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					                                                                                                 WHC (2006) 068


                    WELSH HEALTH CIRCULAR



Parc Cathays                                                                                                Cathays Park
Caerdydd CF10 3NQ                                                                                      Cardiff CF10 3NQ




                                                     Issue Date: 2 nd October 2006
                                                         Status: Select Status
Title: CAPITAL ACCOUNTING MANUAL




For Action by: Directors of Finance LHBs                   Action required See paragraph(s) :




For Information to: Wales Audit Office and attached core distribution list




Sender: Mr Kevin Jones Financial Controller, Department of Health & Social, Care Resources Directorate




National Assembly contact(s) : Mr John Evans, Mrs Jackie Salmon Department of Health & Social Care,
Resources Directorate



Enclosure(s): Copy Of Capital Accounting Manual



                                                                                         Tel: 029 20825111 GTN: 1208
                                                                                  Llinell union/Direct line: 029 20
                                                                                                Ffacs/Fax: 029 20
                                                                                                Minicom: 029 20823280
                                                                             http://howis.wales.nhs.uk/whcirculars.cfm




                                                      1
 Distribution List
Chief Executives                NHS Trusts
Chief Executives                Local Health Boards
HR Directors                    NHS Trusts
HR Directors                    Business Services Centre
Director                        NHS Confederation in Wales
Chief Officer                   Association of Welsh Community Health Councils
Director                        Welsh Local Government Association
Dean                            University of Wales, Bangor
Chief Executive                 Commission for Racial Equality
Chief Executive                 Centre for Health Leadership
Secretary                       British Dental Association in Wales
Postgraduate Dean               University of Wales College of Medicine
Director information services   University of Wales College of Medicine
Secretary                       British Medical Association (Wales)
Regional Head of Health         UNISON
Board Secretary                 Royal College of Nursing (Wales)
Welsh Council Representative    British Dietetic Association
Wales Secretary                 British Orthoptic Society
Wales Secretary                 AMICUS MSF
Regional Secretary              The GMB
Regional Secretary              Transport & General Workers Union
Chair                           Community Pharmacy Wales
Chair                           Royal College of General Practitioners
General Secretary               Wales TUC
Assistant Director              Chartered Society of Physiotherapists
Officer for Wales               Society of Radiographers
IR Officer                      Society of Chiropodists and Podiatrists
Regional Secretary              Union of Construction Allied Trades and Technicians
Board Secretary for Wales       Royal College of Midwives
Officer for Wales               AMICUS Electrical & Engineering Staff Association
Regional Secretary              AMICUS Amalgamated Electrical and Engineering Union
Welsh Executive                 Royal Pharmaceutical Society of Great Britain
Information Officer             Wales Council for Voluntary Action
National Member for Wales       AMICUS - Guild of Health Care Pharmacists
Business manager                Institute of Health Care Management Welsh Division
Chief Executive                 Association of Optometrists
Librarian                       British College of Optometrists
Director General                Audit Commission (Wales)
Director                        Business Service Centre
Patch Managers                  Business Service Centres across Wales (6 copies each)
Secretariat                     Statutory Committees
Regional Directors              NHS Wales Regional Offices
Chief Executive                 Health Commission Wales (Specialist Services)
Chief Executive                 Health Professions Wales
Librarian                       National Public Health Service
Chief Executive                 Welsh Language Board / Bwrdd yr Iaith Gymraeg
Librarian                       Health Promotion Library
Chief Executive                 Healthcare Inspectorate Wales
  Also:
Information Officer             Audit Commission Bristol
Information Officer             National Audit Office Cardiff
Information Officer             Audit Commission in Wales
Information Officer             PricewaterhouseCoopers
Information Officer             Deloitte & Touche
Information Officer             KPMG




                                                         2
Dear Colleague,

CAPITAL ACCOUNTING MANUAL

Summary

1. This circular issues the new revised Capital Accounting Manual for NHS bodies in Wales
   (which replaces the Capital Charges and Trust Equivalent Manual 1993/94.) The manual
   brings together guidance issued under previous Welsh Health Circulars (WHC) and is
   intended to complement the respective NHS Trust and Local Health Board Manual for
   Accounts which are issued by Department of Health and Social Care, Resources Directorate
   each year.

2. This manual is consistent with Financial Reporting Standards 10, 11 and 15 which have
   been issued by the Accounting Standards Board since the first version of the manual was
   published in 1993-94.

3.    Amendments to the manual to enable it to comply with new Treasury requirements or
     accounting standard changes will be issued to NHS Wales as replacement pages via a
     WHC.

4. I am very grateful to the members of the Welsh NHS Trust Capital sub-group whose work
   and expertise has been invaluable in completing this new manual.

5. I am issuing a PDF version of the hard copy of the manual with this circular. Should anyone
   require a paper copy please contact the Resources Directorate.




Kevin Jones
Financial Controller
Department of Health and Social Care
Resources Directorate




                                            3
National Assembly for Wales




NHS Wales Capital Accounting Manual




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NHS WALES CAPITAL ACCOUNTING MANUAL ____________________________________1
    1      INTRODUCTION _______________________________________________________________4
        Purpose of the Manual __________________________________________________________ 4
    2      THE CAPITALISATION AND VALUATION OF FIXED ASSETS ______________________________5
        Introduction ___________________________________________________________________5
        General principles and definitions _________________________________________________ 5
        Tangible fixed assets ____________________________________________________________5
        Grouped assets ________________________________________________________________ 6
        Intangible fixed assets - capitalisation _____________________________________________12
        Deferred assets in PFI schemes___________________________________________________ 14
        Measurement and valuation _____________________________________________________14
        Valuations, review and impairments _______________________________________________ 17
        Indexation ___________________________________________________________________ 20
        Surplus assets and disposals _____________________________________________________21
        Impairments__________________________________________________________________23
        Presentation and disclosure - examples ____________________________________________ 30
        Annex 1 - Definitions ___________________________________________________________ 32
    3      DEPRECIATION AND ASSET LIVES ________________________________________________34
        Introduction __________________________________________________________________34
        Depreciation policy for NHS bodies _______________________________________________ 34
        Chargeable period_____________________________________________________________ 36
        Other considerations ___________________________________________________________ 37
    4      LEASES ____________________________________________________________________41
        Introduction __________________________________________________________________41
        Definitions ___________________________________________________________________42
        Determining the lease type - the 90% test ___________________________________________ 43
        Determining the Lease Type – Other Factors ________________________________________ 44
        Property leases _______________________________________________________________44
        Accounting for finance leases – lessees_____________________________________________45
        Operating Leases______________________________________________________________ 49
        Leases and the External Financing Limit ___________________________________________ 50
        Accounting for leases – lessors ___________________________________________________ 50
        Hire purchase contracts ________________________________________________________ 51
        Future developments ___________________________________________________________ 51
        Accounting entries _____________________________________________________________ 51
    5      CAPITAL CHARGES ___________________________________________________________54
        Introduction __________________________________________________________________54
        Cost of capital charge – calculation of relevant net assets _____________________________55
    6      CAPITAL RESOURCE BUDGETING ________________________________________________57
        Introduction __________________________________________________________________57
        External Financing and Capital Resource Budgeting for NHS trusts ______________________ 59
    7      DONATED ASSETS ____________________________________________________________62
        Introduction __________________________________________________________________62
        Accounting for donated assets ____________________________________________________62
        Accounting entries for donated assets ______________________________________________ 64
    8      PRIVATE FINANCE INITIATIVE __________________________________________________66
        Introduction __________________________________________________________________66
        FRS 5 and SSAP21 ____________________________________________________________66
        PFI Accounting _______________________________________________________________67
        Required accounting ___________________________________________________________69
    9      ASSET REGISTERS ____________________________________________________________73
        Introduction __________________________________________________________________73
        Buildings ____________________________________________________________________75
        External Works _______________________________________________________________ 77
        Assets Under Construction ______________________________________________________78
        Second – hand Assets___________________________________________________________80
        Enhancements Altering Value ____________________________________________________81
        Modern Equivalent Asset________________________________________________________ 82



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      Surplus Assets ________________________________________________________________83
      Educational Use Assets _________________________________________________________84
    10    REFERENCES______________________________________________________________85
    11    USEFUL WEB ADDRESSES ___________________________________________________86
    12    LIST OF ABBREVIATIONS USED IN THE FINANCE MANUAL ____________________________87




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1 Introduction

Purpose of the Manual
1.1   This edition of the Capital Accounting Manual (CAM) brings together guidance
      issued under the previous Health Authority, and NHS trust Circulars and is
      intended to complement the respective Manuals for Accounts, bringing together
      relevant capital related issues into one volume. It is applicable to all LHB’s and
      NHS trusts and replaces the Capital Charges and Trust Equivalent Manual –
      1993/94.

1.2   This Manual therefore refers to all NHS bodies in Wales except where a
      treatment is specific to a certain type of entity. Similarly, term “revenue
      account” is used generically in place of ‘I&E account’ or ‘Operating Cost
      Statement’ (OCS).

1.3   Where differences in treatments exist between bodies, for example because of
      the NHS trust finance regime, then these will be highlighted in the text by
      boxes.

1.4   It is expected that this Manual will be, in the main, used by staff who are
      relatively conversant with accounting principles and are familiar with one of the
      Manuals for Accounts. The CAM will be of less value to staff operationally
      involved in maintaining asset registers, where locally produced procedure notes
      will be more appropriate.

1.5   The CAM interprets standard accounting practice for its application in the NHS
      context. In the rare event NHS bodies propose to set aside guidance in the
      CAM in order to present a “true and fair” view of their transactions,
      organisations must inform NAW contacts so that any further implications can
      be followed through with the Assembly’s central finance department, as
      departures from NAW’s set policies could result in qualifications of Accounts.
      The NAW should also be informed of any issues that may affect national policy,
      or require liaison with the Valuation Office Service, HM Treasury, or the Wales
      Audit Office.

1.6   Private Finance Initiative (PFI) transactions should also be accounted for in a
      manner consistent with the CAM and MFAs. Chapter 8 outlines the key issues
      and accounting treatments around PFI.

1.7   This Manual should be applied by all bodies unless specific exemptions apply
      as set out in the text.




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2 The Capitalisation and Valuation of Fixed Assets

Introduction
2.1   FRS 15, Tangible Fixed Assets, has been applicable to the NHS from the 1999-
      2000 financial year. In the NHS, particular issues around valuation include:
         •   The fact that much of the NHS estate consists of specialised healthcare
             assets for which no true market exists
         •   The use of a current-cost basis of valuation, together with a capital
             charges system, which UK Generally Accepted Accounting Practice (UK
             GAAP) sometimes does not comprehensively address
         •   The existence of assets in the form of streams of future income or cost
             reduction, generated in the course of PFI schemes
         •   The importance of the finance/operating lease distinction because of the
             operation of Treasury controls over external financing and the
             implications of on and off-balance sheet items in capital charging.

2.2   A separate chapter, Chapter 4, deals with leases specifically.


General principles and definitions
2.3   FRS 5, Reporting the Substance of Transactions, defines assets as “rights or
      other access to future economic benefits controlled by an entity as a result of
      past transactions or events”. For NHS bodies “future economic benefits” relate
      to the contribution of assets in some way to the provision of services or other
      outputs.

2.4   Ownership of assets tends to confer access to the economic benefits, but
      circumstances exist where access to benefits is obtained without legal
      ownership (as in finance leases) and so in any consideration of the recognition
      of an asset the concept of “substance over form” must be adopted. Both FRS 5
      and SSAP 21, Accounting for Leases and Hire Purchase Contracts, are
      therefore relevant.


Tangible fixed assets
2.5   FRS 15 defines these as:
          “assets that have physical substance and are held for use in the
          production or supply of goods or services, for rental to others, or for
          administrative purpose on a continuing basis in the reporting entity’s
          activities”

2.6   A tangible fixed asset will always have a life in excess of one year.



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Capitalisation threshold of fixed assets - de minimus limits

2.7   The HM Treasury Financial Reporting Manual (FReM) leaves discretion for
      individual government Departments to set their own capitalisation thresholds,
      having regard to practicality, flexibility, consistency and asset grouping
      considerations. The NAW has adopted a £5,000 capitalisation threshold for
      individual assets, although assets of lesser value should be capitalised if they
      form part of a group, with a group value in excess of £5,000, as defined below.
      The £5,000 figure includes VAT where this is not recoverable.


Grouped assets
2.8   "Grouped assets" are a collection of assets which individually may be valued at
      less than £5,000 but which together form a single collective asset because the
      items fulfil all the following criteria:
         •    the items are functionally interdependent
         •    the items are acquired at about the same date and are planned for disposal
              at about the same date
         •    the items are under single managerial control, and
         •    each individual asset thus grouped has a value of over £250, however this
              deminimus value does not apply in dealing with the initial equipping of
              hospitals. See para 2.16

IT assets

2.9   IT hardware may be considered interdependent if it is attached to a network,
      the fact that it may be capable of stand-alone use notwithstanding. The effect of
      this will be that effectively all IT equipment purchases, where the final three
      criteria above apply, will be capitalised. The effect of such a change may well
      not be material, given the rate of depreciation that would have been applied to
      prior-period purchases.

Interdependency

2.10 The distinction between assets that are in some way dependent on each other for
     their effective and efficient operation, and those that are “stand-alone” items can
     be a fine one. Where items are used within a system (eg trays of sterile
     instruments are designed to be used with a specific sterilisation system), those
     items are likely to be considered interdependent even though they also have a
     value in “stand alone” use.

Tangible fixed assets - expenditure to be capitalised

2.11 FRS 15 clarifies which costs can and cannot be capitalised on acquiring or
     constructing an asset. It says:

            “A tangible fixed asset should initially be measured at its cost. Costs, but only those
            costs, that are directly attributable to bringing the asset into working condition for



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          its intended use should be included in its measurement.”


Attributable costs

2.12 Under FRS 15 “directly attributable costs” include:
         •   labour costs of own employees (e.g. site workers, in-house architects and
             surveyors) arising directly from the construction or acquisition of the
             specific asset. The costs of an NHS body’s capital projects department
             may only be allocated to individual capital schemes where it can be
             demonstrated that these costs relate to the production of a capital asset
             (and not its management or maintenance), and that the basis of
             apportionment is reasonable, and
         •   the incremental costs to the entity that would have been avoided only if
             the tangible fixed asset had not been constructed or acquired. These
             include:
             ◊   acquisition costs such as stamp duty, import duty and non-refundable
                 purchase tax
             ◊   the cost of site preparation and clearance
             ◊   initial delivery and handling costs
             ◊   installation costs, and
             ◊   professional fees (such as legal, architects’ and engineers’ fees).

Non-attributable costs

2.13 The standard specifically says that the following are not directly attributable
     costs and so should be charged directly to the revenue, rather than capitalised:
         •   administration and other general overhead costs
         •   employee costs not related to the specific asset (such as site selection
             activities)
         •   operating losses that occur because a revenue activity has been suspended
             during the construction of a tangible fixed asset
         •   any costs relating to an off-balance sheet PFI scheme
         •   abnormal costs e.g. costs relating to:
             ◊   design errors
             ◊   industrial disputes
             ◊   idle capacity
             ◊   wasted materials, labour or other resources, and
             ◊   production delays.

2.14 Non-attributable costs should not be capitalised at any point and so should be
     charged to the revenue account. NHS bodies should be aware that controls on


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      capital to revenue virement are not permissible so proposals to fund non-
      attributable costs from capital funds must be discussed be avoided.

Interest

2.15 FRS 15 permits capitalisation of finance costs at the entity’s option. However,
     as a matter of policy, interest or finance costs may not be capitalised in the
     NHS.

Initial equipping and setting-up costs of new building

2.16 Assets which are capital in nature but which are individually valued at less than
     £5,000 may be capitalised (at NHS bodies discretion) as collective (or
     “grouped”) assets where they are acquired as part of the setting-up of a new
     building. In this context, the enhancement or refurbishment of a ward or unit
     should be treated in the same way as "new build", provided that the work would
     be considered as capitalisable “subsequent expenditure” in FRS 15 terms (see
     para 2.23 below). It may therefore be appropriate to capitalise the purchase of
     new furniture in a new build or refurbishment exercise, wherever
     practical/possible and based on the principle of materiality.

2.17 UITF Abstract 24 addresses the capitalisation of start-up costs associated with a
     start-up or commissioning period. It is mainly concerned with items that would
     be revenue expenses in normal circumstances (as opposed to those items that
     are capital in nature but treated as revenue because of their value). The UITF
     consensus is that costs that would be revenue expenditure in normal operations
     must be continued to be treated as such, and that any abnormal costs incurred
     simply by virtue of the start-up process also do not give rise to any asset.

2.18 This does not affect the practice of capitalising setting up costs in the NHS
     because the items so capitalised are capital in nature, but usually are taken to the
     revenue account only by virtue of their low value. The UITF Abstract refers to
     expenditure that is revenue in all circumstances, no matter what the value (e.g.
     training expenses, losses in trading, advertising and so on).




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Demolition costs

2.19 Costs incurred in demolishing or rearranging existing assets should be
     capitalised where this is necessary to allow a new asset to be built. Where no
     new asset is to be created, these costs must be taken as revenue expenditure.

Staff training costs

2.20 As the nature of the investment is in staff rather then fixed assets directly, such
     expenditure should always be treated as a revenue expense.

Subsequent expenditure

         “Subsequent expenditure to ensure that the tangible fixed asset maintains its
         previously assessed standard of performance should be recognised in the profit and
         loss account as it is incurred.” – FRS 15

2.21 Therefore, repairs and maintenance expenditure cannot be capitalised and
     should be charged to the revenue account.

2.22 FRS 15 permits capitalisation of subsequent expenditure when:
         •   That expenditure provides an enhancement of the economic benefits of
             the tangible fixed asset in excess of its previously assessed standard of
             performance. (Therefore, this includes an element of betterment which
             leads to an improvement in service).
         •   A component of an asset that has been treated separately for depreciation
             purposes is replaced or restored, or
         •   Subsequent expenditure relates to a major inspection or overhaul that
             restores the economic benefits that have already been consumed and
             reflected in depreciation

         Examples of betterment include

         •   Replacement of a flat roof with a pitched roof;

         •   Replacement of single paned glass with double glazing;

         •   Measures which contribute to the energy efficiency of an area;

         •   Capital works to comply with government legislation such as obtaining a
             fire certificate to allow compliance with Disability Discrimination
             legislation.

2.23 The second and third circumstances seem at first to conflict with the prohibition
     on capitalising repair and maintenance – an overhaul does not differ much in
     concept from routine maintenance. The essential differences however are that
     for such expenditure to be capitalised a separately identifiable component of an
     asset has to exist, having a substantially different economic life from the
     remainder of the asset. Alternatively the asset as a whole must have been
     depreciated in the light of the need for a periodic overhaul. In either case, the


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      expenditure must have the effect of reversing the consumption of economic
      value previously recognised in depreciation. A consequence of this of course is
      that a review of the asset’s expected economic life is triggered.

2.24 The FRS gives an example of an aircraft that must be completely overhauled
     according to a set timetable, and without that overhaul it has no economic life at
     all, as it would not be permitted to fly. The expenditure incurred in the overhaul
     thus extends its life, and can be considered as re-setting the depreciation clock.
     Such major overhauls tend to be in the nature of re-building, so are analogous to
     the creation of a new asset.

2.25 Capitalisation of maintenance expenditure would result in the carrying amount
     of the asset exceeding its recoverable amount (RA). On an impairment review
     or revaluation (see below) the normal consequence of this would be the
     recognition of impairment in the revenue account. Maintenance expenditure
     would thus fall to be treated as revenue expenditure even if initially, and
     erroneously, treated as capital.

Equipment

2.26 Equipment is initially capitalised at its purchase price. Second-hand equipment
     however should be taken onto the balance sheet at its purchase price and there
     will no longer be any entry under depreciation (see NHS Trust MFA Section B
     Chapter 10).

2.27 When a second-hand item is acquired, an assessment of its remaining economic
     life must be made to calculate the depreciation chargeable (see Chapter 3,
     Depreciation and Asset Lives).

Leases

2.28 Finance leases where the NHS body is the lessee will be accounted for as if the
     underlying asset is owned by that body. Chapter 4 below deals with leases.

Donated assets

2.29 Donated assets are brought to account in the same way as purchased assets, at
     cost if newly purchased or constructed, then revalued to a current cost valuation.
     They are valued, depreciated and subject to impairment in the same way as
     other assets. The donated asset reserve is used however in such a way as to
     remove donated assets from capital charges calculations (see Chapter 3 below
     on depreciation and Chapter 5 on capital charges).

2.30 Where a donor has contributed to part of an asset, only that proportion falls to
     be treated as a donated asset. It is possible therefore for an individual asset to
     be partly donated and partly purchased, with separate accounting entries
     associated with each.

2.31 For an asset to be treated as donated, the following condition must apply:




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         •   There should be no consideration given in return (thus the donor, or
             individuals or organisations nominated by the donor, may not be offered
             preferential treatment or other advantages or benefits).

2.32 The following examples do not qualify as “donated”:
         •   An asset transferred between public bodies as a result of a transfer of
             functions (unless the asset was legitimately a donated asset in the
             transferor’s books.
         •   Government grants (see below)
         •   Subsequent capitalised expenditure on a donated asset
         •   The provision by a developer of an access road or transport scheme that
             will benefit the developer’s business. Any asset provided as part of a PFI
             scheme by the developer cannot be considered as donated.

2.33 Any restrictions imposed by the donor on the use of an asset must be disclosed
     in the annual accounts.

Assets transferred between NHS bodies

2.34 Assets will transfer between NHS bodies in a variety of circumstances. The
     accounting bases in respect of valuation are common to the NHS as a whole, so
     it is appropriate to recognise the asset in the receiving body at the same book
     value at which it was carried in the original NHS body. There will generally be
     no need to revalue assets on such transfers. Where an asset is demonstrably
     inaccurately valued in the original body’s books (e.g. an impairment review has
     identified that the carrying amount of the asset is greater than its recoverable
     amount - see paragraphs 2.111 –2.152 below for guidance on impairments) it
     will be appropriate to revalue prior to transfer. The key point however is that
     any revaluation is accounted for as an in-year transaction in either the donor's or
     recipient's books - a revaluation cannot occur "invisibly" at some stage after
     leaving one balance sheet and appearing in another.

2.35 The term ‘transfer’ is loosely used in the NHS, and care must be taken that
     “purchase and sale” transactions are not just described as ‘transfers’ of assets.
     This improper use of ‘transfer’ could lead to the need to organise cash funding
     flows and PDC payments being overlooked.

2.36 As a matter of principle, where assets transfer between an existing NHS trust
     and any other body, the transfer must be effected by a cash sale and purchase.
     This is vital to permit NHS trusts’ PDC to be correctly handled.

2.37 A NHS trust will only transfer assets without a cash transaction in two
     circumstances:
             •    the trust dissolves, and its assets pass to a successor organisation
             •    Donated assets transfer along with the associated Donated Asset
                  Reserve .




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2.38 Assets acquired from other Government departments, Local Authorities and
     other non-NHS bodies, should be purchased at fair value.

2.39 Where transactions are between NHS bodies and third parties, NHS bodies are
     required to value assets scheduled for disposal at open market valuation for
     alternative use.

Assets funded from National Lottery funds

2.40 Assets provided from National Lottery funds (via the “Big Lottery Fund”)
     should be treated as donated assets.

Government grants

2.41 SSAP 4, Accounting for Government Grants, applies in the case of government
     grants. Grants may be received from the European Union, Local Government
     or Government Departments from time to time. Government grants are defined
     in the Standard as “assistance by government in the form of cash or transfers of
     assets to an entity in return for past or future compliance with certain conditions
     relating to the operating activities of the enterprise”. This definition does not
     cover funding from Parliamentary Vote, i.e. in the form of capital (or revenue)
     allocations, so in this context any funding provided by the NAW must be
     accounted for as financing as appropriate (for NHS trusts it should be accounted
     for as either income or PDC financing as appropriate) and not as a grant.

2.42 Assets provided by grant will be treated as any other asset. The asset will be
     carried at its current cost, and the value of the grant must not be netted off its
     carrying amount.

2.43 The amount of the capital grant should be credited to a government grant
     reserve on the balance sheet. Assets financed in whole or in part by a grant
     should be revalued and depreciated in the same way as other fixed assets. To
     the extent that a proportion of a fixed asset has been financed by a grant, that
     proportion of the amount of the revaluation should be credited or debited to the
     government grant reserve instead of the revaluation reserve. The same
     proportion of the asset’s depreciation charge will be debited to the government
     grant reserve and credited to the revenue account (any depreciation arising from
     capital expenditure in excess of the grant will thus, rightly, go unrelieved).
     There will be no cost of capital charge in respect of the proportion of the asset
     financed by grant. The net effect is analogous to treating the grant-aided
     portion of the asset as “donated” – it is exempted from capital charges.

2.44 Details of the depreciation and capital cost absorption treatments can be found
     in Chapters 3 and 5 below.


Intangible fixed assets - capitalisation
Research and development




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2.45 SSAP 13, Accounting for Research and Development, applies in full.
     Essentially, capitalisation of research and development (R&D) expenditure is
     appropriate only in the following circumstances:
         •   There is a clearly defined project
         •   The related expenditure is separately identifiable
         •   The outcome of the project has been assessed with reasonable certainty as
             to:
             •    its technical feasibility, and
             •    its resulting in a service or product that will eventually be brought
                  into use
         •   Adequate resources exist, or are reasonably expected to be available, to
             enable the project to be completed.

2.46 It can be seen from the above that in most cases R&D expenditure will be
     charged to the revenue account in the year in which it is incurred.

2.47 If capitalised, the asset must be amortised over the period in which the product
     or service will be sold or provided for use.

2.48 All capitalised development expenditure must be indexed (as set out in the
     FReM). The index figure to be applied is that for equipment.

2.49 A review of the asset and the justification for maintaining it as an asset must be
     undertaken each year. Where the SSAP 13 criteria are no longer met, the
     balance of the expenditure should be written off to the revenue account
     immediately.

Software

2.50 A purchase of any software is essentially the purchase of a licence to use
     software code developed by, and which remains the property of, a 3rd party.
     NHS developed software has always been capitalised (and should still be
     capitalised as a tangible fixed asset) if the NHS body owns the code such that it
     could copy and sell the application at its discretion.

2.51 Under FRS 10, Goodwill and Intangible Assets, software that remains the
     property of, for example, Microsoft should be capitalised if the user has bought
     the right to enjoy the economic benefits of the use of the software for more than
     one year. Intangible fixed assets (eg software licenses) held for operational use
     are valued at historic cost and indexation should not be applied.

2.52 The provisions of this Manual on the capitalisation limit and grouping of assets
     apply to the capitalisation of expenditure on software. As with IT hardware, it
     is expected that software used on a network will meet the “interdependence”
     criterion for the grouping of fixed assets.

2.53 The Accounting Policies note to the Annual Accounts discloses that intangible
     assets are amortised over estimated lives (and in fact, following FRS 15,


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      standard lives are no longer prescribed for assets in general). It is believed that
      software assets will tend to have relatively short lives, but this is a matter for an
      individual body’s judgement. A further complication affecting amortisation
      might be the practice of upgrading software rather than scrapping it completely.
      It will be difficult to assess a residual value in this case, so the treatment must
      depend on individual circumstances, taking into account contractual
      arrangements and the body’s IT strategy.

Goodwill

2.54 Goodwill does not arise in the NHS as there can be no internally generated
     goodwill, nor can a NHS body acquire goodwill as a result of the purchase of a
     subsidiary undertaking or business.


Deferred assets in PFI schemes
2.55 Some PFI transactions involve the disposal of NHS assets to private partners
     (by lease, sale or otherwise as part of the deal). Unless a NHS body has in
     substance disposed of the asset at undervalue or for no consideration (in which
     case a loss on disposal must be recorded in the revenue account) it is to be
     expected that some benefit will accrue to the NHS in return. This implies that
     an asset of some kind must have been created in return for the exchange of the
     original NHS asset. Chapter 8 gives more detail on PFI accounting.

2.56 Where land is "transferred" to the private sector partner for subsequent sale, this
     will usually be in exchange for a reduction in rental payments. Cash may
     similarly be injected in exchange for a reduction in payments where the land
     becomes available later in the contract period. A calculation of the present value
     of the reduction in payments should be made and this should be present as a
     prepayment within debtors and written off to the revenue account over the
     period of the service payment reductions (normally the contract period, i.e. not
     necessarily the life of the lease). Where buildings are leased to the private
     sector which are integral to the PFI scheme and the private sector take the risks
     and rewards, the deferred asset is equivalent to the existing use value of the
     buildings (i.e. net present value of a reduction in payments) and the write-off to
     the revenue account in this case will be over the life of the lease.

2.57 For the purposes of this Manual however, it should be noted that these deferred
     assets are not fixed assets, and should be accounted for as prepayments within
     current assets. As current assets, they should be included within net relevant
     assets for the purposes of calculating the cost of capital charge.


Measurement and valuation
General Principles

2.58 As noted above, whether acquired or self-constructed, a tangible fixed asset
     should be measured initially at cost. Government accounting policy is to



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      revalue tangible fixed assets systematically (see below) to ensure that assets are
      carried on a current cost basis.


                              Valuation of Tangible Fixed Assets

                                            lower of:



                    Net current                           Recoverable
                 replacement cost                         amount (RA)
                       (RC)
                                                            higher of:



                                         Net realisable            Value in use
                                             Value
                                            (NRV)


2.59 Tangible fixed assets should be valued at the lower of replacement cost and
     recoverable amount.

2.60 Replacement cost (or net current replacement cost) for land and buildings is
     existing use value. For specialised properties, depreciated replacement cost
     (DRC) should be used. (A specialised property is of a type that is rarely sold on
     the open market for continuation of their existing use. FRS 15 mentions
     hospitals and other specialised health care premises as examples of properties
     that may be considered specialised.)

2.61 For equipment assets, depreciated replacement cost is the appropriate measure.
     A “modern equivalent asset” calculation may be used in the circumstances
     described below.

2.62 Recoverable amount is defined as the higher of net realisable value (NRV) and
     value in use, where:

2.63 Net realisable value (NRV) is the actual or expected sale proceeds realisable on
     the open market, net of selling expenses etc.

2.64 Value in use is the cost of replacing the asset’s service potential. For
     specialised property this can be taken to be the depreciated replacement cost of
     the asset. Given that the NHS exists to provide services rather than generate
     income streams (other than of course in income-generation activities), the
     commercial context of “value in use” (as set out in FRS 15) is not helpful.

2.65 Other (non-property) tangible fixed assets’ value in use will be DRC.

Surplus assets



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2.66 Surplus non-operational property should be valued at open market value
     (OMV), less directly attributable selling costs, where material. District Valuers
     now provide valuations based on OMV for “prevailing use”, i.e. having regard
     to the likely use to which the asset would be put in the locality, bearing in mind
     the planning regime ruling in the area.

2.67 For an asset to be treated as "surplus" two conditions must apply:
         •   there is an explicit intention to dispose, eg a Board Decision
         •   the asset is not in operational use.

2.68 Where the former alone applies and the asset remains in use until the disposal
     date, accelerated depreciation is applied to the asset that remains on the balance
     sheet at a DRC valuation (if specialised). The asset will then be depreciated to
     its expected realisable value at the date of disposal. Assets temporarily out-of-
     use continue to be valued and depreciated as normal.

Modern equivalent asset

2.69 The normal basis of valuation may not be appropriate if a modern substitute is
     markedly different in cost, or where technological advances have resulted in
     likely replacements having significantly improved quality or quantity of
     outputs. Under such circumstances, it is necessary to undertake a modern
     equivalent asset calculation to arrive at a satisfactory replacement cost.

2.70 The following considerations apply:
         •   the cost of the modern equivalent asset is at least £100,000
         •   the difference between the replacement cost of the existing asset and that
             of the modern equivalent asset is at least 25%.

2.71 Use of this adjustment is expected to be exceptional. The assumptions used
     must be recorded and agreed with external auditors, particularly where those
     assumptions relate to differences in quality rather than quantity.

2.72 Where these circumstances apply, the replacement cost of the existing asset
     should be taken as a proportion of the cost of the modern equivalent asset and
     not the cost of replacing the existing asset. The modern equivalent asset
     adjustment reduces the cost of the modern equivalent asset to what it would be
     if it had an output comparable to the existing asset. The reduction in the NBV
     should be charged to the revenue account as an impairment and not to the
     Revaluation Reserve. This is because the reduction is a permanent diminution
     in the value of the asset (see paras 2.111-2.141 on impairments).




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2.73 The accounting entries are:
Dr        Revenue account                                With the reduction in the replacement cost of the existing
Cr        Fixed assets                                   asset

Dr        Provision for depreciation account             With the amount of the reduction in the accumulated
Cr        Revenue account                                depreciation on the existing asset

     The net amount charged to the revenue account will, therefore, be the reduction in NBV of the existing asset



Example: modern equivalent asset (MEA) calculation
Assuming no operating cost or economic life differences between the existing and MEA, in £s:

              Output of existing asset p.a. - 20,000 units
              Output of MEA p.a.            - 40,000 units
                                                                                                       £
              Replacement cost of existing asset                                                     150,000
              Accumulated depreciation, existing asset                                                60,000
              NBV existing asset                                                                      90,000

              Cost of MEA                                                                            220,000

              Calculation of MEA cost (for same output as the existing asset):

              220,000*(20,000/40,000)                                                                110,000
              The replacement cost of the existing asset thus becomes 110,000 – a reduction of
              40,000 from its present RC of 150,000. The accumulated depreciation therefore
              needs to be reduced in the same proportion (110/150)* 60,000 = 44,000. Hence:
              Revised RC of existing asset                                                           110,000
              Revised accumulated depreciation on existing asset                                      44,000
              Revised NBV of existing asset                                                           66,000


2.74 The reduction in the gross replacement cost of 40,000 is debited to the revenue
     account, while the written-back depreciation of 16,000 is credited to the revenue
     account, giving a net charge of 24,000 (being the net fall in the asset value as an
     impairment).


Valuations, review and impairments
2.75 Initial valuation of tangible fixed assets is at cost. The NHS adopts a policy of
     revaluation within the meaning of FRS 15, and must consistently apply
     revaluation policies to each asset within a given class of assets. A tangible
     fixed asset’s carrying amount at the balance sheet date should be its current
     value, as calculated below. For land and buildings, the revaluation from cost
     should take place as soon after the date of acquisition or commissioning new
     build as possible, and at any event before the end of the financial year in which
     the asset is acquired or created.

2.76 The Government's policy on the revaluation of land and buildings in the NHS is
     to fully revalue every five years, and thereafter to revalue by means of applying
     indices in each of the intervening years. FRS 15 allows a measure of discretion


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      for public sector and not-for-profit organisations to set their own revaluation
      policies, having regard to the costs involved.

2.77 Equipment assets are also indexed to maintain a current cost (at depreciated
     replacement cost).

2.78 Intangible fixed assets are generally not revalued or indexed but maintained at
     cost less depreciation or amortisation unless they have a readily ascertainable
     market value, in which case the market valuation is used. Capitalised
     development expenditure, however, must be indexed (see para 2.48).

2.79 Revaluations of individual assets may be required where there are material
     changes outside the 5-yearly cycle. Typical examples are:
         •   A newly constructed asset is first brought into use
         •   There is an indication that tangible fixed assets may have suffered
             impairment (see below), or
         •   Property has been subject to significant enhancement expenditure, or
         •   There has been a change of use or level of utilisation of an asset, or
         •   A “modern equivalent asset” calculation is indicated (see above), or
         •   An asset is to be taken out of use, or is surplus to needs.

2.80 Assets under construction are indexed in the same way as completed
     buildings. The carrying amount of an asset under construction must be reduced
     if it becomes apparent that fruitless payments (which are reported in the losses
     register) have been incurred or other costs have been inappropriately
     capitalised.

Ad-hoc ‘housekeeping’ revaluations

2.81 FRS 15 requires that where a tangible fixed asset is revalued, all the assets in
     the same class must be revalued (para 61). The ad hoc revaluation of individual
     assets on a good-housekeeping principle is not therefore permissible. Clearly
     individual assets will still be valued singly in the event of their being impaired
     or their valuation bases being changed (e.g. from cost to DRC or DRC to OMV
     on commissioning or disposal respectively).

Valuers and Disclosures

2.82 The 5-yearly national revaluation exercises for the NHS have been carried out
     by the District Valuation Service, which thus maintains records and has built up
     experience and established a consistent approach to the valuation of NHS
     properties. The assumption in this Manual is that District Valuers (DV) will
     also carry out any interim valuations required, although NHS bodies have the
     freedom to commission such work from other suitably qualified valuers. The
     standard disclosure of accounting policies (Note 1) in the Manual for Accounts
     covers the 5-yearly DV revaluations. In the event of revaluations of a class of
     assets outside the course of the 5-yearly cycle the full disclosure provisions of
     FRS 15 must be followed.


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Non-specialised land and buildings

2.83 Where it is possible to value a property in the context of an active market in that
     type of property in the locality, the District Valuer will attach an open-market
     value for existing use (OMVEU), as defined in Annex 1 below, to the property.
     In effect, this should be the default valuation policy as it gives a clear
     understandable valuation figure. The existence of a vast specialised estate in
     the NHS, however, confines the use of OMVEU to such properties as residential
     accommodation, office buildings and car parks.

2.84 All assets valued at OMV (whether operational or non-operational) are indexed
     on April 1 each year, using the indices provided by the Valuation Office Service
     (see below) to maintain their current cost carrying value.

Specialised land and buildings

2.85 FRS 15 and the FReM produced by HM Treasury require specialised assets to
     be valued on a depreciated replacement cost basis (DRC), as defined in annex 1
     below. It is accepted that this valuation base is something of a proxy for a more
     clear-cut (e.g. OMV) basis of valuation.

2.86 Certain assumptions inherent in the DRC valuation methodology lead to DRC
     valuations invariably being lower than the initial cost of new buildings.
     Although inefficiencies and cost over-runs (“abnormal costs”, under FRS15)
     cannot be capitalised, even as part of initial costs, certain other costs associated
     with capital projects are legitimately capitalised initially, yet are not taken into
     account in arriving at DRC. Examples of these might be the cost implications
     of contractors having to work in an occupied site, or the necessity to put in
     access roads; the cost of having multiple contracts and phases to construct one
     building; and the additional cost of inclement weather. These assumptions are
     currently under review.

2.87 It is expected that the action of revaluing from cost to DRC will produce a fall
     in value/impairment. In line with Treasury agreement, any fall in difference
     between capital cost and carrying value should be taken to the Revaluation
     reserve for new assets.

2.88 The DRC valuation methodology employed by the Valuation Office Service
     analyses property by approximately 25 separate “elements”, based on the
     Building Cost Information Service (BCIS) definitions. Certain elements (e.g.
     substructure, roof, stairs, windows and external doors) relate to the buildings
     themselves, while others (water, electrical, heating, lift installations) relate to
     plant or engineering.

2.89 While NHS bodies may wish to track various elements in their registers
     separately, it is suggested that for the purposes of impairment reviews and
     tracking revaluation reserve balances associated with discrete assets, the asset
     unit should be the building as a whole. Clearly, separate wings or blocks of a
     building might have been added at different times, and be capable of being
     treated as separate assets, or indeed major elements of plant may have
     depreciation lives so different from the structure as to merit treatments as


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      separate assets under FRS 15. Some judgement in defining “an asset” will
      therefore need to be exercised. It is suggested that any block or asset capable of
      separate valuation, or disposal or demolition, is treated as a discrete asset (so the
      elements of a block would not be assets in FRS 11 terms, whereas the block
      itself would be).

2.90 An exception to this general rule is land included in property. Because land and
     buildings asset movements are reported separately in Notes to the Balance
     Sheet, impairments and revaluations need to be apportioned between land and
     buildings, rather than being assigned to the property asset as a whole.

Equipment

2.91 Equipment is carried at depreciated replacement cost. In practice, it is sufficient
     to apply indexation and depreciation to the historic cost of the equipment asset.
     The “modern equivalent asset” calculation may come into play in exceptional
     cases where technological advances mean that a replacement asset of similar
     productive capacity would be materially different in cost, such that indexed
     historic cost exceeds the recoverable amount.


Indexation
2.92 Indexation is intended to maintain assets at current cost values without the
     expense of frequent revaluations. Indexation is a form of revaluation, and
     although identified separately in asset registers and reported in a separate line in
     the Notes to the accounts, it is treated in accounting terms as such.

2.93 Indices are provided by the Valuation Office Service and are based on data
     available from the Building Cost Information Service (BCIS) and the Valuation
     Office Property Market Report.

2.94 Indices for a given financial year are published in allocations working papers
     issued to trusts and LHB’s part of the capital charge estimate (CCE) exercise in
     the preceding September. Indices are intended to reflect price movements
     anticipated over the course of the following financial year. Thus, although they
     are applied to opening asset values as at 1 April, they are intended to provide
     acceptable values for the year-end balance sheet.

2.95 All tangible fixed assets other than IT fixed assets, operational and non-
     operational (including assets held under finance leases and assets under
     construction), should be indexed on 1 April each year. The situation sometimes
     arises where an asset is to be disposed of, and is valued for that purpose in one
     year while the transaction does not actually take place until the next. This can
     result in a loss on disposal if the contract sale price is set at the valuation
     amount and indexation is then applied on the following 1 April - the carrying
     amount will exceed the sale proceeds.

2.96 NHS bodies should always ensure that assets are not sold to third parties at
     undervalue, and so will obtain a valuation to establish a fair price on the date of
     sale. If this is done, and it can be demonstrated to auditors that the most recent


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      valuation does indeed represent a fair value on the date of sale, it is acceptable
      for that particular asset not to be indexed at 1 April. The best course of action
      will be to instruct the valuers to make the best estimate of value at the
      anticipated date of sale. Clearly it would not be acceptable to rely on an out-of-
      date valuation to set a contract price, and indexation may only be set aside in
      this way if the dates of valuation and sale are close (say, within 6 months) and
      fall either side of the year-end.

2.97 When assets transfer between NHS bodies on 1 April, the transfers should take
     place before indexation. For example, if assets are brought onto LHB balance
     sheets from the NHS trust sector on 1 April, the transactions should take place
     before the NHS trust has indexed the assets. A full year’s indexation should
     then be applied in the LHB.

Applying indexation

2.98 The series of indices applied in the NHS to date is shown below:


                                                   2001/02


                                                              2002/03


                                                                         2003/04


                                                                                    2004/05


                                                                                               2005/06
     Land                                        115         140        148        100        105

     Buildings                                   161         184        202        218        222

     Equipment                                   132         136        139        142        145


Notes to table:

1. For land and buildings, detailed regional figures were used in the early years
   (1992/93 and 1993/94). Rather than reproduce a complex table of indices by
   geographical areas, a national index has been estimated using an average for these
   two years.

2. As an example, the uplift to be applied to building values on 1 April 2002 is:

        [(184-161)/161]*100 or 14.286%


Surplus assets and disposals
General

2.99 Where an asset is disposed of, it is important to treat the following transactions
      as separate and distinct events:
            •     revaluation to the appropriate carrying amount
            •     recognition of impairment


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            •     re-profiling of depreciation (only required where there is a time
                  delay between declaring the asset surplus and disposing of it)
            •     recognition of profit/loss on disposal.

      The demolition or scrapping of a building or a piece of equipment is a disposal
      for no consideration (see para 2.101). Similarly, the transfer of an asset to a
      non-NHS body is also a disposal, and if no valuable consideration is received in
      return, a loss on disposal arises (equal to the final carrying amount of the asset).

2.100 Profit/loss on disposal is always calculated as the difference between the final
      carrying amount and the disposal proceeds (i.e. calculated after any impairment
      has been recognised).

2.101 Note: the final carrying amount of a building is its open market valuation for
      alternative use (OMVAU) as assessed by the District Valuer. The DV will have
      regard to the building's type and condition, property market and planning
      conditions prevailing locally. This value should not be set to NIL simply
      because it is intended to demolish the building, or because a deal has been
      struck to transfer the property for no consideration. Revaluation to NIL should
      not be used to avoid losses on disposal where an asset has a value, but a
      management decision results in its destruction or transfer.

2.102 Land and buildings sold together as "property" will attract separate valuations
      and impairment reviews. Revaluations and profit/loss on disposal calculations
      will therefore give rise to separate sets of figures for both land and buildings.

2.103 Where equipment is taken out of productive use its value should be written
      down to its recoverable amount, which in turn (as the asset is not in use) will be
      its net realisable value. The valuation fall is analogous to the recognition that
      the asset has been under-depreciated during its period of use, and so the fall
      should be accounted for as an economic impairment (see paras 2.111-2.141
      below).

2.104 Surplus land and buildings not in operational use should be revalued to open
      market value for alternative use (District Valuers attach valuations based on the
      “prevailing use” concept, having regard to the likely use to which property sold
      in the locality could be put).

2.105 Property may be considered as “surplus” when a management decision has been
      taken to dispose of it. The decision is best evidenced by Board minutes
      recording a decision, but auditors may accept other written evidence or
      representations about the status of property.

2.106 Property thus classed as surplus, but still in operational use, must not be written
      down to OMV for alternative use. It should remain in the balance sheet at its
      normal operational valuation (DRC, or OMVEU as appropriate). The
      depreciation charge should however be adjusted such that the asset is fully
      depreciated to its disposal OMV (equal to its expected net realisable value) over
      its remaining life in the NHS body (see Chapter 3 - Depreciation).




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2.107 The matrix below summarises the transactions:

                                In operational use                       Not in operational use

                           Carry at DRC (if specialised)        If temporarily not in operational use
     Not surplus                         Or                     treat as in operational use
                           carry at OMV for existing use
                             (if market value available)
                        carry at DRC or OMVEU as above            Revalue to OMV for alternative use
                                         and                      and consider economic impairment.
       surplus       revise depreciation profile to reach OMV            Cease to depreciate
                        for alternative use by disposal date


2.108 The term “accelerated depreciation” is used in this Manual to describe
      “ordinary” depreciation that merits special comment and handling only because
      its size may have a materially distorting impact on an entity’s financing and
      revenue performance. Directors of Finance are required to review assets’
      expected economic lives at the end of each accounting period (FRS 15) and so
      adjustments to depreciation profiles will be frequent in the normal course of
      events. Although accelerated depreciation is similar in nature to an impairment
      loss (representing the consumption of economic benefits over a period), it is
      accounted for as depreciation, not impairment. Accelerated depreciation should
      be included in Capital Charge Estimates and fully recovered in tariffs in the
      normal way, but it is accepted that in some instances the higher depreciation
      charge will arise after the CCE exercise and after the SAFF has been agreed.
      For the year preceding that for which the full depreciation charge can be dealt
      with via CCEs:

                 Any LHB or Trust that identifies additional pressures for
                 accelerated depreciation should contact the NAW to establish
                 whether an adjustment to its Revenue Resource Limit/Capital limit
                 is available to cover the additional cost caused by the accelerated
                 depreciation.


2.109 Where accelerated depreciation is calculated in this way, the OMV to be used is
      that of an asset of the same age at the present time, and no attempt should be
      made to predict the OMV at the time of planned disposal. In times of inflation
      then, it is to be expected that the OMV thus established will be lower than the
      OMV ruling at the actual date of disposal, and this may then give rise to a profit
      on disposal. NHS bodies need to take care that an OMV set in the past is not
      assumed to be a fair market price for setting contract terms.

2.110 Where there is uncertainty about the date an asset will be taken out of
      operational use, LHBs and NHS trusts may wish to maintain an assets life and
      depreciation profile unchanged, recognising an economic impairment in the
      year in which the asset is actually taken out of service.


Impairments
Requirements of FRS 11


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2.111 The main objective of FRS 11 is to ensure that all impairment losses (losses of
      value of fixed assets below their carrying amounts) are recognised immediately
      in the financial statements, whether an impairment is expected to be temporary
      or permanent.

2.112 Much of the detail of FRS 11 is concerned with the identification of "income-
      generating units" (as defined by FRS 11) and the measurement of value in use
      (the present value of cash flows from the use of an asset). None of that detail is
      repeated here because it is lengthy and, in the NHS, will apply only to
      impairment losses of fixed assets dedicated to income generation activities.

2.113 The full text of FRS 11 should be consulted where there is an indication of
      impairment concerning an asset dedicated to income-generation activities.

Indications of impairment

2.114 Impairment occurs because something has happened to a fixed asset itself or to
      the economic environment in which it is used. A review for impairment of a
      fixed asset should be carried out if, and only if, events or changes in
      circumstances indicate that there has been an impairment.

2.115 Indications of possible impairment include:
         •   the asset is to be sold
         •   the asset cannot be used for any reason
         •   the asset is surplus to requirements
         •   a newly constructed asset is brought into use
         •   the asset is overspecified for its current use
         •   there is a fall in value on indexation or on 5-yearly revaluation
         •   there is evidence of obsolescence or physical damage to the asset
         •   there is a commitment by management to undertake a significant
             reorganisation and fixed assets are involved.

2.116 An indication of impairment does not necessarily mean there has been an
      impairment but it should prompt a review of the value of the asset, its useful life
      and its residual value (if any). A review of the useful life and residual value is
      appropriate even if the review of the asset value shows that it has not been
      impaired.

2.117 A fall in value of an asset when it is initially re-valued from cost to Depreciated
      Replacement Cost could be due at least in part to the assumption of ideal
      conditions underlying the present method of depreciated replacement cost
      valuations. (A review is being carried out by the Valuation Office to determine
      a refined approach to valuations, based on assumptions of average conditions.
      This would reduce the size of impairments on bringing newly constructed assets
      into use. However, it would increase the value of assets generally and the
      implications of this will be considered as part of the review). Unless and until
      the approach to valuations is refined, the fall in value on revaluation of a new


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      asset from cost to DRC will not be treated as an economic impairment. The
      correct treatment is to take the revaluation fall to the revaluation reserve, even
      though that inevitably creates a negative reserve in respect of the particular
      asset.

2.118 Related to this, it should be noted that construction inefficiencies are not valid
      costs of building an asset and hence should not be capitalised at all. Instead
      they should be written off directly to the revenue account.

2.119 Planned disposal of an asset does not necessarily indicate impairment. Where
      there is the intention of disposing of an asset on a planned date, the depreciation
      charge must be adjusted so that the asset is written down to its expected
      realisable value on the planned sale date. The revised depreciation should be
      included in capital charge estimates at the first opportunity.


Impairment review

2.120 An impairment review compares the carrying amount of an asset with its
      recoverable amount, where recoverable amount is the higher of net realisable
      value and value in use (see diagram following para 2.58 for further details).

2.121 Net realisable value is the amount for which an asset can be disposed of, less
      any direct selling costs. Direct selling costs include legal costs and the costs of
      removing a sitting tenant but they do not include reorganisation costs e.g.
      redundancy costs linked to the sale of a property.

2.122 FRS 11 defines value in use as the present value of the future cash flows from
      the asset's continued use. However, it adds that, where a fixed asset is not held
      for the purpose of generating cash flows, an alternative measure of its service
      potential may be more relevant. HM Treasury have interpreted this for the
      public sector, stating that, other than for commercial profit-making services
      (which should follow FRS 11 in full) value in use will be assumed to be at least
      equal to the cost of replacing the service potential provided by the asset. The
      cost of replacing the service potential of operational assets in the NHS is
      existing use value or, if such a value is not available (as is the case for
      specialised property) depreciated replacement cost.

2.123 An impairment review of a NHS asset therefore usually compares the carrying
      amount of the asset with the higher of existing use value/depreciated
      replacement cost and net realisable value. However, if an asset cannot be used
      or is surplus to requirements, the impairment review compares the carrying
      amount of the asset with net realisable value only, since there is no value in use.
      Where an asset is over-specified for its current use, the impairment review
      compares the carrying amount of the asset with the higher of net realisable
      value and the existing use value/depreciated replacement cost of an asset of the
      lower specification.

Recognition of impairment losses




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2.124 As in the application of all Financial Reporting Standards, impairment losses
      need only be recognised (i.e. accounted for) when they are material. The
      following paragraphs relate to material impairment losses.

2.125 If an impaired asset has not previously been indexed or revalued whilst held
      (even if previously held and indexed/revalued by another NHS body) the
      impairment loss should be recognised in the revenue account. The exception to
      this principle relates to newly constructed buildings that attract a first DRV
      valuation that is invariably lower than cost (see para 2.141 et seq).

2.126 If the asset has been previously indexed or revalued whilst held, the place to
      recognise the loss depends on its cause. In principle, impairments of revalued
      fixed assets fall into two general groups:
            •     those that are “clearly caused by a consumption of economic
                  benefits”, and
            •     those caused by a general fall in prices.

2.127 The first type is similar to depreciation and is treated in the same way i.e.
      recognised in the revenue account. The second type is a valuation adjustment,
      which falls to be recognised in the Statement of Recognised Gains and Losses
      (SRGL) until the credit balance in respect of that asset on the Revaluation
      Reserve is used up, after which it should be recognised in the revenue account.

2.128 However, FRS 15 says that if it can be demonstrated that the recoverable
      amount of the asset remains higher than the revalued amount, the whole of the
      fall can be charged to the SRGL (see below, para 2.137).

2.129 In practice, it can be difficult to allocate an impairment to one of the two groups
      with certainty. FRS 11 states that where there is doubt it should be treated as
      one caused by a general fall in price i.e. the impairment loss should be
      recognised in the SRGL until the balance in respect of that asset on the
      revaluation reserve us used up, after which it should be recognised in the
      OCS/I&E account.

2.130 Having dealt with the effects of price changes annually, as above, it will usually
      be appropriate to treat any other type of impairment as a clear consumption of
      economic benefits, with a consequent charge to the revenue account.

Losses of economic benefit

2.131 Impairment losses resulting from the indications listed above (para 2.106) are
      losses of economic benefits and should be recognised in the revenue account. If
      in such cases there is a credit balance for the asset on the revaluation reserve, a
      transfer from the revaluation reserve to the I&E reserve or General Fund should
      be made equal to:
            •     The amount of the impairment, or
            •     The credit balance on the revaluation reserve for the asset, if lower.




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2.132 Adjustments to the I&E reserve do not affect breakeven performance for NHS
      trusts.

Price falls

2.133 Fixed assets within the NHS are indexed annually and property assets are
      professionally revalued every five years. Indexations purely reflect price
      changes and the 5-yearly revaluations check the accuracy of the national indices
      applied in the circumstances of an individual asset, as well as picking up any
      other changes in the asset.

2.134 If a fall in value on a 5-yearly revaluation is found to be due to a consumption
      of economic benefits, it should be charged to the revenue account. This,
      however, should be rare, as an indication of an impairment should prompt an
      immediate impairment review rather than being left until the 5-year point to be
      identified.

2.135 If a fall on routine revaluation is not due to a clear consumption of economic
      benefits, or there is a fall in value on indexation, the general rule is that it should
      be charged to the SRGL until the balance in respect of that asset in the
      Revaluation Reserve is used up, after which it should be recognised in the
      revenue account. However, FRS 15 says that, if it can be demonstrated that the
      recoverable amount of an asset remains higher than its revalued amount, the
      whole of the fall in value can be charged to the SRGL. It is acceptable for some
      temporary negative revaluation reserve balances to be created in these
      circumstances.

2.136 HM Treasury has stated that, for not-for-profit activities, recoverable amount
      will be taken as being greater than the revalued amount if it can be
      demonstrated that:
              •   The fall in value has not been caused by a consumption of economic
                  benefits
              •   For assets valued at a market based valuation (e.g. EUV) the
                  reduction is short-term and informed opinion is that it will be
                  reversed in the medium term
              •   For assets held at DRC changes in technology in the sector are small
                  so that any falls are likely to be short-term.

2.137 If, subsequently, it is decided that any part of the downward price movement is
      in fact permanent, an adjustment between the revenue account and the
      revaluation reserve should be made in the current accounting period.



Newly-constructed assets

2.138 On bringing a newly constructed (building) asset into use there is invariably a
      significant fall in value. If this is due to a loss of economic benefits it should be
      charged to the revenue account. However, it is more likely that the fall is due to
      the present approach to depreciated cost valuations which assumes ideal


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      construction conditions (with, for example, the costs of site works and
      contingencies not being reflected in present DRC valuations).

2.139 If the fall in value is due to the application of the DRC valuation methodology
      alone, and costs had been legitimately capitalised as under FRS 15, it should be
      recognised in the SRGL. Negative revaluation reserve balances will inevitably
      arise - these are acceptable. A Valuation Office review of the DRC basis is
      currently underway, and any changes that might be made in consequence would
      be expected to reduce impairments on completion of new-build.

2.140 Related to this, it should be noted that inefficiencies in construction are not
      valid costs of construction and so should not be capitalised at all. They should
      be written-off to the revenue account when recognised. FRS 15 lists as
      examples of "abnormal costs" not to be capitalised: design errors; industrial
      disputes; idle capacity; wasted materials, labour or other resources; and
      production delays.

            For NHS trusts, fundsflows are not allowed in respect of abnormal
            costs.

Enhancement expenditure

2.141 Expenditure legitimately capitalised in enhancing an owned or leased asset is
      treated in the same way as that incurred in constructing a new asset. It follows
      that revaluation to DRC on completion of the work may produce valuation falls
      (impairments) just as revaluation of new-build generally results in a fall. The
      accounting treatments of impairments are the same in both cases.

Revaluation reserve balances

2.142 It is important to be able to relate balances taken to the Revaluation Reserve
      with their associated assets. All NHS bodies will therefore need to ensure that
      they have systems in place to enable Revaluation Reserve balances to be
      analysed to the level of individual assets. Para 2.79 above defines, as far as
      possible, an "asset" in the context of revaluation reserve apportionment and
      impairment calculations.

2.143 When an asset is disposed of the balance on the Revaluation Reserve in respect
      of it should be transferred to the General Fund/I&E Reserve. Since "price falls"
      and newly-constructed asset "impairments" are taken to the revaluation reserve,
      debit entries for individual balances are allowed on this reserve.

2.144 Further, UK GAAP requires a transfer to be made from the revaluation reserve
      to the General Fund/I&E Reserve where an asset, although carrying a positive
      revaluation history, suffers a loss of economic value.

        “FRS 11 says that a revaluation loss is to be recognised wholly in the profit
        and loss account if it is caused by a “clear consumption of economic benefits”
        …… this is equated to an impairment, and accordingly the whole deficit
        should be charged to the profit and loss account as an operating charge
        analogous to depreciation. This applies even if the asset was previously



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        valued upwards and is still worth more than its depreciated historical cost. If
        the deficit against carrying value is charged to the profit and loss account any
        corresponding credit balance in the revaluation reserve relating to that asset
        will be transferred to the profit and loss account as a reserve movement”.

Donated assets, Big Lottery Fund (New Opportunities Fund) and Government
Grants

2.145 Similar approaches to those above should be adopted for donated assets and
     assets provided by a grant from the Big Lottery Fund, using the Donated Asset
     Reserve or Government Grant Reserve (GGR) instead of the Revaluation
     Reserve, except that:
            •     where an impairment loss can be recognised in the SRGL in the first
                  instance the balance of the loss should be recognised in the revenue
                  account when the Donated Asset Reserve or GGR has been reduced
                  to the value at which the asset was first taken on
            •     where an impairment loss is recognised in the revenue account, an
                  offsetting transfer should be made to it from the Donated Asset
                  Reserve or GGR.
2.146 As price movements impact on the donated asset reserve, and economic losses
      taken to the revenue account result in the transfer noted above, the donated asset
      reserve in respect of a particular asset will continue to equal its carrying
      amount.

2.147 Similar treatment is required for assets financed by Government Grants, where
      the transfers will be from the Government Grant Reserve.

Reversal of past impairments

2.148 A debit to the revenue account, as shown above, can be reversed (after
      adjustment for subsequent depreciation) for any reversal of a past impairment.
      This means that the reversal of an impairment loss is recognised in the revenue
      account to the extent that it increases the carrying amount of the asset to what it
      would have been had the impairment not occurred.

2.149 It is expected that reversals of impairments will be rare, as neither indexation
      nor 5-yearly revaluations are considered as reversals of earlier impairments
      taken to the revenue account as consumption of economic benefits. Reversals
      will happen in cases where an economic loss has been recognised on an asset
      written down to OMV (disposal value) prior to disposal, which subsequently is
      taken back into operational use on a change of plan.

Presentation and disclosure

2.150 Impairment losses recognised in the revenue account should be included in
      operating costs. Impairment losses recognised in the SRGL must be disclosed
      separately on the face of the statement.

2.151 In the fixed asset note to the annual accounts the impairment loss should be
      treated as follows:


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            •        Impairments charged to the SRGL should be shown in the
                     cost/valuation (top half) part of the note
            •        Impairments charged to the revenue account should be shown in the
                     depreciation (bottom half) part of the note.

2.152 Where (exceptionally) an impairment loss recognised in an earlier period is
      reversed, the financial statements should disclose the reason for the reversal.


Presentation and disclosure - examples
2.153 The examples below illustrate the recognition, and reversal, of impairments in
      accounts.

Accounting entries and examples

2.154 The Manual for Accounts gives details of the correct disclosure of the various
      movements in the Notes to the accounts on tangible fixed assets. The examples
      below are intended only to illustrate the principles.

Impairment – price change

In the example the impairment is 100 and the revaluation reserve stands at 20.
Dr             20     Revaluation reserve          The loss can be offset first against
               80     Revenue Account              the revaluation reserve associated
Cr            100     Tangible fixed assets        with the asset.

Impairment – loss of economic benefits

Impairment 100, revaluation reserve 20.

Dr            100     Revenue Account              With the total impairment, as an
Cr            100     Tangible fixed assets        economic loss

Dr              20    Revaluation reserve          To eliminate the balance on the
Cr              20    General Fund/I&E Reserve     revaluation reserve

Impairment - price change (donated asset)

The example shows the treatment of an upwards revaluation from 170 to 250 followed
by an impairment (price change) of 100

Dr              80    Tangible fixed assets
                                                   With the increase in value
Cr              80    Donated asset reserve

Dr             80     Donated asset reserve
               20     Revenue Account              To reflect the impairment
Cr            100     Tangible fixed assets

Dr              20    Donated asset reserve        To neutralise the impact of the
                20    Revenue Account              impairment on the Revenue
Cr
                                                   Account




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Impairment - loss of economic benefits (donated asset)
As above, but the loss is a loss of economic benefits rather than a price change

Dr             100     Revenue Account
                                                           With the impairment
Cr             100     Tangible fixed assets

Dr             100     Donated asset reserve               To neutralise the impact of the
               100     Revenue Account                     impairment on the Revenue
Cr
                                                           Account




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Annex 1 - Definitions
Existing use value

        “An opinion of the best price at which the sale of an interest in property would
        have been completed unconditionally for cash consideration on the date of
        valuation, assuming:
                (a)       a willing seller;
                (b)       that, prior to the date of valuation there had been a reasonable
                          period……. for the proper marketing of the interest, for the
                          agreement of price and terms and for the completion of the sale;
                (c)       that the state of the market, level of values and other
                          circumstances were, on any assumed date of exchange of
                          contracts, the same as on the date of valuation;
                (d)       that no account is taken of any additional bid by a prospective
                          purchaser with a special interest;
                (e)       that both parties to the transaction had acted knowledgeably,
                          prudently and without compulsion;
                (f)       that the property can be used for the foreseeable future only for
                          the existing use; and,
                (g)       that vacant possession is provided on completion of the sale of
                          all parts of the property occupied by the business.”

Depreciated replacement cost (property)

        “The aggregate amount of the value of the land for the existing use or a
        notional replacement site in the same locality, and the gross replacement cost
        of the buildings and other site works, from which appropriate deductions may
        then be made to allow for the age, condition, economic and functional
        obsolescence, environmental and other relevant factors; all of these might
        result in the existing property being worth less to the undertaking in
        occupation than would a new replacement.”

Value of plant and machinery

        “An opinion of the price at which an interest in the plant and machinery
        utilised in the business would have been transferred at the date of the valuation
        assuming:
                (a)       that the plant and machinery will continue in its present uses in
                          the business
                (b)       adequate potential profitability of the business, or continuing
                          viability of the undertaking, both having due regard to the value
                          of the total assets employed and the nature of the operation, and




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                (c)     that the transfer is part of an arm’s length sale of the business
                        wherein both parties acted knowledgeably, prudently and
                        without compulsion.”
Open market value

        “An opinion of the best price at which the sale of an interest in property would
        have been completed unconditionally for cash consideration on the date of
        valuation, assuming:
                (a)     a willing seller
                (b)     that, prior to the date of valuation there had been a reasonable
                        period……. for the proper marketing of the interest, for the
                        agreement of price and terms and for the completion of the sale
                (c)     that the state of the market, level of values and other
                        circumstances were, on any assumed date of exchange of
                        contracts, the same as on the date of valuation
                (d)     that no account is taken of any additional bid by a prospective
                        purchaser with a special interest
                (e)     that both parties to the transaction had acted knowledgeably,
                        prudently and without compulsion.

Extracts from the Appraisal and Valuation Manual (Royal Institution of Chartered
Surveyors, quoted in FRS 15).




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3 Depreciation and asset lives

Introduction
3.1   Depreciation is a measure of consumption of economic benefits, rather than a
      means of valuation. This Chapter outlines the provisions of FRS 10 and FRS 15
      in relation to depreciation in the NHS. Of particular importance is the treatment
      of depreciation of revalued assets.

The concept of depreciation

3.2   Depreciation is defined by FRS 15 as “the measure of the cost or revalued
      amount of benefits of the tangible fixed asset that have been consumed during
      the period”. “Depreciation” is the term normally applied to tangible fixed
      assets, while “amortisation” is used in respect of intangibles – the two terms are
      equivalent, and in this Manual depreciation should be taken also to embrace
      amortisation.

3.3   As noted above, depreciation is not a measure of loss of value and so the
      arguments that it should not be applied to some categories of assets (that have
      indefinite life, perhaps by virtue of routine maintenance and refurbishment) is
      not valid. Only in the case of investment properties, not applicable in the NHS
      (other than for charitable funds), does SSAP19 permit depreciation not to be
      recognised. Depreciation must be charged whether or not there has been a loss
      in value over the period. UK GAAP points out that the concept of depreciation
      is one of profit and loss rather than balance sheet – it matches the consumption
      of an asset with the benefits arising from its use in a given period.

3.4   Depreciation is not intended to provide a fund for replacement, as FRS 15
      makes clear.

          The operation of the NHS trusts capital charges regime (see also
          Chapter 5) does indeed have the effect of generating a pool of cash
          from which replacement assets may be partially or wholly provided.
          This is however a function of the NHS trust financial regime and
          funding mechanisms rather than a function of the concept of
          depreciation.

Depreciation policy for NHS bodies
3.5   The policies set in accordance with the Accounts Direction to comply with UK
      GAAP and the FReM are outlined below.

3.6   The NHS adopts a policy of straight-line depreciation. FRS 15 suggests that
      this method is usually adopted as a default where the pattern of consumption of
      economic benefits is uncertain (as it generally is in the NHS specialised estate).
      This being the policy adopted for the NAWs Summarised Accounts, other
      methods (e.g. reducing balance, sum of digits methods) are not permissible.


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Land

3.7    Land is not depreciated, because it is considered to have an infinite life.

Building assets

3.8    Building assets are depreciated over the period of their assessed lives, as
       determined by District Valuers’ valuations. Property consists of land and
       building elements, and Valuers will apportion the cost of the property between
       (depreciable) buildings and (non-depreciable) land elements.

3.9    Surplus buildings with a known disposal date (but still in operational use)
       continue to be carried at their DRC or OMVEU valuations, but are depreciated
       at a rate such that they reach their OMV for disposal value on the disposal date
       (see paras 3.23 – 3.27 for accelerated depreciation).

Equipment

3.10 Equipment is depreciated over its useful economic life. Prior to 1999-2000,
     standard lives for various categories of assets were determined by the NAW, but
     the implementation of FRS 15 requires Directors of Finance to review
     equipment asset expected lives (and residual values) at the end of each
     accounting period. This may lead to a departure from standard lives where
     expectations of useful economic life are "significantly different".

3.11 FRS 15’s instruction is:

           “The useful economic life of a tangible fixed asset should be reviewed at the end of
           each reporting period and revised if expectations are significantly different from
           previous estimates. If the useful economic life is revised, the carrying amount of the
           tangible fixed asset at the date of the revision should be depreciated over the revised
           remaining useful economic life”

and on residual value:

           “Where the residual value is material it should be reviewed at the end of each
           reporting period to take account of reasonably expected technological changes
           based on prices prevailing at the date of acquisition (or revaluation). A change in
           its expected residual value should be accounted for prospectively over the asset’s
           remaining useful economic life, except to the extent that it has been impaired at the
           balance sheet date”.

3.12 FRS 15 however only requires a change in the depreciation profile of an asset to
     be made where the review suggests that a “significant” adjustment to lives or
     residual value is appropriate. It is suggested then that NHS bodies adhere to the
     standard lives of equipment assets as laid down in previous Manuals, and
     repeated below, adopting individual lives only where it is clear that the standard
     lives are materially inappropriate:
         •   Short life engineering plant and equipment - 5 years
         •   Medium life engineering plant and equipment – 10 years


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         •   Long life engineering plant and equipment – 15 years
         •   Vehicles – 7 years
         •   Furniture – 10 years
         •   Office and IT equipment – 5 years
         •   Soft furnishings – 7 years
         •   Short life medical and other equipment – 5 years
         •   Medium life medical equipment – 10 years
         •   Long life medical equipment – 15 years
         •   Mainframe-type IT installations – 8 years

Residual value

3.13 As noted above – the residual value is based on the prices prevailing at the time
     of purchase or revaluation. It is not an estimate of how much the asset could
     be sold for at the end of its useful economic life. Thus, if an asset has a 6 year
     estimated useful life, the residual value is the net realisable value of a 6 year old
     asset at the date of purchase or revaluation. This means, for example, that
     holding gains cannot be anticipated.

Assets under construction

3.14 Assets under construction are not depreciated, because depreciation is
     appropriate only when assets are in operational use.

Intangible fixed assets

3.15 Intangible fixed assets are amortised over the period of the assets' expected
     economic lives.

Finance leases

3.16 Assets leased under finance leases should be depreciated over the shorter of the
     primary lease term and the assessed remaining life of the asset. If the leased
     asset continues to be used by the lessee after the end of the primary lease term it
     should be revalued by the District Valuer to its residual value. The residual
     value should then be depreciated over the remaining useful economic life of the
     asset.


Chargeable period
Availability for use

3.17 Depreciation is payable on assets from the start of the quarter following the
     quarter in which the asset first became available for use.

3.18 The date at which an asset becomes available for use will not always be clear
     and a realistic approach must be adopted in deciding the appropriate date.


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3.19 Buildings are deemed to become available for use at the earlier of:
         •   first use
         •   the date Unified Business Rate first becomes payable (whether at full or
             half rate).

Disposals and surplus assets

3.20 Depreciation ceases to be payable when an asset is disposed of. Disposal is
     deemed to arise when the asset is no longer available for use and is removed
     from the asset register. This will occur because the asset is:
         •   sold (or ownership is transferred, e.g. in PFI transactions)
         •   recorded in the asset register and losses register as being lost or destroyed.
             An asset that is totally lost or destroyed will be accounted for as being
             disposed of. If a partial loss occurs, e.g. when an asset is damaged, this is
             treated as an impairment and the net book value of the asset will be reduced
             as appropriate. This will result in a reduced depreciation charge
         •   scrapped.

3.21 Depreciation also ceases to be payable when an asset is formally declared as
     surplus, is taken out of operational use, and is revalued to open market value for
     alternative use, but has not yet been disposed of.


Other considerations
Transfer of an asset under construction to use

3.22 Assets under construction are not subject to depreciation, but when they become
     available for use they must be reclassified as buildings or equipment.
     Depreciation is chargeable from the beginning of the quarter following the asset
     becoming available for use.

Functional life adjustment – accelerated depreciation

3.23 The situation often arises where an asset remains in operational use although it
     is scheduled for disposal. This fact does not itself prove impairment, but does
     affect the life and depreciation profile of the asset. The previous NHS practice
     of revaluation with a functional life adjustment is now replaced by the technique
     outlined below.

3.24 When there are firm plans to dispose of a currently operational building asset in
     the future, a review should be carried out of its economic life and residual value,
     and the asset should be depreciated accordingly. In practice this will result in
     accelerated depreciation as the charge is set so as to depreciate the asset down to
     its open market value for alternative use (effectively, its net realisable value).
     This value should be set, in compliance with FRS 15 principles, on the basis of
     current prices. In other words, no attempt should be made to predict its
     realisable value at the future date of sale.



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3.25 The increased depreciation must be included in capital charge estimates at the
     first opportunity. Where there is uncertainty about the date an asset will be
     taken out of operational use, NHS bodies may wish to maintain an assets life
     and depreciation profile unchanged, recognising an economic impairment in the
     year in which the asset is actually taken out of service.

3.26 Where accelerated depreciation is to be calculated in this way, the OMV to be
     used is that of an asset of the same age at the present time, and no attempt
     should be made to predict the OMV at the time of planned disposal. In times of
     inflation then, it is to be expected that the OMV thus established will be lower
     than the OMV ruling at the actual date of disposal, and this may then give rise
     to a profit on disposal. All NHS bodies will need to take care that an OMV set
     in the past is not assumed to be a fair market price for setting contract terms.



3.27 In the unlikely event that the open market disposal value exceeds the current
     carrying amount, it should continue to be carried at depreciated replacement
     cost (this being lower than the recoverable amount) with depreciation charges as
     normal, calculated on its assessed life. The revaluation to OMV on taking the
     asset out of use, and prior to disposal, will then result in a revaluation gain.

Disposal of a surplus asset

3.28 Depreciation is chargeable in the quarter in which disposal of an asset takes
     place. Depreciation is also chargeable in the quarter in which a building asset is
     formally declared surplus and revalued to open market value for alternative use,
     but has not yet been disposed of. No further depreciation is charged on a
     surplus building asset after this point provided that it is not in operational use.

Collective assets

3.29 Collective or grouped assets should be treated as single assets for the calculation
     of depreciation.




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Fully depreciated assets

3.30 When an asset reaches the end of its useful economic life it is fully depreciated,
     giving a nil net book value. If it continues to be used, no adjustment is made in
     the books and its cost and full depreciation continue to be carried (though the
     net of these two is nil), until it is no longer available for use. Fully depreciated
     assets should continue to be recorded in the asset register. The replacement cost
     and accumulated depreciation continue to be indexed, but as the same index is
     applied to both cost and depreciation the net book value remains nil.

3.31 The necessity to adopt this treatment should be rare in future, if estimates of
     useful economic life are made regularly. If the amount of fully depreciated
     assets still in use is significant enough to distort the financial statements, the
     assets should be revalued to their estimated value to the NHS body and further
     depreciated over their estimated remaining useful lives.

Long-life assets

3.32 FRS 15 recognises that some assets with very long lives and/or high residual
     values will attract immaterial levels of depreciation. In the NHS all assets,
     including ones falling into this category, should be depreciated as a matter of
     policy to achieve consistency.

Infrastructure assets

3.33 It is very unlikely that infrastructure assets as defined by FRS 15 and the FReM
     will be found in the NHS. They are generally those assets that form part of an
     integrated network servicing a wide geographical area. Typically, they are
     maintained on a rolling basis and under renewals accounting the expenditure
     required to maintain the operating capacity of the infrastructure asset is treated
     as the depreciation charge for the period and deducted from the carrying amount
     (as accumulated depreciation). Actual expenditure is capitalised as part of the
     cost of the asset as incurred.

3.34 The FReM gives motorway and trunk roads as examples of infrastructure assets
     but excludes local roads. It is clear then that infrastructure assets are unlikely to
     be found in the NHS, and bodies should contact the NAW to discuss the
     accounting treatment to be adopted where it is believed that renewals
     accounting may be appropriate.

Heritage assets

3.35 Heritage assets have cultural, environmental or historical associations that
     confer an obligation on the owner to preserve them in trust for future
     generations. It is unlikely that any NHS body will have any such assets (as
     defined by the FReM), and individual works of art lying outside main national
     collections are unlikely to merit this classification. Characteristics of heritage
     assets are:
         •   A value to the Government and public in cultural, educational and
             historic terms that is unlikely to be reflected in a financial mechanism or
             price


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         •   Established custom or primary statute or trustee obligations that impose
             prohibition or severe restrictions on sale
         •   They are often irreplaceable and their value may increase over time even
             if their physical condition deteriorates
         •   They may require considerable maintenance expenditure, and
         •   Their life is measured in hundreds of years.

3.36 A distinction must be drawn between operational and non-operational heritage
     assets. Operational heritage assets e.g. historic buildings in use, should be
     treated as any other type of tangible fixed asset in terms of valuation,
     depreciation and capital charges.

3.37 Non-operational heritage assets should be valued and capitalised where
     possible. This assists the NHS to inform the public about assets held, aids
     stewardship and informs decisions on holding and maintaining assets. It will be
     necessary for any NHS body holding what may be considered as non-
     operational heritage assets to discuss their classification and accounting
     treatment with the NAW.




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4 Leases

Introduction
4.1   In addressing the accounting treatment for leases and hire purchase transactions,
      SSAP 21 Accounting for Leases and Hire Purchase Contracts sought to
      improve comparability between companies in terms of gearing and asset rates of
      return. Further, it was important that the users of financial statements should be
      able to understand the heavy obligations falling on companies that rely on long-
      term lease finance.

4.2   In the NHS the main impact of SSAP 21 is in the area of Capital Charges,
      Capital Resource Limits and, for NHS trusts, External Financing Limits (EFLs).
      The classification of a lease as “finance” or “operating” determines whether an
      asset is recognised in the balance sheet and so attracts Capital Charges and
      counts as capital expenditure, or is simply a revenue transaction.

4.3   SSAP 21 needs to be considered alongside FRS 5 Reporting the Substance of
      Transactions and the Treasury Guidance Technical Note 1 (revised) on FRS 5
      in dealing with more complex or PFI transactions. FRS 5 gives way to any
      SSAP or FRS containing more specific guidance, and so SSAP 21 is appropriate
      for single transactions, while wider complex arrangements invoke FRS 5. Both
      the SSAP and FRS follow the “substance over form” principle and in complex
      related transactions (e.g. sale and leaseback, PFI schemes) the nature of the
      series of transactions needs to be considered as a whole, rather than
      concentrating on individual transactions.

4.4   The guidance in this Chapter is consistent with the approaches taken by the
      Wales Audit Office and the Valuation Office Service, and (as for the Manual
      generally) complies with Treasury’s guidance on Resource Accounting in the
      FReM.

4.5   Quotations used in this Chapter are, unless otherwise stated, taken from SSAP
      21.

4.6   Chapter 8 on PFI transactions lists some quantitative and qualitative indicators
      that may be of use in helping define lease types.

4.7   The ASB Discussion Paper “Leases: Implementation of a New Approach” is
      mentioned at the end of the Chapter: any subsequent FRS arising from these
      proposals will require major revisions to NHS capital accounting policy.

4.8   NHS bodies should not make any changes in their asset procurement policies
      simply because of possible changes to the accounting treatment. Any change
      will affect all Government entities and Treasury will issue guidance on
      accounting and capital expenditure controls (e.g. External Financing Limit
      (EFL) and Capital Resource Limit (CRL)) in due course. In the meantime,
      purchase or lease decisions should remain based on value for money
      considerations.


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Leasing arrangements between NHS bodies

4.9   There has been a convention that leases between NHS bodies should always be
      treated as operating leases, whatever the terms of the lease. This arrangement
      had the merit of being simple to operate and could be justified as reflecting the
      ultimate control of the asset concerned by the NAW. To comply with UK
      GAAP however, it is necessary for bodies to consider the nature of the lease,
      and treat it as finance or operating as required. There should be no possibility
      of a lease being treated differently in the books of the lessor and lessee, as the
      lack of information that can cause this in the commercial sector does not apply
      in the NHS.


Definitions
Lease

        “A lease is a contract between two parties (the lessor and lessee) for the
        hire of a specific asset. The lessor owns the asset, but conveys the right to
        use the asset to the lessee for an agreed period of time in return for the
        payment of specified rentals”.

Finance lease

4.10 A finance lease is a lease “that transfers substantially all the risks and rewards
     of ownership of an asset to the lessee”.

Operating lease

4.11 “a lease other than a finance lease”.

The lease term

4.12 This “is the period for which the lessee has contracted to lease the asset and
     any further terms for which the lessee has the option to continue to lease the
     asset, with or without payment, which option it is reasonably certain at the
     inception of the lease that the lessee will exercise”. Generally, the lease period
     can be divided into primary and secondary terms. In the primary lease term
     the lessee is committed to make certain rental payments, with a termination
     payment sometimes payable on termination of the primary term. The
     secondary lease term is that in which the lessee may extend the lease if
     desired. The secondary term is normally included in the lease term for the
     purposes of the 90% test (see below) if it is reasonably certain that the lease will
     so be extended. A nominal or peppercorn rent in the secondary term may be
     ignored for the purposes of the 90% test if it is not material.




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Fair value

4.13 “The price at which an asset could be exchanged in an arm’s length transaction
     less, where applicable, any grants receivable towards the purchase or use of the
     asset”. In applying the 90% test, if this value is not known, an estimate may be
     used.


Determining the lease type - the 90% test
4.14 This test is not definitive: UK GAAP notes a move towards more qualitative
     tests in deciding whether risks and rewards of ownership have been transferred,
     with the 90% test being just one factor. It suggests that FRS 5 leans towards the
     approach of considering the factors affecting the economic substance of a
     transaction. NHS bodies are encouraged then to look more widely at all the
     factors surrounding the terms of a lease, given the narrow deterministic nature
     of the 90% test.

4.15 The 90% test is satisfied if the Present Value (PV) of the minimum lease
     payments over the period of the lease amounts to substantially all (i.e. in excess
     of 90%) of the fair value of the asset.

4.16 Minimum lease payments may be made up (depending on the intended use of
     the minimum lease calculation) of:
         (a) the minimum payments over the remaining part of the lease term
         (b) any residual amount guaranteed by the lessee or a party related to him,
             and
         (c) any residual amounts guaranteed by any other party.

4.17 In the calculation of the implicit interest rate for the 90% test, all the above
     components (a), (b)&(c) are used. The lessor will use all the components (a),
     (b)&(c) in his 90% test. The lessee uses (a) and (b) only in his 90% calculation.

4.18 The implicit interest rate is the discount rate that “at the inception of the lease,
     when applied to the amounts which the lessor expects to receive and retain,
     produces an amount (the present value) equal to the fair value of the leased
     asset”. The “amounts the lessor expects to receive and retain” are:
         (a) the minimum lease payments to the lessor [(a), (b)&(c) above] plus
         (b) any unguaranteed residual value: less
         (c) any amounts included in (a)&(b) for which the lessor will be accountable
             to the lessee.

4.19 It is expected that the implicit interest rate will be known in most cases,
     however the lessee may not be in possession of the full details, as the lessor is
     likely to be, to calculate the implicit interest rate. In these circumstances,
     estimates may be made of the amounts the lessor expects to receive, or failing
     that, the rate that the lessee would expect to pay on a similar lease may be used.




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      UK GAAP suggests that where this is not known, the lessee’s rate of
      incremental borrowing should be used.

4.20 As LHBs have no powers to borrow (except in relation to finance leases and PFI
     arrangements) and an interest rate of incremental borrowing is not readily
     available for NHS trusts, the Treasury discount rate of 3.5% + inflation may be
     used instead.

4.21 Examples of the use of the 90% test are given at the end of this chapter. In
     applying the test, NHS bodies and their auditors will need to consider the
     reliability of fair value, residual value and implicit interest rate figures used.
     Care must be taken that these values are not manipulated to produce a figure
     under 90% to “prove” the existence of an operating lease. It is perfectly
     possible for transactions returning a lower PV than 90% to be finance leases in
     substance and vice versa. Other indicators are noted below.


Determining the Lease Type – Other Factors
4.22 UK GAAP notes that affirmative answers to the following questions would tend
     to indicate that a finance lease exists:
         •   if the lessee can cancel the lease, will he bear any losses associated with
             the cancellation?
         •   will the lessee gain or lose from any fluctuations in the market value of
             the residual amount? For example, the lessee could receive a rental
             rebate equalling most of the sale proceeds at the end of the lease
         •   does the lessee have the ability to continue to lease the asset for a
             secondary term at a nominal rental?
         •   is the expected lease term equal to substantially all of the asset's expected
             useful life?
         •   are the leased assets of a specialised nature such that only the lessee (or a
             limited number of other parties) can use them without major
             modifications being made?

4.23 Responsibility for maintenance, insurance etc can be an indicator, but the fact
     that a lessor bears these costs is meaningless if he recovers them through
     rentals.


Property leases
4.24 The principles outlined above apply equally to property leases. Some specific
     considerations are noted below.

Statutory rights of renewal

4.25 The lease agreement may contain an 'option to renew' clause. Alternatively
     there is in England and Wales a statutory right of renewal for a period equal to
     the length of the original contractual term subject to a maximum of 14 years


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      under the Landlord and Tenant Act 1954, assuming the parties have not elected
      to opt out of these provisions. At the end of each renewal period, the statutory
      extension provisions can be reapplied, giving the possibility of a primary lease
      term approaching or equal to the physical life of the building in some cases. For
      leased property assets, unless for operational reasons the contrary is apparent, it
      should be assumed that, where available, statutory rights of renewal of the lease
      will be exercised at the end of the primary lease term. The lessee's intentions
      with regard to continued occupation are not always clear at the inception of the
      lease. Where the lessee has a clear intention not to occupy the building after the
      initial contractual period expires, e.g. when a new building is being constructed
      or services relocated, then the lessee is regarded as having waived his option to
      renew. Where the lessee is unable to clarify his intentions one way or the other
      the assumption by default, in the absence of any contrary information, is that the
      occupation will continue with the statutory right of renewal being invoked on
      the next occasion.

Break clauses

4.26 The existence of a break clause in what appears to be a finance lease can be
     sufficient to make it an operating lease where the power to break lies only with
     the landlord. If, on the other hand, only the lessee has the power to exercise the
     break clause, this should be considered along with all other factors to decide
     whether the lease can be classified as an operating lease or a finance lease.

Other considerations

4.27 Short-term hire of property for a period considerably less than the remaining
     life, e.g. rental of office or storage space for five years when it has a remaining
     life of 30 years, may be regarded as an operating lease. Also a property lease
     may be an operating lease if the purpose for which the asset is used is not a
     main core use or the parties have opted out of the security provisions of the
     Landlord and Tenant Act 1954. Leases of parts of a building where the landlord
     is responsible for repairs to the structure, but does not impose a service charge
     for this, are likely to be regarded as operating leases. Leases where the landlord
     would be expected to be able to obtain possession for their own purposes, e.g.
     parts of former health centres disposed of to GPs and leased back, are likely to
     be regarded as operating leases. In all cases the classification will depend on
     the substance of the lease agreement over the form, in accordance with FRS 5.


Accounting for finance leases – lessees
4.28 NHS bodies will far more frequently be lessees rather than lessors. The
     treatment of assets held under finance leases by the NHS in terms of the 3.5%
     cost of capital. Assets held under finance leases and finance lease creditors will
     be included in the cost of capital calculation when calculating average relevant
     net assets.

4.29 While the asset held under a finance lease attracts a cost of capital charge, the
     related finance lease creditor attracts a negative charge. The net asset value
     held under a finance lease will often therefore be marginal.


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Capitalisation

4.30 The leased asset should be first recorded in the lessee’s books and asset register
     at the present value of the minimum lease payments. In practice, the present
     value of the minimum lease payments in a finance lease will normally be at
     least 90% of the fair value of the leased asset and it is therefore acceptable to
     record the leased asset in the lessee’s books and asset register at its fair value,
     i.e. at valuation (land and buildings), or replacement cost (equipment).

4.31 The date the asset is capitalised will be the date the asset becomes operational.
     Where a contractual commitment is entered into in advance of the operational
     date, a disclosure in the Notes to the Accounts must be made.

Revaluation

4.32 Having taken the leased asset onto the balance sheet as noted above, the asset
     should be revalued before the year-end to place it on the same basis as assets
     owned by the NHS body. Specialised properties will be valued under the
     Depreciated Replacement Cost (DRC) basis of valuation, while other assets
     capable of market valuation will be revalued to open market valuation for
     existing use.

4.33 The District Valuer will carry out a periodic revaluation of leased land and
     buildings, usually every five years. NHS bodies must also revalue leased land
     and buildings on an indication of impairment under FRS 11. Valuation gains
     and losses will be treated as for owned assets, applying the provisions of FRS
     11 and as outlined in Chapter 2.

Indexation

4.34 Annual indexation must be applied to the asset on the first day of the financial
     year. If an asset is leased part way through a year no indexation is applied in
     that year.

Depreciation

4.35 The leased asset must be depreciated on a straight line basis, over the shorter of
     the lease term and the assessed remaining life of the asset (the secondary lease
     period is included in the lease term if it is reasonably certain that the lessee will
     exercise an extension option). Leased land and assets under construction must
     also be depreciated. This is because the depreciation of a leased asset represents
     the consumption of the lease rather than of the asset itself. As land has an
     infinite life and assets under construction have not yet started their lives, the
     choice to depreciate over the shorter of the primary lease term and the asset life
     does not arise; the asset will always be depreciated over the primary lease term.

4.36 The depreciation on leased assets should be charged to the revenue account, and
     is separately identified in the tangible fixed assets Note to the Accounts.

4.37 Depreciation is charged from the beginning of the quarter following the date at
     which the lease is acquired (or becomes available for use). It is charged in the



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      quarter in which the lease expires. Depreciation must be charged even if the asset
      has been sublet for another purpose, whether at a 'peppercorn' rent or otherwise.

4.38 Backlog depreciation will arise on leased assets because of indexation and
     revaluations of the accumulated depreciation. This should not be charged to the
     reserve account but should be debited to the Revaluation Reserve.

4.39 Depreciation will arise on the residual value of an asset (which needs to be
     capitalised) during a secondary lease term. This is charged to the revenue
     account as normal, but matched by a transfer from the revaluation reserve to the
     General Fund/I&E Reserve (where any positive revaluation reserve still remains
     in respect of the asset).

Finance lease creditor

4.40 At the inception of the lease the lessee body will have a financial obligation
     equal to the present value of the total minimum lease payments (or the fair value
     of the asset). The opening lease creditor balance and opening NBV of the
     leased asset will therefore be equal. The lease creditor balance will be reduced
     each year by the amount of the capital element of the annual rental payment,
     and must be shown in the Creditors note to the Accounts, analysed between
     creditors due within one year and creditors due after more than one year.

Finance charges

4.41 The total finance charge is the difference between the total undiscounted
     minimum lease payments borne by the lessee over the primary lease term and
     the capitalised fair value of the leased asset at the inception of the lease. It
     represents the interest element of the rental payments. The finance charge
     should be allocated to accounting periods to produce a constant rate of interest
     on the outstanding balance, or a close approximation. There are three methods
     of doing this:

4.42 Straight-line Method. This is the simplest, but least accurate, method. It
     involves calculating the total finance charge for the term of the lease, and
     apportioning this on a straight-line basis over the full lease term. For example,
     if the total rental payments for a 10 year lease are £20000 and the fair value at
     the inception of the lease is £15000, then the total finance charge is £5000, or
     £500 per year.

4.43 Sum of Digits (Rule of 78) Method. In practice, this is probably the best
     compromise between simplicity and accuracy. It involves establishing, at the
     inception of the lease, the number of rentals that are payable and calculating the
     sum of the digits. For example, if there are 10 rental payments then the sum of
     the digits is 1+2+3+4+5+6+7+8+9+10 = 55. For long lease periods it is best to
     use the formula:
        sum of digits = (n (n+1))/2

        where n is the number of rentals. The finance charge can then be allocated to
        accounting periods using the following formula:



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        Number of rentals remaining/total number of rentals x Total finance charge =
        Finance charge for period.

4.44 For example, in the first year the finance charge will be (10/55) x £5000 = £909,
     in the following year it will be (9/55) x £5000 = £818, and so on. This assumes
     that the rental payments are made in arrears. If the payments are made in
     advance of the accounting period to which they relate, then the sum of the digits
     at the inception of the lease in the example will be 45. The finance charge in
     the first year will be (9/45) x £5000 = £1000 and so on, and no finance charge
     will arise in the final year of the lease term.

4.45 The Actuarial Method. This is the most accurate method, but it involves more
     complex calculations and it is suggested that it should only be used if a material
     difference from the sum of digits result is expected. These differences are likely
     in long leases (e.g. in on-balance sheet PFI) and so should be tested where the
     lease runs for over 10 years. NHS bodies are advised to refer to SSAP21 for an
     explanation of this method of apportioning finance charges to accounting
     periods.

Rental payments

4.46 The rental payment to the lessor consists of a capital element and an interest
     element, the finance charge, representing the lessor's return from leasing out its
     asset.

4.47 The NBV and lease creditor balance will only match when the lease is first
     taken out. Subsequently there will be a mismatch because:
         •   Annual indexation and periodic revaluation will affect the net book value
             of the asset, but will not affect the annual rental payments
         •   Depreciation does not commence until the quarter following acquisition
             of the asset, whereas lease payments and hence the reduction in the
             capital liability may commence before this
         •   If the actuarial or sum-of-the-digits methods of allocating finance charges
             are used, the finance charge will not simply be the rental payment less the
             depreciation for a period.

4.48 Because of the mismatch the depreciation charge in a period does not represent
     the capital element of the rental. The capital element must be calculated as the
     total rental payment for the period minus the interest element (i.e. the finance
     charge). The finance charge is the same in each period if the straight-line
     method of apportionment is used.

Cost of capital charge

4.49 The guidance on Capital Charges Estimates, will be issued each September by
     the Health and Social Care Finance Department. This change will ensure
     compliance with any future changes to Treasury guidance (see Chapter 5:
     Capital Charges).

Improvements to leased assets


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4.50 Normal repair and maintenance expenditure on a leased asset should be charged
     to revenue. Expenditure can be capitalised where it involves renovation or
     upgrading which has significantly enhanced the standard of the asset. The
     improvements should be capitalised and treated as a separate, purchased asset.
     This applies equally to operating and finance leases, even though under an
     operating lease the original leased asset was not capitalised. Depreciation on
     the 'improvements' asset is charged to the revenue account and the asset is
     included in average relevant net assets when calculating the rate of return. The
     life of the improvements will be the shorter of the remaining primary lease term
     and the assessed life of the improvement. On reversion of the original asset to
     the lessor the improvements should be treated as a disposal. Enhancement
     expenditure is discussed in more detail in Chapter 2 .

4.51 Under law in England and Wales, provided the landlord's consent to carry out
     improvements was obtained, improvements remain the tenant's property for a
     period of 21 years from the next renewal of the lease. The improvements
     should be shown on the tenant's balance sheet. If the landlord obtains
     possession, the tenants are generally entitled to compensation based on the
     value of the improvements to the landlord, or, depending on the terms of the
     lease, to take the improvements away. The only exception to this is where the
     improvements were carried out as a condition of the lease and the rent was
     reduced to reflect this requirement. This is sometimes done when property is in
     bad repair and the tenant is really doing some typical landlord's work. In this
     case the improvements are treated as the landlord's for rent review purposes
     after the rent reduction period and should be capitalised by the landlord. The
     lessor would therefore treat such costs as revenue expenditure as no asset is
     created in the lessor's books.

Termination of lease

4.52 Early termination of a finance lease can be considered as a disposal of the
     capitalised asset by the lessee if the asset reverts to the lessor. In this case a
     profit or loss on disposal may arise. Profit/loss on disposal is calculated by
     comparing the net book value of the asset, less the outstanding lease creditor,
     with any final cash settlement.


Operating Leases
Operating Lease incentives

4.53 Accounting for operating lease rentals is straightforward. One complication
     concerns the use of "operating lease incentives". In negotiating a new or
     renewed operating lease, a lessor may provide incentives for the lessee to enter
     into the agreement. Examples of such incentives are an up-front cash payment
     to the lessee or the reimbursement or assumption by the lessor of costs of the
     lessee (such as relocation costs, and costs associated with a pre-existing lease
     commitment of the lessee). Alternatively, initial periods of the lease term may
     be agreed to be rent-free or at a reduced rent.




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4.54 UITF Abstract 28 addresses the issue. The consensus treatment is that the lessee
     should recognise the aggregate benefit of incentives as a reduction of rental
     expense. The benefit should be allocated over the shorter of the lease term and
     a period ending on a date from which it is expected the prevailing market rental
     will be payable. The allocation should be on a straight-line basis unless another
     systematic basis is more representative of the time pattern of the lessee’s benefit
     from the use of the leased asset.


Leases and the External Financing Limit
4.55 Chapter Six gives details of the treatment of finance leases for external finance
     purposes. Essentially, all finance leases are classified as sources of external
     finance, and so count toward the external financing limit.


Accounting for leases – lessors
4.56 NHS bodies will more frequently be lessees than lessors, although one may
     lease out an asset that it owns to another body. This could be another NHS
     body or a private organisation or individual. For operating leases, the asset will
     be shown in the NHS body’s books and asset register at its full value, i.e. the
     value is not reduced to reflect the lease. The asset will be depreciated and
     included in “average relevant net assets”.

4.57 Exceptionally, where existing occupiers (e.g. agricultural tenants and some
     occupiers of dwelling houses) became entitled to security of tenure under the
     relevant Acts, following the removal of crown immunity, the value of the NHS
     body’s freehold interest will be assessed, by the District Valuer, to reflect the
     existence of the tenancies.

4.58 In certain cases where leasehold agreements have resulted in full consideration
     (by means of a capital receipt) being received by the lessor body, the lease may
     be treated as a finance lease. In such cases, the NHS body that granted the lease
     should not continue to record the asset as an operational fixed asset within its
     accounts and will not have to pay depreciation or charge for the cost of capital
     on the asset. Any residual payments, accruing to the lessor after full
     consideration has been received (e.g. from ground rent) should be accounted for
     as miscellaneous revenue income. In essence, the transaction is accounted for
     as a sale or disposal.

4.59 In cases where a NHS body leases out assets at low or peppercorn rent, there is
     a net cost to the NHS. NHS bodies are required to weigh this cost (which
     includes the depreciation and the cost of capital charge on the asset) against the
     overall benefits received from the lessee. These benefits may be of a non-
     financial nature.




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Hire purchase contracts
4.60 In the UK there is normally no provision in a lease contract for legal title to the
     leased asset to pass to the lessee during the lease term. However, under a hire
     purchase contract the lessee may acquire legal title by exercising an option to
     purchase the asset upon fulfillment of certain conditions. The precise
     conditions of a hire purchase contract may vary, but normally when an asset is
     purchased in this way the legal title does not pass to the purchaser until every
     installment has been paid and a small amount, usually included in the last
     payment, is paid which legally exercises an option to buy the asset. In other
     words, to buy on hire purchase is to legally hire the asset until a certain time,
     when an option can be exercised to take over the legal title to the asset. The
     hire purchaser is not normally compelled to complete the transaction, and may
     return the goods and not pay any further installments. They will, however,
     forfeit the right to have any of the previous installments repaid to them. The
     accounting treatment for a hire purchase contract will be basically the same as
     for a finance lease, but the final payment to acquire legal title must be included
     when calculating the present value of the rental payments.


Future developments
4.61 A discussion paper “Leases: Implementation of a New Approach” from the
     ASB and other members of the G4+1 group was issued in December 1999. It
     questions the distinction between operating and finance leases and seems likely
     to give rise to an FRS that will fundamentally affect lease accounting in the UK.

4.62 As stated previously, NHS bodies should not make any changes in their asset
     procurement policies simply because of possible changes to the accounting
     treatment. Any change will affect all Government entities and Treasury will
     issue guidance in due course. In the meantime, purchase or lease decisions
     should remain based on value for money considerations.


Accounting entries
Capitalisation of leased asset
Dr            Tangible fixed assets                With the present value of total minimum
Cr            Creditors                            lease payments (or fair value of asset)

Depreciation of leased asset
Dr            Revenue account                      With depreciation for period (based on shorter
Cr            Provision for depreciation account   of primary lease period or assessed life)


Payment of rental to lessor – finance charge
Dr            Revenue account                      With the finance charge element
Cr            Finance Charges                      of rental payment



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Dr            Finance Charges                      With the finance charge element
Cr            Cash/bank                            of rental payment

Payment of rental to lessor – capital element
Dr            Creditors                            With the capital element of rental
Cr            Cash/bank                            payment

Revaluation of leased asset
Dr            Tangible fixed assets                With increase in value (no adjustment
Cr            Revaluation reserve                  of finance lease creditors)

Dr            Revaluation reserve
                                                   With backlog depreciation
Cr            Provision for depreciation account

Indexation of leased assets
Dr            Tangible fixed assets                With increase in value (no adjustment
Cr            Revaluation reserve                  of finance lease creditors)

Dr            Revaluation reserve
                                                   With backlog depreciation
Cr            Provision for depreciation account

Expiry of lease
Dr            Provision for depreciation           With accumulated depreciation – sets NBV to zero as
Cr            Tangible fixed assets                asset has been fully depreciated over the lease term

Continuation of lease after primary lease term
Dr            Tangible fixed assets                With residual value, calculated or
Cr            Revaluation reserve                  on valuation

Depreciation in secondary lease term
Dr            Revaluation reserve
                                                   With depreciation for the period
Cr            Provision for depreciation account

Rental payment in secondary lease term
Dr            Revenue account                      With total rental payment (all finance charge
Cr            Cash/bank                            as capital element now fully discharged)


Finance lease – example calculation

4.63 Lease of equipment for 10 years. Assessed life is 15 years. Depreciate over 10
     years. Rental payments are £2000 per annum or £20000 total. Fair value at
     inception of the lease is £15000. The total finance charge is therefore £5000,
     and is apportioned using the sum of digits method. The asset is revalued part-
     way through year 3 of the lease.




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      Asset Value Movements in        £          Lease Creditor Movements     £         Fin. Lease Obligations at     £
                Year                                      in Year                          Balance Sheet Date

     YEAR 1
     Opening RC                       15000      Opening Creditors          15000    Within 1 Year                   2000

     Indexation 4%                        600    Total Rental Payment        2000    Between 1 and 5 years          10000

     Indexed RC                       15600      Finance Charge              (909)   After 5 Years                   6000

     Opening AD                             0    Capital Repayment          (1091)   Subtotal                       18000

     Backlog Depreciation                   0    Closing Creditors          13909    Future Finance Charges         (4091)

     Depn. of indexed RC             (1560)                                          Outstanding Obligation         13909

     Closing AD                      (1560)

     Closing NBV                      14040

     YEAR 2
     Opening RC                       15600      Opening Creditors          13909    Within 1 Year                   2000

     Indexation 5%                        780    Total Rental Payment        2000    Between 1 and 5 years          10000

     Indexed RC                       16380      Finance Charge              (818)   After 5 Years                   4000

     Opening AD                      (1560)      Capital Repayment          (1182)   Subtotal                       16000

     Backlog Depreciation                 (78)   Closing Creditors          12727    Future Finance Charges         (3273)

     Depn. of indexed RC             (1638)                                          Outstanding Obligation         12727

     Closing AD                      (3276)

     Closing NBV                      13104

     YEAR 3
     Opening RC                       16380      Opening Creditors          12727    Within 1 Year                   2000

     Indexation 3%                        491    Total Rental Payment        2000    Between 1 and 5 years          10000

     In-Year Revaluation                  337    Finance Charge              (727)   After 5 Years                   2000

     Indexed Revalued RC              17208      Capital Repayment          (1273)   Subtotal                       14000

     Opening AD                      (3276)      Closing Creditors          11454    Future Finance Charges         (2546)

     Backlog Depn (index)                 (98)                                       Outstanding Obligation         11454

     Backlog Depn (reval)                 (66)

     Depn. of indexed RC             (1721)

     Closing AD                      (5161)

     Closing NBV                      12047                                                                          etc...




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5 Capital charges

Introduction
Capital charges

5.1   Capital charges are taken to mean:


       For LHBs
       •          Depreciation and amortisation charged annually to the OCS, and
       •          The cost of capital charge.


       For NHS trusts
       •          Depreciation and amortisation charged annually to the I&E account, and
       •          The cost of capital charge.


5.2   Depreciation is dealt with in Chapter 3, and the cost of capital charge is
      discussed below.

Background

5.3   The capital charging system was designed to:
           •   increase the awareness of health service managers of the cost of capital
           •   provide incentives for the efficient use of capital resources, and
           •   recognise the cost of capital.

5.4   Capital charges reflect the costs of capital which are:
           •   the wearing out of assets – depreciation, and
           •   the money tied up in assets and not available for use elsewhere - cost of
               capital.

5.5   All NHS bodies are required to earn a return (currently 3.5%) on their relevant
      net assets. This capital cost absorption target is set so as to be consistent with
      the returns required from all Government bodies. The FReM requires a cost of
      capital charge for all Government organisations.

5.6   The treatment of Capital Charges differs between LHBs and NHS trusts
      reflecting their differing financial regimes. A circular is issued each year in
      September / October giving details of the capital charges procedure to be
      followed by NHS bodies in Wales.



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Capital charges estimates (CCEs)

5.7   The NAW requires trusts and LHB’s to submit returns detailing NHS bodies’
      estimates of the capital charges they will bear in the next financial year.

5.8   On receipt of the CCEs, the NAW will calculate the overall funding
      requirements to meet NHS capital charges. Generally, adjustments to LHB and
      trust funding baselines will be re-based in respect of capital charge changes that
      arise from price movements. In principle, volume changes do not give rise to re-
      basing.

5.9   It is to be expected that all NHS bodies will find the task of estimating capital
      charges demanding and time consuming: asset acquisitions, disposals,
      revaluations, impairments and reviews of economic life and residual values all
      impact, and need to be predicted up to 18 months ahead. The potential for
      inaccuracy in estimates has increased with the necessity to annually review
      equipment lives and to consider impairments under FRS 11 & 15.

5.10 It is important to make realistic estimates of capital charges, as all NHS bodies
     are now required to charge 3.5% cost of capital on actual average net relevant
     assets through their revenue account. There is no automatic increase to
     Resource Limits to offset the effects of inaccurate estimates of capital charges.


Cost of capital charge – calculation of relevant net assets
5.11 Average relevant net assets are normally found by adding the opening and
     closing balances for the year (as calculated below) and dividing by 2. Opening
     relevant net assets are the values carried forward from the previous year and
     before indexation. In addition, assets transferred from other NHS bodies on 1
     April must be included as opening balances in the calculation (even though
     summarisation schedules may show them as in-year acquisitions). Closing
     relevant net assets are normally those reported at the balance sheet date, after all
     the year’s transactions and valuations have taken place.

5.12 Occasionally, assets are acquired or disposed of by NHS bodies so close to the
     balance sheet opening or closing dates that the calculation of NRAs is
     materially distorted. In these cases it is permissible for bodies to adjust the
     opening or closing balances to give a more accurate average value. A point of
     principle is that NHS assets in aggregate should not be misstated in the
     averaging calculation, and assets must not 'disappear' from NHS accounts as a
     whole through this method. NHS bodies must prepare working papers to
     reconcile the cost-of-capital charge calculated on simple opening/closing values
     to that actually presented in the OCS.

5.13 Liabilities attract a negative cost of capital charge, so it is possible for a
     commissioning body to have a credit to its OCS. The simplest way to view the
     cost of capital charge calculation is to appreciate that a 3.5% charge is made on




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       the total net assets employed (ie including current assets/working balances) with
       a few exclusions as detailed below.

Cost of Capital Charge -

5.14 The calculation of average relevant net assets in 2005-06 is as follows;

LHBs

        Total capital and reserves (total assets employed)                        X
        less donated asset reserve                                               (X)
        less government grant reserve                                            (X)
        less cash balances in Paymaster accounts                                 (X)
                                                                                X/(X)

NHS trusts

        Total capital and reserves (total assets employed)                        X
        less donated asset reserve                                               (X)
        less government grant reserve                                            (X)
        less cash balances in Paymaster accounts                                 (X)
        less National Loans Fund deposits                                        (X)
                                                                                X/(X)




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6 Capital Resource Budgeting

Introduction
6.1   Capital Resource Limits at the time of publication of this manual have not yet
      been introduced in NHS Wales except for Powys LHB. The examples in this
      section are indicative of how they operate in NHS England.

6.2   The introduction of Resource Accounting and Budgeting in the NHS required
      the introduction of a capital control - the capital resource limit (CRL), which
      controls capital expenditure in full accruals terms. All NHS bodies have capital
      resource limits. The CRL is accruals based as opposed to the cash-based EFL
      in NHS trusts.

6.3   Underspends against the CRL can be carried forward (but should not exceed 5%
      of the CRL). Overspends against the CRL are not permitted.

Capital Resource Limits

6.4   A capital resource limit controls the amount of capital expenditure that a NHS
      body may incur in the financial year.

6.5   Initial CRLs are issued before the start of the financial year. CRL adjustments
      are made in the course of the year.

6.6   The charge against the CRL is:
        •     Gross capital expenditure ( including the capitalised value of finance
              leases)
        •     Less, net book value of assets disposed of
        •     Less, capital grants and donations

        Expenditure can be of money or money’s worth – including the OMV of an
        asset “part-exchanged” or swapped for another asset. Assets injected to a PFI
        project in return for a deferred asset are “disposed of” in CRL terms and are
        credited to the CRL calculation.

Example
                                                                             £000s
Gross capital expenditure                                                    50,000
Less, NBV of capital assets disposed of                                      -4,000
Less, capital grants and donations                                          -10,000
Charge against the capital resource limit                                    36,000

6.7   These lines are defined as follows:

            Gross capital expenditure is:



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                •     Expenditure to acquire tangible fixed assets, and
                •     Expenditure to acquire intangible fixed assets, and
                •     The capital value of finance leases taken out in the year

             The net book value of assets disposed of is:
                •     value of capital assets in the balance sheet before disposal 1

             Capital grants and donations are:

                •     Capital income from funds held on trust
                •     Big Lottery Fund money, and
                •     Other grants (EC or other Government Departments included) that
                      are not part of NAW funding

6.8      Note – the credit to the CRL arising on the disposal of fixed assets is equal to
         the NBV (carrying amount) of those assets and not the cash receipt. Assets
         scrapped or demolished are considered as disposed of and so will be recorded
         alongside sales.

6.9      Assets transferred (as opposed to purchased and sold) between bodies within the
         RA boundary are not considered as disposals in the context of the CRL control
         (although they are accounted for as disposals in notes to the balance sheet in
         accounts).

6.10 Where donated assets are transferred from a NHS trust to an LHB, the CRL is
     similarly unaffected. Such transfers are accounted for by the NHS trust as
     disposals, but not in the context of the CRL.

Example: calculation of charge to the CRL

6.11 An LHB incurs capital expenditure of £18,750k; sells a property with an OMV
     of £3,125k; receives a grant of £1,000k and a donation of £320k. The charge
     against the CRL is:
            Gross cap expenditure                           18,750
            Less, NBV of capital assets sold                (3,125)
            Less, capital grants and donations              (1,320)
            Charge against CRL                              14,305

Finance leases and PFI

6.12 On balance-sheet PFI projects, together with finance leases, are charged to the
     CRL in the year in which the asset becomes operational. Where assets (land
     and buidings, typically) are contributed to a PFI project, the disposal of the
     fixed asset counts as a disposal in CRL terms.The capital element of annual
     repayments do not score against the CRL. Capital additions will occur for
     certain PFI assets as a result of unwinding of discount over the life of the asset.

1
    this will be an open-market valuation


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6.13 Annual payments under PFI contracts that are revenue in nature (service
     charges and interest charges) continue to be charged to the Operating Cost
     Statement (OCS), as do finance lease interest charges.

The rest of this chapter deals with NHS trusts


External Financing and Capital Resource Budgeting for NHS trusts

Introduction

6.14 The External Financing Requirement (EFR) and External Financial Limit (EFL)
     are fundamental elements of the NHS trusts financial regime. As funding and
     expenditure control mechanisms they are not directly relevant to a manual
     dealing with capital accounting, but in view of their inter-relation with capital
     financing and capital charges an outline of their use is worth including in the
     CAM.

6.15 Where finance generated by NHS trusts in the course of their operations is
     insufficient to fund all their activities (including the acquisition of assets)
     external finance is required. External finance provided by HM Treasury is a
     charge against the Public Sector Borrowing Requirement (PSBR) and so is
     tightly controlled and monitored.

6.16 The introduction of Resource Allocation and Budgeting in the NHS required the
     introduction of a further capital control - the Capital Resource Limit (CRL).

6.17 The EFL is a cash-based control, while the CRL controls capital expenditure in
     full accruals terms.

The External Financing Requirement (EFR)

6.18 The EFR can be defined as the difference between what a NHS trust plans to
     spend in a year and what it can generate from its operations. In practice, the
     EFR will be the NHS trust’s capital requirement less its internally generated
     resources. The EFR can be negative if it is planned to spend less overall than is
     generated.

      External finance = capital requirements – internal resources

Capital requirement

6.19 The capital requirement consists of:
            •     Expenditure to acquire fixed assets – capital expenditure as defined
                  in Chapter 2; and,
            •     A working capital requirement. This is positive where net working
                  balances increase over the year (e.g. as stocks build up or debtors
                  increase or creditors decrease). It is negative when working balances
                  decrease.



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Internally generated resources

6.20 A NHS trust’s internally generated resources are:
            •     Depreciation charged to the I&E account (provided matching income
                  is received)
            •     Any I&E surplus arising after payment of PDC dividends, and
            •     Cash proceeds from the disposal of assets.

External Financing Limit (EFL)

6.21 Where the NAW approves a NHS trust’s planned capital expenditure, the EFR
     becomes in effect the EFL. A positive EFL arises as a NHS trust is required to
     draw on Government funding or utilise its cash resources. A negative EFL
     arises where the NHS trust is required to repay PDC or save cash.

6.22 Capital charge estimates are important in calculating the level of internally
     generated resources (IGR) and setting EFLs. A lower or higher outturn
     depreciation than planned should not impact on the achievement of the EFL –
     the I&E surplus (another component of IGR) will be higher if depreciation is
     lower, and vice versa, thereby neutralising the effect on the EFL.

Components of external finance

6.23 The following elements count as external finance:
            •     Grants from central government
            •     Issue and repayment (cash) of PDC
            •     All other borrowing regardless of source or time to maturity
            •     The capital value of finance leases and similar transactions where the
                  risks and rewards of ownership remain with the NHS trust.

6.24 The capital element of subsequent lease payments is treated as negative external
     finance (although in NHS trust accounts the calculation of the EFR does not
     take account of the capital element of lease payments. Where cash funding is
     required to meet these repayments, an advance of PDC may be sought from the
     NAW).

6.25 Trust accounts disregard movements of cash in and out of short-term deposits
     for the EFR calculation.

6.26 For NHS trusts, external finance will, in the main, be provided from PDC
     issues/repayments and finance leases.

Finance leases

6.27 All finance leases and most transactions that are in substance borrowing are
     capitalised in Treasury’s control total. The taking out of such a lease can be
     thought of as the acquisition of an asset and the borrowing of the funding for the
     asset in the same transaction.


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6.28 The Treasury definition of a finance lease for these purposes matches the
     accounting definition.
            •     The capital value of a finance lease increases the EFR
            •     The capital value of repayments under a finance lease reduce the
                  EFR (although this is not reflected in NHS trust accounts pro-
                  formas)
            •     The finance charge element of lease payments is a revenue expense
                  that represents a reduction in internal resources
            •     Depreciation on leased assets is a positive internal resource, as it
                  generates cash receipts from commissioners to match the non-cash
                  expenditure item.



Disposal of an asset at other than book value

6.29 The book value of the asset disposed of determines the amount available for
     further capital investment. Where the sale proceeds differ from the final
     carrying amount (which should be OMV for alternative use less disposal costs,
     if material), the profit or loss is taken to the I&E account.

6.30 Where a loss on disposal is incurred, the cash received will be less than the
     capital expenditure that the trust can incur. The "cash shortfall" will then be
     financed from revenue.

6.31 Where the asset realises more than its book value, the profit credited to I&E
     may be spent on increased revenue expenditure or transferred to the CRL to
     finance additional capital expenditure.

Working capital movements

6.32 An important feature of the CRL is that additional capital expenditure cannot be
     financed by the use of working capital (e.g. by an increase in revenue creditors).

The CRL and EFL

6.33 The EFL remains an important control over cash consumption. The EFL will be
     derived from the financing requirement determined by the CRL.

6.34 The EFL is:
            •     The CRL
            •     Less, cash funding from planned depreciation




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7 Donated assets

Introduction
7.1   Chapter 2 on Capitalisation and Valuation outlines the criteria for the
      recognition of donated assets. This chapter gives more detail on accounting for
      the acquisition, depreciation and disposal of such assets.


Accounting for donated assets
Capitalisation

7.2   The provisions in Chapter 2 apply: essentially, donated assets are valued on
      precisely the same basis as purchased assets; being carried at cost, DRC or
      market valuation as appropriate. It is necessary to be able to identify donated
      assets separately from purchased, and this enables disposals and impairments to
      be correctly accounted for.

7.3   Assets provided from National Lottery funds are to be treated as donated.

Revenue expenditure

7.4   Where donations are of assets that fall below the normal capitalisation
      thresholds, the accounting treatment is to record both income and expenditure,
      the expenditure being the value of the items received but not capitalised. No
      entries are made to the revaluation reserve or to the fixed assets note. The
      different Manuals for Accounts give further guidance on this.

Improvements to donated assets

7.5   The normal rules on the capitalisation of enhancement expenditure, and the
      charging of repairs and maintenance to revenue expenditure, apply. Capitalised
      expenditure has the effect of creating a part-purchased and part-donated asset.
      The purchased element should be separately identified and attracts capital
      charges. It does not give rise to any donated asset reserve transactions. Any
      impairment will need to be apportioned between purchased and donated
      elements, because of their different treatments.

Cost of Capital charges

7.6   As shown in the note on calculation in paragraph 5.14, donated assets are not
      included in the calculation of average relevant net assets.

Donated asset reserve

7.7   The donated asset reserve is maintained to: (a) represent the financing
      associated with the receipt of a donated asset (i.e. provides the credit side to the
      transaction debiting fixed assets); and (b) to provide a mechanism for


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      neutralising depreciation, impairments or profit/loss on disposal charged to the
      revenue account in respect of donated assets (a transfer from the donated asset
      reserve is made to the revenue account to match the revenue account charge).

7.8   The donated asset reserve is used to account for the following transactions
      involving donated assets:
         •   On revaluation of donated assets, the debit or credit is taken to the
             donated asset reserve, not the revaluation reserve
         •   On indexation of donated assets, the debit or credit is taken to the
             donated asset reserve, not the revaluation reserve. Indexation
             adjustments are applied in the same way as for purchased assets and so do
             not apply to donated assets received after 1 April in any year
         •   On impairment of a donated asset, the principles outlined in Chapter 2
             (paragraph 2.114) apply. Donated assets are analysed with purchased
             assets in the Fixed Asset Notes to the Accounts, and impairments need to
             be recorded against donated assets as normal. For the sake of
             consistency, impairments of donated assets should be calculated and
             accounted for as for purchased assets, although the use of the donated
             asset reserve means that both “price” and “economic” impairments have
             the same net (nil) impact on the revenue account.
             •    The debit for a price impairment is taken to the donated asset
                  reserve, whereas for purchased assets it would go to the revaluation
                  reserve where a sufficient balance exists
             •    For an economic impairment, the debit is taken to the revenue
                  account, as it would be for a purchased asset. However, an equal
                  sum is debited to the donated asset reserve and credited to the
                  revenue account to neutralise this
             •    The ultimate effect then of either treatment is to reduce the donated
                  asset reserve by the amount of the impairment, and neutralise its
                  impact on the revenue account. The carrying amounts of donated
                  assets continues to equal the value of the donated asset reserve
         •   Depreciation is charged to the revenue account in exactly the same way
             as would the depreciation on a purchased asset. It is chargeable from the
             quarter following the date of acquisition, and in the quarter of disposal.
             A transfer is made from the donated asset reserve to the revenue account
             to match the depreciation charged. No release is made in respect of
             revalued amounts to the General Fund/I&E Reserve (as for purchased
             revalued assets) as the full credit is required in the current year revenue
             account to neutralise the charge.

Disposal of donated assets

7.9   Where equipment is taken out of productive use its value should be written
      down to its recoverable amount, which (as the asset is not in use) will be its net
      realisable value. The valuation fall is analogous to the recognition that the asset
      has been under-depreciated during its period of use, and so the fall should be
      accounted for as an impairment.


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7.10 Surplus land and buildings not in operational use should be revalued to open
     market value for alternative use.

7.11 Property classed as surplus, but still in operational use, must not be written
     down to OMV for alternative use. It should remain in the balance sheet at its
     normal operational valuation (DRC, or OMVEU as appropriate). The
     depreciation charge should however be adjusted such that the asset is fully
     depreciated to its disposal OMV (equal to its expected net realisable value) over
     its remaining life. This accelerated depreciation is again matched by transfers
     from the donated asset reserve to the revenue account.

7.12 Profit or loss on disposal are calculated in the normal way, as the difference
     between the carrying amount and net sale proceeds, and credited or charged to
     the revenue account. A transfer from the donated asset reserve to the revenue
     account is made to match the profit/loss. This transfer is treated as transfer
     from the donation reserve in note 4 to the accounts. The net result of this
     transaction is to re-state the donated asset reserve such that it is equal to the
     value of the sale proceeds. Finally, a transfer clears any remaining donated
     asset reserve balance to the General Fund/I&E Reserve.

Realised donation reserve

7.13 Under the Treasury FReM guidance, it is no longer necessary for NHS bodies to
     maintain a realised donation reserve. On disposal of a donated asset, the entries
     described in the preceding paragraph effect (a) a transfer to or from the donated
     asset reserve to balance any profit or loss on disposal, and (b) the clearance of
     any remaining balance on the donated asset reserve to the General Fund/I&E
     Reserve. Final balances transferred in this way should equal the sale proceeds.

7.14 If the covenants around the original donation require that if the asset is sold it
     must be replaced by another specified fixed asset, the resulting asset is still
     considered as donated and so a donated asset reserve is maintained.

7.15 Where an NHS body chooses to purchase a new or replacement asset, using
     donated asset sale proceeds, no new donated asset is created. The replacement
     or new asset is a purchased, not donated, asset.


Accounting entries for donated assets
Acquisition of donated asset
Dr            Tangible fixed asset (donated)       With cost, DRC, or market valuation
Cr            Donated asset reserve                (equipment at cost)

Depreciation of donated asset
Dr            Revenue account                      With full depreciation charge for
Cr            Provision for depreciation account   period, including on revalued amount

Dr            Donated asset reserve                With the same amount as charged to
Cr            Revenue account                      revenue account above




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Revaluation of donated asset (price change)
Dr              Tangible fixed assets (donated)
                                                             With increase in value
Cr              Donated asset reserve

Dr             Donated asset reserve                         With backlog depreciation (buildings
Cr             Provision for depreciation account            and equipment)
Entries reversed if there is a fall in value on revaluation (and see impairments)

Indexation of donated asset
Dr              Tangible fixed assets (donated)
                                                             With increase in value
Cr              Donated asset reserve

Dr             Donated asset reserve                         With backlog depreciation (buildings
Cr             Provision for depreciation account            and equipment)
Entries reversed if there is a fall in value on indexation

Impairment of donated asset (price change)
Dr              Donated asset reserve
                                                             With fall in value
Cr              Tangible fixed assets (donated)

Impairment of donated asset (economic loss)
Dr              revenue account
                                                             With fall in value
Cr              Tangible fixed assets (donated)

Dr              Donated asset reserve
                                                             With the same amount
Cr              revenue account

Disposal of donated asset – closure of asset account
Dr              Asset disposals account
                                                             With asset valuation
Cr              Tangible fixed assets (donated)

Dr              Cumulative depreciation account
                                                             With the accumulated depreciation
Cr              Asset disposals account

Disposal of donated asset – sale proceeds, profit/loss on disposal
Dr              Cash
                                                             With sale proceeds
Cr              Asset disposals account

Dr              Asset disposals account                      With profit on disposal (entries reversed for
Cr              Revenue account                              loss on disposal)

Dr              Revenue account                              With the same profit as posted above to OCS
Cr              Donated Asset Reserve                        (entries reversed for loss on disposal)

Dr              Donated Asset Reserve                        With the remaining balance – this now equals
Cr              General Fund/I&E Reserve                     the same proceeds




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8 Private Finance Initiative

Introduction
8.1   The objective of the PFI is to harness the benefits of private sector management
      by purchasing services rather than fixed assets.

8.2   The various transactions that comprise a PFI project differ from “routine” NHS
      accounting only by virtue of their novelty and complexity. UK GAAP applies
      equally to PFI accounting and so the provisions on capital accounting contained
      in this Manual, and the guidance on general LHB/NHS trust accounting in the
      various Manuals for Accounts, apply in full to PFI transactions. Specific
      relevant PFI accounting guidance is to be found in:
         •   ASB Application Note “Amendment to FRS 5 – Reporting the Substance
             of Transactions: Private Finance Initiative and Similar Contracts”
             (September 1998).
         •   Treasury Taskforce Technical Note No 1 (Revised) (July 1999).
         •   Land and Buildings in PFI Deals
         •   Website: http://www.doh.gov.uk/pfi/

8.3   The specialised and complex nature of PFI accounting is addressed in detail in
      guidance issued by HM Treasury. The purpose of this Chapter is to highlight the
      key accounting issues arising from PFI and outline their accounting treatment.


FRS 5 and SSAP21
8.4   These standards apply in full to PFI transactions. SSAP21 details the
      categorisation of leases into “finance” or “operating”. Chapter 4 discusses lease
      accounting. In the PFI context, however, lease or lease-type transactions will
      often be part of a wider inter-related series of transactions and so it will not
      always be possible to apply SSAP21 in isolation to individual transactions.
      Rather, FRS 5 should be applied and the substance of the transactions as a
      whole considered. The Treasury Technical Note (TN1) (revised) gives the
      definitive guidance for the Public Sector.

8.5   Similarly, if a PFI contract’s elements are separable such that service elements
      can be identified and valued, the remaining property element can be subjected
      to SSAP21 analysis.




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PFI Accounting
Separation of contract elements

8.6   The first stage of the accounting analysis is to determine if the PFI contract is
      separable (i.e. the commercial effect is that the 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. Any such separable elements that relate solely to services should be
      excluded when determining which party has the asset of property.

8.7   The Technical Note gives examples of separable and non-separable contracts.
      Having excluded any separable service elements PFI contracts can then be
      classified into:
         •   Those where the only remaining elements are payments for property.
             These will be akin to a lease and SSAP21 should be applied or,
         •   Other contracts, where the remaining elements include some services.
             These contracts will fall directly within FRS 5 rather than SSAP21.

Application of FRS 5

8.8   For those assets that fall to be considered under FRS 5, whether a party has an
      asset of the property will depend on whether it has access to the benefits of the
      asset and exposure to the associated risks. This will be reflected in the extent to
      which each party bears the potential variations in property profits or losses. The
      principle is to distinguish potential variations in costs and revenues that flow
      from features of the property from those that do not (and which therefore are not
      relevant to determining who has the asset of the property).

8.9   Service-related variations in costs and revenues are irrelevant to determining
      which party has the asset of property. Thus, penalties related to below-standard
      food quality will not be relevant in considering the holding of a catering facility
      asset.

8.10 In quantitative risk analyses the private sector should be treated as one single
     entity (so the contractor’s laying off risks to other private sector entities will not
     affect the comparative risk analysis). The potential variations in property
     profits must be evaluated in NPV terms using the real discount rate used by
     Treasury in the evaluation of public sector projects (currently 3.5%).

8.11 The Technical Note discusses the following types of risk in quantitative terms:
         •   Demand risk
         •   Design risk
         •   Construction risk
         •   Penalties for under-performance or non-availability
         •   Potential changes in relevant costs



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         •     Obsolescence and changes in technology
         •     Residual value risk

8.12 Qualitative indicators of asset holding:

     Feature          Indications that the property is an    Indications that the asset is an asset
                            asset of the NHS body                      of the operator
Termination for   The Application Note says: “a             There is no guarantee that the bank
operator default  financing arrangement would be            financing will be fully paid out by
                  indicated where, in the event that        the purchaser.
                  the contract is terminated early, the
                  bank financing will be fully paid out
                  by the purchaser under all events of
                  default, including operator default".
Nature of         “An assessment of the operator’s          The level of equity funding should
operator’s        financing arrangements (all aspects       not be used as an indicator that the
financing         should be taken into account, eg the      property is an asset of the operator,
                  use of senior or subordinated debt        because the operator may require
                  and the presence of any guarantees)       that level of equity to match the
                  may indicate a level of debt funding      service risk it has accepted under the
                  that could be credible only if            contract. This is therefore a one-
                  another party stood behind the            sided test.
                  operator.”
                  This means that very high levels of
                  gearing are an indicator that
                  insufficient risk has been transferred
                  and that the property is an asset of
                  the purchaser.
Who determines “The purchaser determines the key            “The operator has significant and
the nature of the features of the property and how it       ongoing discretion over how to fulfil
property          is to be operated, bearing the cost       the PFI contract and makes the key
                  implications of any changes to the        decisions on what property is built
                  method of operation. The purchaser        and how it is operated, bearing the
                  may determine the key features of         consequent costs and risks. For
                  the property explicitly by agreeing       example, this would be the case if
                  them as terms of the PFI contract         the operator is free to redesign the
                  or, for example, through a                property extensively during the term
                  contractual acceptance provision at       of the contract (perhaps even to
                  the end of the construction phase.        scrap the original property and
                  Alternatively, the purchaser may          build a replacement), in the hope of
                  implicitly determine the key features     reducing its costs. Similarly, in a
                  of the property. For example, a           PFI contract to design, build and
                  contract for a road may specify that      operate a road, the operator may
                  the road will revert to the purchaser     have complete discretion over the
                  in a predefined state after a             balance between the quality of the
                  relatively short period: this may         original road build and the
                  have the effect that the operator has     consequent level of maintenance
                  little discretion over the standard of    costs.”
                  road to build in the first instance or    The operator may have the freedom
                  how it is maintained subsequently.”       to make design changes during the


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                    For the avoidance of doubt: The fact    construction period that, whilst not
                    that the key features of the property   being necessary to meet the contract
                    are recorded in the PFI contract,       requirements, are made in the
                    which is agreed by the purchaser,       expectation of reducing (or avoiding
                    does not necessarily mean that the      an increase in) expected operating
                    purchaser has determined those key      and life cycle costs.
                    features.
                    In practice, prior to service
                    commencement, the operator may
                    be required to demonstrate to the
                    purchaser that the arrangements put
                    in place will meet the output
                    specification. Acceptance of the
                    service by the purchaser (based as
                    far as possible on service
                    commencement based tests), without
                    any “approval” of the means of
                    delivery of the service will not, in
                    most cases, mean that the purchaser
                    determines the key features of the
                    property.

Required accounting
Purchaser (NHS body) has an asset of the property

8.13 Where it is concluded that the purchaser has an asset of the property and a
     liability to pay for it, these should be recorded in its balance sheet. The initial
     amount recorded for each should be the fair value of the property, and the asset
     should be recognised in the balance sheet in its first year of operation. Finance
     lease commitments (i.e. contracts entered into but asset not yet delivered) must
     be disclosed in the accounts but should not be capitalised.

8.14 Subsequently, the asset should be depreciated over its useful economic life and
     the liability should be reduced as payments for the property are made. In
     addition, an imputed finance charge on the liability should be recorded in
     subsequent years using a property-specific rate. The remainder of the PFI
     payments (i.e. the full payments, less the capital repayment and the imputed
     financing charge) should be recorded as an operating cost. If the purchaser has
     any other obligations in relation to the PFI contract, these should be accounted
     for in accordance with FRS 12 ‘Provisions, Contingent Liabilities and
     Contingent Assets’.

8.15 Generally, the purchaser should recognise each property when it comes into use.
     An exception is where the purchaser bears significant construction risk, in
     which case it should recognise the property as it is constructed.

8.16 For NHS trusts, there will be charges to the EFL and CRL at the point the asset
     is capitalised.




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Operator (PFI Partner) has an asset of the property

8.17 Where it is concluded that the purchaser does not have an asset of the property,
     there may nevertheless be other assets or liabilities that require recognition.
     These can arise in respect of the acquisition of the residual interests and other
     obligations of the purchaser and in respect of contributions.

Residual Interests

8.18 In some PFI transactions, all or part of the property (e.g. the land element) will
     pass to the purchaser at the end of the contract. Where the contract specifies
     that this transaction should take place at market value at the date of transfer, no
     accounting is required until the date of transfer, as this represents future capital
     expenditure for the purchaser.

8.19 Where the contract specifies the amount (including zero) at which the property
     will be transferred to the purchaser at the end of the contract, the specified
     amount will not necessarily correspond with the expected fair value of the
     residual estimated at the start of the contract. Any difference must be built up
     over the life of the contract in order to ensure a proper allocation of payments
     made between the cost of services under the contract and the acquisition of the
     residual. At the end of the contract the accumulated balance (whether positive
     or negative), together with any final payment, should exactly match the
     originally estimated fair value of the residual. For example, if the expected
     residual value at the end of a 30-year contract is £20 million, but the contract
     specifies that £30 million should be paid by the purchaser for that residual at
     that date, then a credit balance of £10 million should be accrued over the life of
     the contract, with the corresponding charge each year being included in the
     service expense. The payment of £30 million at the end of the contract will
     extinguish the balance of £10 million and establish an asset of £20 million,
     representing the value of the residual.

8.20 If, during the life of the contract, expectations change so that the expected value
     of the residual falls (but there are no changes to the payments scheduled under
     the contract), then consideration should be given to whether there has been an
     impairment. Ultimately, a positive difference may become negative, in which
     case a provision is required. Using the example above, if the expected residual
     value fell to zero after five years, then an expense and liability of £20 million
     would be recorded immediately. The remaining £10 million is still accrued
     over the life of the contract, giving a final liability of £30 million which is paid
     at the end of the contract.

8.21 It should be noted that an asset thus created falls to be included in the
     calculation of relevant net assets and so impacts on capital charges. The asset is
     carried in the balance sheet under the relevant category (land or buildings),
     rather than as a current asset (as is the case with deferred assets, for example).

8.22 Unitary payments should be analysed between service costs (revenue) and the
     capital element that gives rise to the residual interest. The capital additions
     counting against the CRL will be the unwinding of the discount on residual
     assets.


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Contribution of existing assets – debtor (prepayment)

8.23 Contributions to a PFI contract by the purchaser may take a number of forms,
     including an up front cash payment or the contribution of existing assets for
     development by the operator. The accounting treatment of such contributions
     depends on whether they give rise to future benefits for the purchaser. For
     example:
         •   If the contribution of an existing property results in lower service
             payments, the carrying amount of the property should be reclassified as a
             debtor (prepayment) in current assets and subsequently charged as an
             operating cost over the period of reduced PFI payments. The asset is
             valued at the NPV of the future stream of service payments savings. If
             there is in effect a sale of part of the contributed asset (for example, a
             parcel of surplus land that is not used in the PFI contract), any profit
             should be recognised
         •   If the contribution does not give rise to a future benefit for the purchaser,
             it should be charged as an expense when the contribution is made. For
             example, a capital grant might be given for which the operator would
             have qualified even if the transaction had not been part of the PFI, or
             short life assets might be donated to the contract for no value. Disposal
             of a capital asset in this way will result in a loss on disposal of assets as a
             charge to the Operating Cost Statement, as the asset is disposed of for no
             consideration
         •   Land and Buildings in PFI Deals gives more detail on the recognition and
             handling of such assets.

Disclosure requirements

8.24 The disclosure requirements for a lessee under a PFI contract are set out in
     SSAP21: Leases and the Purchase Contracts. However to take account of the
     long term nature of most PFI contracts, the following additional disclosures are
     required for off balance sheet transactions and the “services” element of any on
     balance sheet transactions:
         •   The total amount charged as an expense in the Operating Cost Statement
             in respect of PFI transactions;
         •   The payments which it is committed to make during the next year,
             analysed between those in which the commitment expires:
             •    within one year
             •    in the 2nd to 5th year inclusive
             •    in the 6th to 10th year inclusive
             •    and so on in five year bandings

8.25 Since the annual payments under PFI contracts are likely to vary from year to
     year, beyond an adjustment due to indexation, the payments in later years might
     differ from those which the purchaser is committed to make during the next
     year. If the estimated annual payments in future years are expected to be


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      materially different from those which the purchaser is committed to make
      during the next year, the likely financial effect also needs to be disclosed in the
      financial statements.

8.26 The following information is also required for those schemes assessed as off
     balance sheet:
         •   description of scheme
         •   estimated capital value, and
         •   contract start and end dates.

8.27 The disclosure requirements of paragraph 30 of FRS 5: Reporting the substance
     of transactions are also relevant to PFI transactions. This requires that:
         •   the disclosure of a transaction in the financial statements; whether or not
             it has resulted in assets or liabilities being recognised or ceasing to be
             recognised, should be sufficient to enable the user of the financial
             statements to understand its commercial effect, and
         •   where a transaction has resulted in the recognition of assets or liabilities
             whose nature differs from that of items usually included in the relevant
             balance sheet heading, the differences should be explained.

8.28 Therefore, even where the transaction does not result in any items being
     recognised in the balance sheet, the transaction may give rise to guarantees,
     commitments or other rights and obligations which, although not sufficient to
     require recognition of an asset or liability, require disclosure in order that the
     financial statements give a true and fair view.




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9 Asset registers

Introduction
Maintenance of an asset register

9.1   Each NHS body must maintain an asset register. Asset registers support the
      annual accounts and so are subject to audit by an auditor appointed by Wales
      Audit Office. The benefits arising from keeping a comprehensive asset register
      are:
         •   improved physical asset accountability and risk management
         •   access for managers to an information system covering all their assets
         •   the provision of a firm baseline for improved asset management
         •   the capacity for a planned asset maintenance, repair and replacement
             programme
         •   assistance in the calculation of capital charges
         •   the ability to make comparisons between NHS bodies of a similar type
             e.g. between NHS trusts.

9.2   The asset register may also be used to ensure proper management and control
      over assets that cost less than the capitalisation threshold or those held under
      operating leases. If this is done, the asset register must be so designed to ensure
      that capital assets are distinguishable from non-capital assets.

Minimum data set

9.3   The minimum data set to be used to establish and maintain an asset register for
      capital accounting purposes is as follows:
         •   Asset identification and description
         •   Asset location
         •   Date of acquisition
         •   Method of acquisition
         •   Initial capital expenditure
         •   Gross replacement cost (for equipment)
         •   Depreciated replacement cost (for buildings)
         •   Cumulative depreciation charged (including buildings since date of
             acquisition or revaluation)
         •   Indexation adjustments
         •   Revaluation adjustments
         •   Impairments


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         •   Assessed life

9.4   This is a minimum data set for accounting purposes, and should permit the
      analysis of the revaluation reserve asset by asset. Additional data will be
      required for asset management purposes. Data recorded in the minimum data
      set should allow a NHS body to produce reports that detail the revaluation
      reserve attached to individual assets, and show a value for historic cost
      depreciation that can be compared with current depreciation to calculate the
      revaluation reserve to General Fund/I&E Reserve annual transfer.

Scope of asset registers

9.5   All capital assets must be itemised on the asset register, including donated
      assets, assets held under finance leases, collective assets, and fully depreciated
      assets. The initial equipping and setting-up costs of a new building must be
      included where these are capitalised.

9.6   The asset register must clearly distinguish between:
         •   purchased capital assets on which depreciation is charged and a cost of
             capital charge made
         •   leased capital assets
         •   donated assets which are depreciated (although the depreciation charge is
             met from the donated asset reserve), but upon which no cost of capital is
             charged
         •   assets provided under Government grants
         •   non-capital assets
         •   grouped assets.

9.7   The asset register must be structured in such a way as to itemise:
         •   land separately from the buildings upon the land
         •   different buildings on the same site with:
                 building structure
                 engineering services
         shown separately.

9.8   The asset register may itemise the different building elements.

9.9   The asset register must also be designed so as to allow the allocation or
      apportionment of depreciation charges to the appropriate cost centre.

9.10 Where assets are disaggregated for the purpose of applying separate
     depreciation regimes to different components, registers must facilitate this.


Periodic Revaluations



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9.11 Land and buildings are revalued by District Valuers periodically and given an
     assessed remaining life at the time of the revaluation.

9.12 Where other changes occur between formal revaluations, and a valuation is
     considered necessary, LHB’s and NHS Trusts should approach their local
     District Valuer.

9.13 Land and any retained building elements held as assets in the course of
     construction are subject to periodic revaluations.

9.14 Land and buildings held for operational use are valued at their depreciated
     replacement cost, unless the open market value for existing use can be clearly
     established.

9.15 Land and buildings surplus to requirements are valued at open market value for
     alternative use.

9.16 Land and buildings which have not been formally declared surplus to
     requirements will be assumed to be in operational use at the date of valuation.

9.17 Land and buildings which are donated assets should be identified as such and
     included in periodic revaluations.

9.18 Equipment held for operational use is valued at depreciated replacement cost.
     This is calculated to be the gross replacement cost at current valuations less the
     depreciated to date.

9.19 Equipment surplus to requirements is valued at net recoverable amount.

Annual Prospective Indexation


9.20 The asset base to which annual prospective indexation should be applied will
     include assets in the course of construction and assets acquired through finance
     leases. Estimated asset valuations for a financial year, derived by applying
     prospective indexation, will form the basis of asset valuations and associated
     capital charges to be included within the statutory accounts for that year.

9.21 Separate indices will be issued for land, Buildings and Equipment. These
     indices will be related to publicly available index figures, including the Building
     Cost Information Service Indices (BICS), the Health Service Price Indices
     (HSPI) and the Valuation Office Property Market Report (PMR).



Buildings
Buildings Depreciated Replacement Cost

9.22 For most buildings the District Valuer will use (and make available) a separate
     valuation figure for each of the following 26 categories to derive the buildings


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      depreciated replacement cost. The value of the building will then be the sum of
      these separate valuation figures.

      1 Substructure                          4 Fittings

      2A Frame                                5A Sanitary Appliances
      2B Upper Floors                         5B Services
      2C Roof                                 5C Disposal
      2D Stairs                               5D Water Installation
      2E External Walls                       5E Heat Source
      2F Windows and External Doors           5F Space Heating and Air
      Treatment
      2G Internal Walls and Partitions        5G Ventilation Systems
      2H Internal Doors                       5H Electrical Installations
                                              5I Gas Installations
      3A Wall Finishes                        5J Lift and Conveyor Installations
      3B Floor Finishes                       5K Protective Installations
      3C Ceiling Finishes                     5L Communications Installations
                                              5M Special Installations

As part of the valuation, the District Valuer will provide subtotals as follows:

      1 Substructure                          4 Fittings
      2 Structure                             5 Engineering Services
      3 Finishes


9.23 In some health bodies, the asset register will show each building analysed into
     these five subtotals rather than the 26 constituent building elements. In these
     cases the subtotal valuation figures would be entered on the asset register and
     used to calculate depreciation.

9.24 For certain small or temporary buildings, such as workshops and portacabins,
     District Valuers will give values divided into:

      1 to 4 Building Structure
      5 Engineering Services

9.25 For accounting and capital charges purposes this division (between building
     structure and engineering services) is the minimum acceptable detail for any
     building in operational use.



Existing Use Value

9.26 Where an existing use value will be provided for some buildings of a
     commercial nature, such as office blocks, and most domestic living
     accommodation. The value will be apportioned between land, building structure
     and engineering services.



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9.27 An open market value will be given for land and building assets surplus to
     requirements. This value is not apportioned.

9.28 Covered Ways are defined above as being part of Roads and Services Areas.
     Some Trusts or authorities have treated Covered Ways as separate building
     blocks and this is acceptable.


External Works

External Works Large Sites

9.29 The definition of a large site may vary and is currently “a site of more than 1
     hectare”.

9.30 For these sites external works are grouped into eight categories and each
     category is given a value. Each of the eight categories is reported in a similar
     manner to building blocks and are not further aggregated by the District Valuer.

9.31 The eight categories are defined as follows:


1. Roads and Service Areas

Various Constructions
Kerbs
Footpaths
Covered Ways
Pedestrian Subways

2. Vehicle Parking

Surface Parking
Multi – storey Parking
Underground Parking
Controls

3. Lighting

External Lighting
All Signage
Floodlighting

4. Boundaries Walls and Fences

Various Constructions
Retaining Walls

5. Drains and Sewers



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Drains
Inspection
Chambers
Sewers
Drainage Pumps
Treatment Plant

6. Distribution Pipework

Non Ferrous
Ferrous
Pressurised Steam
Insulation

7. Sundries

Underground Service Walkways
Wells
Helicopter Landing Areas

8. Other Piped and Wire Services

Overhead Electrical
Overhead CommunicationsRadio Masts
Underground Electrical
Underground Communications
Gas Supplies

2. External Works Small Sites

The definition of a small site may vary and is currently “a state of 1 hectare or less”.

For these sites, in the absence of the above full details, the District Valuer will adjust
the valuation by a percentage addition to the value of the building and engineering
elements on the site.




Assets Under Construction

Land Purchased for Building


9.32 This is valued at open market value. The interest element of capital charges is
     payable until the date of commencement of construction.



Commencement of Construction


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9.33 The date construction commences is defined as the date at which the site is
     handed over to the contractor.

9.34 Capital charges are payable at a rate of 3.5% on assets under construction.

9.35 Assets under construction will be valued at the total of:

i.      the value of land;
ii.     any retained building elements within the site under the control of the
        contractor;
iii.    any capitalised expenditure incurred to enable the construction work to
        commence;
iv.     any capitalised expenditure incurred on preliminary works, to enhance the
        prospects of a disposal ;
v.      invoices received for work carried out (whether paid or otherwise);
vi.     the estimated value of work carried out but for which an invoice has not yet
        been received (which should be treated as capital creditors);
vii.     retentions (which should be treated as creditors until settled).

9.36 Assets under construction will be revalued using indices at the start of each
     financial year.

Cessation of Construction Before Completion

9.37 For a formal cessation (i.e. documented instructions received by the contractor),
     the site, together with the value of construction to the date of cessation, is
     revalued by the District Valuer at alternative use value and capital charges are
     payable on that value.

9.38 For informal suspension or delay, the site and part construction continue to be
     valued as assets under construction.


Removal of Building from Operational Use for Refurbishment


9.39 Provided the following conditions are met, the building will be classed as an
     asset under construction:

i.      it is planned to be out of operational use for at least three months; and
ii.     there is evidence of refurbishment or upgrading activity on the site; and
iii.    it must be sufficiently self contained to allow alternative use, ie disposal or
        rent.

Assets Made Available For Use


9.40 The valuation to be given to the asset should be its current value on the date on
     which it is made available for use. This should be calculated on the basis set out
     in paragraph 2 above.



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9.41 An asset may be revalued by the District Valuer as at the date on which it
     becomes available for use.

9.42 Alternatively, in cases where the value has not been formally assessed by the
     District Valuer, the remaining life of the asset which is being made available for
     use should be taken to be 35 years. Where the work involved is of a particularly
     specialist nature a shorter period may be chosen at the discretion of individual
     LHBs or NHS Trusts.

9.43 In cases where only part of the asset is made available for use, eg if a building is
     brought into use on a staged basis, the proportion of the current value which is
     attributable to that part of the asset should be transferred to the appropriate
     tangible assets accounts.



Second – hand Assets
9.44 Second – hand equipment assets should be entered in the asset register as
     follows:


Purchase price

9.45 The value of the asset should equal the purchase consideration and will not be
     considered to have any depreciation attached to it.

Standard Asset Life

9.46 The standard life for the category of asset, ie the fact that the asset is second
     hand is irrelevant.

Annual Depreciation

9.47 Replacement cost divided by standard life.

9.48 This method means that assets are valued at full replacement cost. It also
     recognises that assets purchased second hand are likely to have a remaining life
     that is less than standard life for that category of asset.

9.49 The following example illustrates the method to be used for second hand assets:

9.50 An asset is purchased second hnad for £3,000. The cost if it were new would be
     £5,000. The asset’s standard life is five years.

9.51 It would be included in the books as follows:


        Net Book Value (Replacement Cost less accumulated depreciation):
        £3,000

        Capital charge for quarter following purchase:


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        Depreciation (replacement cost divided by standard life) ie £5,000 / (5 * 4)
        £250

       Rate of return (Net Book Value at 3.5% pa)
       I.e. £3,000 * 0.06 / 4
                £45


Enhancements Altering Value

9.52 Repair and maintenance expenditure is designed to keep assets in good repair.
     This expenditure should be charged as revenue.

9.53 On an exceptional basis, expenditure can be capitalised where expenditure on
     renovation or upgrading has enhanced the value of the asset.


Land & Buildings

9.54 Enhancement expenditure to land and buildings should generally be added to
     the book value of the asset at the time it is incurred. The remaining life of the
     asset should not be extended. It should be depreciated and indexed in common
     with the original asset until the next revaluation by the District Valuer.

9.55 Enhancement expenditure must be treated as an addition to the net book value
     of the asset and not as a revaluation of the asset., within both the annual
     accounts and the asset register. For LHBs, enhancement expenditure should be
     represented by an addition to the capital account.

9.56 Exceptionally, where a building is planned for replacement or disposal (section
     6.4) and capital expenditure is incurred on preliminary works to enable the
     prospects of a disposal to be enhanced, such expenditure should not be added to
     the net book value of the asset. The expenditure may be regarded as an
     enhancement to the open market value of the asset rather than an enhancement
     to its existing use value. In such cases, the expenditure should charged to the
     assets under construction account (section 5.4) until the sooner of:

      i.      the date the building is taken out of use prior to the disposal of the asset;
      ii.     the next revaluation by the District Valuer.

9.57 When the asset is taken out of use prior to its disposal, it will be valued at its
     open market value. When the asset is next revalued by the District Valuer the
     enhancement will be included within the overall valuations of the site as
     appropriate. In either case the expenditure should not continue to be treated as
     an asset under construction.


Equipment



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9.58 In some cases the enhancement may be sufficiently independent to justify the
     creation of a new asset.

9.59 In most cases, however, the expenditure should be added to the current
     replacement value and net book value of the asset. The resulting totals should be
     indexed and revalued, as appropriate, and depreciated over the remaining life of
     the original asset.

9.60 The remaining life of the asset can be extended where the enhancement
     expenditure has significantly extended the remaining life of the asset. The
     extended life must not exceed the standard life of the asset.



Modern Equivalent Asset
9.61 Modern equivalent assets are assets where:

     •   An existing asset would be replaced by assets of a significantly different
         specification;

     •   The cost of the modern equivalent asset is at least £100,000;

     •   The difference between the replacement cost of the existing asset and the cost
         of the modern equivalent asset is at least 25%.

9.62 In practice, modern equivalent assets are likely to be those where technological
     advances mean likely replacements have significantly improved quality or
     quantity of outputs.

9.63 Where these circumstances apply, the replacement value of an existing asset
     should be the cost of a modern equivalent asset and not the cost of replacing the
     current asset.

9.64 The assumptions used must be recorded and agreed with the auditors. This is
     particularly necessary where those assumptions relate to differences in quality
     rather than quantity.

9.65 The modern equivalent asset calculation, which is likely to be exceptional, is
     demonstrated in the following example:

         Current cost of original asset                       £150,000
         (indexed historical cost)

         Cost of modern equivalent asset                      £220,000

         Output of existing asset                             20,000 units pa

         Output of modern equivalent asset                    40,000 units pa

Replacement cost calculation:


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        £220,000 * 20,000 / 40,000 =                         £110,000


9.66 This simple example assumes no difference in operating costs and standard
     lives between the existing and modern assets.

9.67 The result of the calculation is to reduce the cost of the modern equivalent asset
     to what it would be if it had an output comparable to the existing asset.


Surplus Assets

Definition

9.68 Land and buildings which have not been formally declared surplus to
     requirements by the health authority or NHS Trust will be assumed to be in
     operational use at the date of valuation.

9.69 Where buildings have been formally planned for disposal or closure, the District
     Valuer may be asked to reassess the valuation of the buildings and their
     remaining life .

9.70 On closure of the building, prior to disposal, the property must be revalued as a
     surplus asset.

9.71 In most situations it will be relatively clear when an asset has been removed
     from operational use. In particular, buildings prepared for demolition, and
     declared surplus to requirements, would cease to be available for operational
     use.

9.72 In cases of doubt, it should be assumed that an asset has not been taken out of
     operational use except when the complete asset is capable of independent
     disposal.

9.73 Partial closure, eg during a rundown period, will not be regarded as making an
     asset capable of independent disposal.


Basis of Valuation

9.74 Surplus land and building assets should be revalued by the District Valuer at
     their open market value as at the date they are taken out of operational use.

9.75 Equipment surplus to requirements is valued at net recoverable amount but
     revaluation will not be necessary when a standard life asset has been fully
     depreciated.


Capital Charges



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9.76 Capital charges are payable on surplus assets, but these are charged on the new
     valuation, and they are payable as follows until (and including) the quarter of
     disposal:

      •   Land: interest only;
      •   Buildings: interest and depreciation
      •   Equipment: interest and depreciation


Educational Use Assets
9.77 In practice, problems regarding the definition of NHS assets are most likely to
     arise regarding teaching hospitals and other educational bodies.

9.78 This means that capital charges are payable on all educational use assets except
     where the asset was originally funded by another body such as the Welsh
     Funding Councils (formally the University Funding Council). Where
     identifiable elements of a building were NHS funded, the capital charges should
     relate to a valuation of those elements, otherwise a valuation of the whole
     building should be apportioned on the basis of the original contribution.

9.79 Service Increment for Teaching and Research (SIFTR) payments will be
     increased by the amount payable in capital charges on educational use assets. It
     is not therefore necessary to attempt to recover these capital charges through
     increased prices.

9.80 In some instances, there are rental agreements whereby NHS assets are leased to
     teaching hospitals. Capital charges will be payable by the lessor on these assets
     but the rental charge should not be increased accordingly since it is proposed to
     increase SIFTR by the amount of the charge.




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 10 References

 10.1 The following publications are referred to in this Manual:

FRS 5 – Reporting the Substance      1994 (and subsequent Application Notes),
of Transactions                      Accounting Standards Board.
                                     ASB Publications, PO Box 939, Milton Keynes,
                                     MK9 2HT (01908 230344)
FRS 11 – Impairment of Fixed         1998, Accounting Standards Board.
Assets and Goodwill
FRS 15 – Tangible Fixed Assets       1998, Accounting Standards Board.
Guidance - Land and Buildings in     Via the NHS Web
PFI Deals                            http://www.doh.gov.uk/pfi/land.htm


Leases – Implementation of a         1998, Accounting Standards Board.
New Approach - Discussion
Paper
NHS Trust Manual for Accounts

Local Health Boards Manual for
Accounts
Royal Institute of Chartered         Royal Institute of Chartered Surveyors
Surveyors (RICS) – Appraisal         http://www.rics.org.uk
and Valuation Manual
SSAP4 – Accounting for               1990, ASC
Government Grants                    Available from ASB Publications – see above
SSAP13 – Accounting for              1977, ASC
Research and Development
SSAP21 – Accounting for Leases       1984, ASC
and Hire Purchase Contracts
Treasury Technical Note No 1         1999, HM Treasury
(Revised)– How to Account for        0171 270 4558/4860/4870
PFI Transactions                     http://www.ogc.gov.uk/pfi/series_3/technote/tech_contents.ht
                                     m




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11 Useful Web Addresses

        Finman
        Primary Care Trust, StHA, NHS trust, Funds Held on Trust Manuals and
        spreadsheets, Primary Care Trust, Capital Accounting Manuals, Clinical
        Negligence spreadsheets, and Financial Matters.
        www.doh.gov.uk/finman.htm

        Other Department of Health
        Information on Primary Care Trusts can be accessed at:
        http://nww.doh.nhsweb.nhs.uk/nhs/pricare/index.htm

        PFI and capital information can be found at
        http://www.doh.gov.uk/pfi/index.htm

        Reference cost information and the NHS Costing Manual can be found at
        http://www.doh.gov.uk/nhsexec/costing.htm


        Resource accounting and budgeting guidance can be found at:
        http://www.doh.gov.uk/allocations/rab.htm

        Wales Audit Office
        http://www.wao.gov.uk/

        HM Treasury
        http://www.hm-treasury.gov.uk/

        Accounting Standards Board
        http://www.asb.org.uk




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12 List of abbreviations used in the finance manual

ASB             Accounting Standards Board

AVC             Additional Voluntary Contribution

CBI             Confederation of British Industry

CGA             Central Government Accounts

CHC             Community Health Council

NAW             National Assembly for Wales

EFL             External Financing Limit

ELS             Existing [clinical negligence] liabilities scheme

FHOT            Funds held on trust

FRED            Financial Reporting Exposure Draft

FRS             Financial Reporting Standard

GAAP            Generally Accepted Accounting Practice

NBV             Net Book Value

NHS             National Health Service

NI              National Insurance

NIC             National Insurance Contribution

PAYE            Pay As You Earn

PDC             Public Dividend Capital

PFI             Private Finance Initiative

PPA             Prior Period Adjustment

RA              Resource Accounts

RAB             Resource Accounting and Budgeting

RTA             Road Traffic Act



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SAS             Statement of Auditing Standard

SFS             Summary Financial Statement

SSAP            Statement of Standard Accounting Practice

UITF            Urgent Issues Task Force

UK GAAP         United Kingdom Generally Accepted Accounting Practice

VFM             Value For Money

WGA             Whole of Government Accounts




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