‟s expected usage as described above. This can be
                        illustrated graphically by extending the diagram, below:
                                      Example forecast usage of a secondary school in years 1 to 15 of a PFI contract


                  600


                              Real capacity
                  500



                                                             Max
                  400                                                                                        Expected pupil numbers
  Pupil Numbers




                                                                             Min

                  300




                  200




                  100




                    0
                         1     2      3        4       5        6        7         8      9       10       11      12     13      14   15

                                                                         Year of contract




5.14                    The maximum and minimum lines represent the potential demand risk that the LEA
                        anticipate they might bear. The maximum pupil numbers are capped at the real
                        capacity of the school since to accommodate further numbers would require the
                        provision of additional facilities beyond the original specification. Hence the demand
                        risk in say year 4, is the NPV of: the expected variation around the 240 pupils
                        multiplied by the unit cost per pupil (i.e. the Availability charge divided by the real
                        capacity of 500 pupils).




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                         33


What are the components of demand risk in schools?

5.15   Essentially, there are 3 components of demand risk for a school:

             initial demand risk while the school is being filled;

             day-to-day operational demand risk; and

             long term demand risk.

Initial demand risk

5.16   New schools are usually filled by a combination of pupils transferred in from other
       schools and natural upward progression of pupils each year. In the earlier example,
       the new school was filled entirely by the latter method and the demand risk during
       this early phase was represented by the uncertainty of pupil numbers matching
       expectations in each year.

5.17   Conversely, where pupils are transferred in from other schools, this may lead to a
       demand risk issue in relation to the other schools, represented by the under-utilisation
       that may occur in those transferring schools, which would need to be included in the
       calculation of demand risk for the PFI scheme. If, however, the LEA can demonstrate
       that it fills the new school, for example, by vacating temporary classrooms at existing
       schools, then there would be no „alternate‟ demand risk at these other schools since
       the surplus capacity created elsewhere would be removed from the total school
       capacity in the area.

Operational risk

5.18   There will always be an element of day-to-day operational demand risk at the margins
       where the school may be operating with fewer or more pupils than expected due to
       pupils leaving and joining during the year.

Long-term demand risk

5.19   The Application Note highlights that the length of the contract may influence the
       significance of demand risk – in general, demand risk increases later in the contract,
       due to the greater difficulties in forecasting for later periods.

5.20   The long-term demand risk will be driven, primarily, by demographic factors within
       the catchment area, for example, houses being built, employment prospects etc.




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                        34


What factors influence demand for schools? [DfEE and LEA contributions
to this section needed]

5.21   The inherent demand risk in schools schemes can be affected by a number of factors,
       as described below.

Primary School v. Secondary School

5.22   Inherently, it should be easier to predict the pupil numbers for a secondary school in
       the early years of a scheme. Pupil numbers for primary schools can, be determined
       with greater certainty for five years ahead, represented by the known number of years
       of pre-school children in the catchment area, after which predictions become more
       difficult.

5.23   Secondary schools can, theoretically, predict 11 years ahead with considerable
       certainty. This is due to the known pupil numbers in the primary school(s) below it,
       together with the additional pre-school children noted above.

5.24   Primary schools may also be considered to have a higher demand risk in practice
       since there are limitations on the measures that LEAs can take to mitigate demand
       risk. For example, while it may be acceptable to transport secondary pupils significant
       distances to a school, it is not normally acceptable to transport primary pupils to the
       same degree.

Refurbishment/Replacement v. New School

5.25   Inherently, it is more difficult to predict the demand for a new school in an area as
       assumptions must be made over growth in pupil numbers in the catchment area. The
       refurbishment or replacement of an existing school has an existing „market‟ for
       pupils.

High growth areas v. low growth areas v. shrinking demand

5.26   In a high growth area, there is often a significant likelihood that the expected future
       growth in the catchment area will more than exceed the capacity of the school(s) to be
       provided under the PFI, and require additional schools to be built sometime in the
       future. In these circumstances, the long-term demand risk for the school(s) in question
       may be negligible.

5.27   However, this only holds true for the first few schools provided in such a high growth
       area. As more schools are added later, it will generally become increasingly difficult
       to confidently forecast demand unless the original growth assumptions also increase
       substantially.

5.28   In a low growth area, there will usually be more uncertainty, and particularly for new
       schools which will not have an existing „market‟ unlike refurbishments/replacements.




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5.29   In principle, areas of shrinking demand should be no riskier than high growth areas.
       However, in practice, shrinking demand may be more difficult to predict accurately
       than increasing demand, and the extent to which LEAs can manage the risk, for
       example, closing schools and moving pupils into temporary classrooms on other
       school sites, without incurring measurable demand risk, may be limited. [useful to get
       LEA comments here on how they have managed such processes in the past].

Single schemes v. grouped

5.30   Grouped schemes (i.e. of more than one school within each category) do not, perhaps,
       have more inherent demand risk than single school schemes, but potentially have
       more risk in practice due to the reduced capability to manage demand risk across a
       portfolio of schools.

5.31   For example, LEAs can choose to fill a single PFI school by taking pupils from other
       non-PFI schools in its portfolio. In such circumstances, demand risk would be
       measured by reference to the „empty‟ portion created in other schools. However, if the
       LEA were able to do this by emptying temporary classrooms at its other schools, or
       even closing smaller schools, then there would be no alternative cost to the LEA and
       hence no significant demand risk.

5.32   Where a scheme comprises a portfolio of schools, the level of overall demand across
       the portfolio may be no different than the scenario above, but the LEA may have less
       flexibility to manage its demand risk across the schools due to its contractual
       commitments. A PFI school is unlikely to have temporary classrooms and thus any
       reduction in pupil numbers is likely to result in real demand risk being borne by the
       LEA. Therefore, in contrast to the single-school scenario described above, a portfolio
       of PFI schools are unlikely to have temporary classrooms to vacate and hence demand
       risk would occur in practice.

Urban v rural

5.33   Similarly to grouped schemes, there is, arguably, greater scope for an LEA to manage
       its demand risk in an urban area than in a rural area, where the distances between
       schools may be greater and thus the scope for bringing pupils in from other schools
       may be limited. All other things being equal, rural areas therefore may have a higher
       demand risk in practice.

Practical considerations

Sources of information

5.34   In the first instance, the forecast pupil numbers will be available from the Schools
       Planning unit within the LEA. However in most cases, these numbers can only be
       predicted with any reasonable degree of certainty for a few years and certainly will
       not be sufficient to estimate the demand risk over the whole life of the contract.




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5.35   LEAs need to determine the long-term demand risk based on other sources of
       evidence, including local demographic trends and economic factors e.g. employment
       growth and types of employment.

Measures that an LEA might take to mitigate demand risk

5.36   LEA‟s may feel that because they would use the PFI school in preference to other
       schools in the area, the new school would always be full and hence there is no
       demand risk.

5.37   This is not correct for PFI accounting however, nor indeed in commercial terms - in
       such circumstances the demand risk would be represented by the cost to the LEA of
       the other schools operating at less than capacity. In cases where this would be difficult
       to measure, due to inexact cost information for the other schools, it would be
       necessary to measure it based on the PFI school as if it were operating at less than
       capacity.

5.38   This response assumes that pupils would otherwise fill permanent classrooms at these
       other schools and therefore that the LEA‟s costs in respect of this are fixed. If,
       however, the LEA can demonstrate that these pupils would otherwise be
       accommodated in temporary classrooms at the other schools, and that the LEA can
       dispose of these classrooms, then there is no „opportunity cost‟ attached to them.

5.39   In summary, therefore, where a PFI school is filled at the „expense‟ of other schools,
       then some demand risk remains. However, where temporary classrooms are vacated at
       other schools, and can subsequently be disposed of by the LEA, then demand risk in
       respect of this element can be avoided.

KEY MESSAGES

Where LEAs adopt the payment mechanism in the Model Contract, they will bear demand
risk.

At Outline Business Case stage, LEAs should prepare a detailed commentary and analysis
on the demand projections for each school.

It is not permissible to simply state that there is no demand risk – experience suggests that
all schemes will have at least an element of ‘inherent’ demand risk. Consideration needs to
be given to all aspects of demand risk – initial, operational and long-term demand risk.

Where PFI schools are filled in preference to other schools, demand risk should be
assessed across the portfolio.

Some types of schemes have more inherent demand risk than others.

There are some steps that LEAs can take to reduce demand risk commercially, which will
therefore reduce modelled risk.




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VI Design risk (including obsolescence)
Definition

6.1    The Application Note highlights that where the operator has significant discretion
       over how to fulfil the PFI contract and makes the key decisions on what property is
       built and how it is operated, bearing the consequent costs and risks, this is an
       indication that the property is the operator‟s asset.

Who bears this risk?

6.2    The operator should provide a design solution to meet the LEA‟s output specification,
       and accept responsibility for all construction and annual costs incurred as a
       consequence. In such circumstances, the operator will bear design risk. This is further
       supported by two clauses in the Model Contract:

6.3    Clause 24.1 (Maintenance) states that the contractor must ensure that the schools are
       continuously available, are kept in good structural and decorative order in accordance
       with the Agreement and the LEA‟s requirements and that the schools are handed back
       to the Authority on expiration in a condition complying with these requirements.

6.4    Clause 19.7 (Latent defects and the existing schools) states that the contractor accepts
       entire responsibility (including any financial or other consequences which result
       directly or indirectly) for the ascertaining of, and dealing with, Latent Defects.

Evaluating design risk

6.5    When evaluating this risk it may be helpful to consider design risk under the
       following three headings:

             failure against initial design;

             variations in the quantum of ongoing lifecycle and maintenance costs; and

             latent defects.

Failure against initial requirements

6.6    Although a process of acceptance testing may well occur within the commissioning
       phase, there is still remains the possibility that problems might occur in, say, the first
       year of operation. A parallel can be drawn here with traditional procurement where
       the LEA would normally withhold a retention payment to the contractor until 6 or 12
       months after completion, in the event of unforeseen problems occurring.

6.7    This risk should be modelled based on the probability of occurrence and the
       minimum, most likely and maximum cost (expressed as a percentage of the initial
       construction cost).



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Variations in the quantum of on-going lifecycle and maintenance costs

6.8    This element identifies the risk that the operator‟s cost might vary for reasons other
       than changes in prices (which is dealt with under potential changes in relevant costs).

6.9    We are only concerned with variations in building, plant and equipment annual
       maintenance and lifecycle costs, which should be modelled on the basis of minimum,
       most likely and maximum percentage variations against the operator‟s annual baseline
       cost

Latent defects

6.10   This element identifies the risk that problems may occur later in the contract as a
       result of the design solution chosen. In addition, due to the provisions of clause 19.7
       quoted above, the operator appears to be taking latent defects risk on existing
       buildings for refurbishment schemes.

Practical considerations

Why do we exclude risks around construction costs?

6.11   The accounting treatment is determined with regard to the risks associated with the
       property during the operational period of the contract. The Application Note
       highlights that construction risk is not generally relevant because such risk normally
       has no impact during the property‟s operational life. DfEE would not expect LEAs to
       include construction-related risks in their accounting analyses.

What are appropriate risk ranges to use?

6.12   Where LEAs have engaged Technical Consultants to provide assistance in the
       evaluation of the bidders‟ design solutions, they will normally be best placed to
       provide appropriate risk ranges.

6.13   Where however, such consultants are not used, the ranges in Part 4 of this document
       are suggested as guidelines, based on past experience of schemes. The ranges for each
       scheme will vary, however, depending on the design solution chosen by the operator.

KEY MESSAGES

LEAs must ensure that they use an Output Based Specification in order to transfer design
risk to the operator

This risk is based on the operator’s chosen design solution.

Where the LEA is using Technical Advisors, they are best placed to provide suitable risk
ranges. Where such advisors are not used, the risk ranges in Part 4 of this document may
be used as a guide, but should be considered for appropriateness in each scheme.



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VII Residual Value risk
Definition

7.1    Residual value risk is the risk that the actual residual value of the property at the end
       of the contract will be different from that expected. This risk is more significant
       where the length of the PFI contract is significantly shorter than the expected
       economic life of the property.

Who bears this risk?

7.2    „Standardisation of PFI Contracts‟ issued by HM Treasury PFI Taskforce notes that
       where a property has no alternative use, the operator will seek to generate its expected
       return over the life of the contract and there is no realistic prospect of transferring
       residual value risk. A school would normally be considered as a property with no
       alternative use, and therefore residual value risk should normally lie with the LEA.

7.3    Clause 8.12 (Expiry of Agreement) of the Model Contract provides that, on contract
       expiry, the operator shall either assign its interest in the Head Lease to an assignee
       notified by the Authority, or shall surrender its interest in the Head Lease to the
       Authority.

7.4    Clause 8.13 provides that the operator shall not be compensated for any un-expired
       interest in the Head Lease.

7.5    Taken together, these clauses provide for the LEA to take back the property at the end
       of the contract for nil consideration. Consequently, residual value risk lies with the
       LEA.

7.6    If the contract were such that the LEA has the option to re-acquire the property for nil
       consideration, then, for the purposes of the risk analysis, it would be assumed that the
       LEA will exercise the option. This is simply due to the fact that there would be no
       commercial reason for them not to exercise the option and thereby obtain an asset for
       nil cost.

Evaluating residual value risk

7.7    The Technical Note provides that for specialised properties, such as schools, where
       there is no ready market, residual value risk should be calculated by reference to
       Depreciated Replacement Cost (DRC).

7.8    The risk should, then be calculated by reference to variations in the DRC due to
       changes in real prices over the life of the contract.

7.9    In practice this means modelling a measure of movements in construction indices
       against movements in RPI over the contract period.




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What impact, if any, do hand-back provisions have?

7.10   As noted in paragraph 6.3 above, Clause 24.1 provides that, on expiry, the schools are
       handed back to the LEA on a condition complying the contract requirements (i.e. they
       meet the Output Specification). This provides contributory evidence that the property
       will not be impaired beyond a condition expected of a property that age, and
       consequently, no adjustment would be needed to the residual value calculated using
       DRC.

KEY MESSAGE

As with all risks, the decision as to which party bears residual value risk should be driven
by value for money considerations. The Model Contract provides for residual value risk to
remain with the LEA, and is consistent with the guidance issued by HM Treasury
Taskforce on Private Finance, for specialised properties.




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VIII Third party revenue risk
8.1    Third party revenues, where present, should be modelled.

8.2    Risk ranges should reflect possible variations in third party income and can take into
       account assumptions concerning expected growth as a consequence of improvements
       to the property.

8.3    Where, in a grouped school scheme, third party revenues are only generated from
       certain properties, e.g. secondary schools, then, if schools are being treated for
       accounting purposes as distinct properties, this risk should be applied against the
       relevant schools in the quantitative analysis.

8.4    Where the contract provides for third party income above a certain level to be shared,
       the LEA will bear upside revenue risk.

KEY MESSAGE

Third party revenue risks should be modelled, as even where they are considered to be a
relatively small risk, this may make the difference between an on- and off-balance sheet
result.




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IX Penalties for under-performance and non-availability
Definition

9.1    Most PFI schemes include penalty regimes that provide for deductions to be made to
       the Unitary Charge where the property is unavailable or where services fall below
       agreed standards.

Who bears the risk?

9.2    Parts 3 and 4 of Schedule 7 of the Model Contract provide frameworks for penalty
       regimes for, respectively, poor-performance of services and unavailability of the
       property.

Practical considerations

9.3    When assessing the level of likely deductions to be applied, a realistic view should be
       taken, based on the following factors:

Likelihood of failures

9.4    If the operator‟s design solution is particularly innovative, for example, through the
       use of new construction techniques or materials, problems could arise during the
       operational period, leading to deductions.

9.5    However, if the design is straightforward and the construction uses standard
       techniques and materials then this is less likely to lead to operational problems and
       financial deductions. When compared to other types of PFI building schemes, for
       example hospitals and prisons, one might expect a lower level of design risk,
       reflecting the less complex nature of the facilities.

9.6    Care must be taken when using past experience to predict the likelihood of failures
       since the PFI property will be newer than the previous property and should be subject
       to programmed maintenance.

Rectification periods

9.7    If the rectification periods are generous then the operator could resolve problems
       sufficiently quickly to avoid significant penalties.

What is the likely level of deductions?

9.8    There are two general approaches to considering the expected level of deductions:

       (a)    Consider individual failures and calculate the actual financial deductions that
              would occur through the deduction regime; or




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The Accounting Treatment of Schools PFI Projects – Discussion Draft                        43

       (b)    Take a holistic view of the likely level of annual deductions to the Unitary
              Charge for all relevant failures.

9.9    Although the first approach is technically a „purer‟ method, in practice the latter
       approach is generally used and considered sufficiently accurate for the purpose.
       Typically these are modelled as percentage deductions applied to the Unitary Charge.
       It is important to remember that the relevant Unitary Charge should be used for
       this i.e. excluding any separable elements and non-relevant services.

9.10   When using the latter approach, however, care must be taken when considering the
       estimated level of deductions and a „common sense‟ view needs to be applied. For
       example, consider the following triangular distribution of annual deductions as a
       percentage of the Unitary Charge.

       Minimum         0%
       Most Likely     5%
       Maximum         10%

9.11   Whilst, at first glance, this may not seem unreasonable, a „most likely‟ deduction of
       5% implies that the operator will generally bear a 5% deduction every year for the life
       of the contract. However, a 5% deduction typically represents significant problems in
       most deduction regimes, such that if they persist, penalty escalation mechanisms are
       likely to substantially increase the deduction and could then trigger the contract
       default mechanisms.

9.12   Alternatively, when faced with an annual deduction of this magnitude, the operator
       may choose to default on the contract rather than suffer continued deductions.

What risk range is appropriate?

9.13   It is for the LEA to consider an appropriate range of deductions, taking into account
       the issues described above. [DfEE to comment on appropriateness of requiring an
       indicative risk range].

KEY MESSAGES

The annual deduction percentages applied to the Unitary Charge should be based on
realistic levels.

The relevant Unitary Charge should be used i.e. after the exclusion of separable elements
and non-relevant services

LEAs should determine an appropriate risk range based on their scheme, however they
may use the indicative risk range provided by DfEE in Part 4 of this document.




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X      Potential changes in relevant costs
Definition

10.1   This is the risk that relevant costs will vary in a different manner to that expected. The
       relevant costs are those annual costs that are considered for design risk purposes,
       namely, lifecycle replacement and annual maintenance.

Who bears the risk?

10.2   The Technical Note observes that “Who bears this risk will depend upon whether or
       not the price variations can be passed onto the purchaser. If the unitary payment is
       fixed or varies in relation to a general inflation index the risk is borne by the operator.
       If the unitary payment varies with specific indices to reflect actual costs of the
       operator then the pricing risk is borne by the purchaser.”

10.3   In the Model Contract, Under Part 5 of Schedule 7, the Base Unitary Charge consists
       of an Indexed Element and an Un-Indexed Element. The Indexed Element will be
       indexed each year in line with Retail Prices Index.

10.4   The risk of potential changes in relevant costs lies, therefore, with the operator

Evaluating the risk

10.5   This risk should, therefore, be modelled by reference to likely changes in the relevant
       cost streams against likely increases in RPI.

Is there any DfEE guidance on how such costs might change?

10.6   In practice, for schools schemes, in many cases, changes in construction cost indices
       can serve as a suitable proxy for changes in the relevant costs, and as such the same
       data used for measuring residual value risk can be used here.


KEY MESSAGE

LEAs should follow the indexation provisions in the Model Contract to pass this risk to the
operator.




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XI Factors Not Capable of Meaningful Quantification
11.1   As noted previously, where a quantitative analysis is undertaken, it should only
       include those risks that are capable of meaningful quantification. Consideration needs
       to be given, therefore, to those risks that cannot be meaningfully quantified and the
       impact that they might otherwise have on the results of the quantitative analysis.

11.2   The approach to assessing the potential impact of these „unquantifiable‟ risks on the
       overall judgement involves considering whether or not such risks provide substantive
       evidence to suggest that the conclusions drawn from the quantitative risk analysis and
       the qualitative indicators should be overturned. In particular, the Technical Note states
       that “the potential impact of these risks on the overall judgement will need to be
       carefully considered and properly justified”.

11.3   Typically the risks considered here are those that might result in changes to the
       property e.g. changes in general and sector-specific legislation and inadequacies in the
       output specification, together with those that might create „big-bang‟ changes in
       demand.

Substantial changes in demand

11.4   Potential reasons for substantial changes in demand include changes in:

              public policy for education;

              substantial changes in local demographics; and

              changes in education delivery, for example through IT advances.

[DfEE input required here e.g. double shifts, IT]

Incorrect/inadequate specification for the life of the contract

11.5   The LEA should consider the extent to which the Output Based Specification may be
       incorrect or inadequate for the life of the contract.

Changes in specific legislation

11.6   This includes changes in school design that would require alteration of the property.
       Often the impact of this risk is either borne by the LEA or shared with the operator.

Changes in general legislation

11.7  This includes the impact on the property arising from changes to e.g. health and safety
      legislation, environmental legislation, fire regulations etc. Typically, this risk is borne
      by the operator.
[DfEE to provide guidance on max risk impact of these to the facilitate LEAs‟ judgement]



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XII The Overall Judgement
12.1   In forming the overall judgement, it is necessary to consider all three elements – the
       results of the quantitative indicator, the qualitative indicators and the unquantifiable
       risks together. This is an area where professional judgement must be applied, and
       cannot be done in a mechanistic way. The decision tree below, however, provides a
       useful mechanism for reaching a decision, but is provided for assistance only.



                                                               Likely
                      Test                                   Accounting
                                                             Treatment

                      Does the Quantitative            Yes
                      Indicator point to an On               On Balance
                      Balance Sheet view?                      Sheet

                                      No

                      Would the likely net effect of
                      the unquantifiable risks be to   Yes   On Balance
                      overturn the quantitative                Sheet
                      indicator?
                                      No

                      Does Termination for Operator
                                                             Professional
                      Default and/or the Operator's    Yes
                                                              judgement
                      Financing point to an On-
                                                               required
                      Balance Sheet view?
                                       No

                             Off-Balance Sheet




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XIII What do we do if our scheme is assessed as on-
     balance sheet?
13.1   The scheme is likely to be on-balance sheet if demand risk is sufficiently significant
       to outweigh other risks. This is likely to be inherent to the scheme.

13.2   If generic risk ranges have been used for areas such as design, one option is to revisit
       these for robustness. Two issues need to be borne in mind when taking this course of
       action:

             Any risk ranges must be balanced, consistent with the underlying commerical
              rationale and supported by appropriate evidence. The LEA must therefore
              ensure that it does not simply choose, or ask its consultants to provide, ranges
              that will result in an off-balance sheet view; and

             It is possible that further consideration might result in ranges that generate a
              stronger on-balance sheet view.

13.3   Other, more radical, options surround the risks borne by the LEA, i.e. demand and
       residual value risk. However, these options are likely to have implications in respect
       of value for money or education quality and thus should not be considered without
       due care or DfEE approval. RISKS MUST NEVER BE TRANSFERRED AT THE
       EXPENSE OF VALUE FOR MONEY.

Options for demand risk

13.4   One option is to reduce the absolute capacity of a school such that it will always be
       less than the minimum number of expected pupils. The additional pupils will then
       either need to be accommodated in temporary classrooms or at other schools.

13.5   While such a measure might have the effect of achieving an off-balance sheet
       assessment, it clearly needs to be weighed against the reality of procuring a property
       which is expected to be inadequate for the number of anticipated pupils. This
       potentially has implications for the quality of education provision, as well as value for
       money and political considerations.

13.6   A second option could be to transfer demand risk, in whole or in part, to the operator.
       The fact that the operator may have little influence over this risk may well result in an
       increase to the Unitary Charge with consequent implications for value for money and
       affordability.




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Options for residual value risk

13.7   Since residual value is based on the Depreciated Replacement Cost of the property,
       and as with all of the risk is calculated in NPV terms, one option is to increase the
       length of the contract. This will have the effect of reducing the DRC value, since the
       length of the contract will be closer to the life of the property. Additionally, since the
       risk is „realised‟ further into the future, the NPV of the risk will also reduce.

13.8   Against this must be weighed the operational requirements and strategic plans of the
       LEA in entering into a contract for a longer period. There is also a secondary impact
       for the accounting analysis for demand risk which may be expected to be more
       difficult to predict for very long periods into the future.

13.9   A second option is to transfer residual value risk to the operator by acquiring the site
       at the end of the contract for a sum that reflects the value of the property, for
       example, depreciated replacement cost, that takes into account the condition of the
       property and external cost factors. There are two main considerations here –
       commercial issues and the LEA‟s long-term plans.

13.10 Dealing with the commercial issue first - while the school buildings themselves may
      have little alternative use, the land may have development potential, particularly if it
      is sited near to housing developments. One factor against this, however, may be the
      lack of planning permission for alternative use.

13.11 Conversely, if the site is in an area where property values are high and expected to
      remain so in relative terms, e.g. in a metropolitan area, then commercial
      considerations might mean that the LEA would not wish to transfer the site even if it
      does not necessarily expect to use it for a school following the end of the contract.

13.12 Similarly, if there is high certainty that a school will be needed on the site after the
      PFI contract has ceased, then the LEA would probably wish to re-acquire the site for
      nil value.




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                                    PART 3



            DATA COLLECTION FORMS




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PART 3 – DATA COLLECTION FORMS

This section sets out pro-forma schedules for collating data on the relevant risks.

1   GENERAL INFORMATION

2   DEMAND RISK

3   DESIGN RISK

4   RESIDUAL VALUE RISK

5   THIRD PARTY REVENUE RISK

6   PENALTIES FOR UNDER PERFORMANCE AND NON-AVAILABILITY

7   POTENTIAL CHANGES IN RELEVANT COSTS




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1      GENERAL INFORMATION

This section sets out general information on each school within the scheme.

The following schedule should be completed for each school in the scheme:

School:
Primary or Secondary?
Absolute capacity (pupil places)
Will the works under the PFI contract be:
New Build / Refurbishment/ Extension
Expected Capital value of works
Location: i.e. Urban or Rural
Is demand in the catchment area expected to
be :
       High growth
       Static
       Shrinking
Expected Economic Life of Buildings




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2      DEMAND RISK

This schedule should be prepared to reflect the LEA‟s detailed assessment of demand risk,
following the principles described in Section V.

For grouped schools schemes, a separate schedule should be prepared for each „property
group‟ to be assessed, as described in Section III.

Operational Year of Contract                         Forecast Pupil Numbers
                                             Minimum        Most likely   Maximum
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Year 8
Year 9
Year 10
Year 11
Year 12
Year 13
Year 14
Year 15
Year 16
Year 17
Year 18
Year 19
Year 20
Year 21
Year 22
Year 23
Year 24
Year 25
Year 26
Year 27
Year 28
Year 29
Year 30




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3        DESIGN RISK


Failure of design against initial requirements

This is the risk that the property does not meet the design brief, both in terms of functional
capability, and also the risk that incorrect items have been used in construction.

It is important to note that this excludes risks occurring in the construction phase. This risk is
expected to crystallise in year 1 once the property is commissioned.

                                                     Cost impact % Initial Capital Cost

                                  Probability Minimum             Most likely      Maximum

Year 1


Variation in annual maintenance and lifecycle costs

This relates to uncertainty in the level of annual maintenance and lifecycle costs arising from:

     Unforeseen design problems
     Poor management of maintenance
     Latent defects

An estimate is required of how the operator‟s base maintenance and lifecycle costs will vary.

It is important to note that this excludes variations in costs due to changes in price – these are
picked up through the „Potential changes in relevant costs‟ risk.

                                                       % Operator’s Base Estimate

                                                Minimum           Most likely      Maximum

Annual maintenance and lifecycle




                                                                                        May 2001
The Accounting Treatment of Schools PFI Projects – Discussion Draft        54


4      THIRD PARTY REVENUE




                                                                      May 2001
The Accounting Treatment of Schools PFI Projects – Discussion Draft                  55


5   PENALTIES            FOR      UNDER        PERFORMANCE                AND    NON-
AVAILABILITY



                                                     % Availability Charge
Penalties for under performance and
non-availability                    Minimum                 Most likely    Maximum

Year 1

Years 2 – x, etc




                                                                                May 2001
The Accounting Treatment of Schools PFI Projects – Discussion Draft        56




                                    PART 4



              STANDARD RISK RANGES




                                                                      May 2001
The Accounting Treatment of Schools PFI Projects – Discussion Draft        57


PART 4 – STANDARD RISK RANGES




                                                                      May 2001

				
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