Are You Capital Rich but Revenue Poor?

Tuesday 01 May 2018   Category: Local Authorities By Laura Fallon

Did you know that as a local authority you can capitalise interest costs for assets that are being made ready for use? As with all capitalisation this enables you to spread costs over a number of future years and lowers the immediate revenue impact: with only a little bit of extra accounting treatment you have the potential to lower your council tax bill. Despite this Arlingclose seldom see this option used by our local authority clients representing what we think is a widely missed opportunity.

The treatment is not only common but mandatory in the private sector as International Accounting Standard (IAS) 23 on ‘Financial Instruments: Presentation’ requires that borrowing costs for qualifying assets are capitalised. Under the Chartered Institute of Public Finance and Accountancy (CIPFA) Code local authorities have the option to do this, or not. ‘Qualifying assets’ constitutes an asset that takes ‘a substantial period of time to get ready for its intended use or sale’. This will commonly be assets under construction but does not have to be: if you’ve borrowed to buy equipment that you can’t use yet because the building to house it hasn’t been finished this would also be included.

The ‘borrowing costs’ that can be capitalised may also be wider than you think. These are defined as ‘interest and other costs than an authority incurs in connection with the borrowing of funds’. The CIPFA Code Guidance Notes make it clear that if you as an authority are an external borrower you can capitalise borrowing costs even if you haven’t needed to take out a specific new loan to fund new capital expenditure. The weighted average cost of borrowing over the period the asset is being made ready can be used (potentially good news for authorities with expensive historical debt portfolios).

The policy to capitalise interest or not must be applied equally to all qualifying assets: you cannot do it for some things and not others. The main downside is likely to be the additional accounting entries required in capitalisation including a potential increase to your capital financing requirement and therefore a need to make minimum revenue provision (loans fund repayments in Scotland). As with all capitalisation it does not get rid of the cost but defers it to a future date. You are also required to disclose any capitalised interest and the rate used in your accounts - so capitalisation of interest is not a good way to try to hide any high borrowing costs.

Arlingclose feel that capitalisation of interest is a prudent and relatively easy method for local authorities to make savings in the current difficult climate. It is one that could be used more often.

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