Accounting for Fair Value through Other Comprehensive Income Mark Swallow

Back in April we saw the Department of Levelling Up Housing and Communities (DLUHC) publish their response to the consultation on the IFRS 9 Statutory Override which saw an extension to this until 31st March 2025.

The override refers to the accounting treatment for changes in the fair values on some of the financial instruments held by local authorities and ensures that any volatility in fair values does not hit the income and expenditure statement and therefore cause difficulty in Council Tax setting on a year-on-year basis.

Under International Financial Reporting Standard 9 (IFRS 9), fair value is considered as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, which for the sake of local government accounts will always be the 31st March.

In most private sector organisations changes in fair value are recognised in the profit and loss account, potentially leading to volatility in annual reported earnings. Local authorities do not operate to generate profits but instead aim to deliver a balanced budget, one that can be funded from the revenues it receives from government grants, local taxation receipts and fees and charges. Under a strict imposition of IFRS 9 swings in fair values could result in higher Council Tax in years where fair values have fallen, but because increases in fair values are not realised until an asset is sold it would not normally lead to a reduction in years where asset prices rise.

An alternative approach is known as electing financial assets as Fair Value through Other Comprehensive Income (FVOCI) which is allowable under IFRS 9 for some asset classes, but auditors have argued that this cannot be applied to certain investments held by local authorities. But what would happen if rather than election taking place, local authorities were able to account for FVOCI for those financial assets that have caused this issue without having to make this election?

Other Comprehensive Income refers to gains and losses that are not included in a local authority’s income and expenditure statement but are instead recognised directly on the balance sheet. By using FVOCI, the effects of fair value changes can be excluded from the regular day-to-day operating activities, thereby minimising the impact on the General Fund. This is what currently happens through the override that is in place, the benefits of making FVOCI the de facto method of accounting for fair value changes would be:

  • Smoother Income and Expenditure profiles: By recognising fair value changes in OCI, local authorities would avoid the direct impact on its revenue budget. This approach would help to smooth out any short-term fluctuations and reduce volatility in the annual budget setting process.
  • Better understanding of the Balance Sheet: FVOCI items are reflected in the Total Reserves section of the balance sheet. Separating fair value changes from the income and expenditure statement improves transparency, enabling stakeholders to differentiate between income and expenditure from core services and those arising from market fluctuations. One of the arguments put forward by auditors is that this would make local authority accounts less comparable with other organisations that account under FVPL, but local authorities do not operate for profit and do not have equity in the same way as private sector organisations, so this argument is flawed.
  • Better Strategic Investment Decision-Making: Most long-term investments that are currently the subject of the override are considered to be strategic in nature and are linked to reserves held for future expenditure. Accounting as FVOCI will allow local authorities to make longer-term decisions on holding these assets or moving between asset classes on a strategic basis rather than making knee jerk decisions based on short-term market volatility.

The override has been extended for a further two years but in its commentary DLUHC hasn’t explicitly stated that that is the end of the road, so there is still time for the sector to lobby the Government and the accounting standard setters to get FVOCI applied as the way to account for these financial instruments.

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