In times of financial stress Revenue budgets come under scrutiny to identify areas where reductions in expenditure can be achieved.
One area which may be overlooked is in relation to interest expenditure which relates to the funding of an asset in its construction period prior to it becoming operational.
Local authorities have been used to the concept of charging design staff salaries to capital on the basis that these costs are integral to the creation of a long-term asset. This happens without concern that staff salaries are essentially a Revenue item. That being the case why is it that local authorities rarely apply the same reasoning to interest expenditure?
Perhaps it’s down to custom and practice of charging all interest expenditure to Revenue? Perhaps it’s because Cipfa’s Accounting Code makes capitalisation of interest optional? Perhaps it’s because it sounds too complicated? Or perhaps it’s probably not material?
Outside of local government it’s common practice to capitalise interest. For one thing International Accounting Standard (IAS) 23 on "Borrowing Costs" requires that borrowing costs for qualifying assets are capitalised. It also makes good sense. Only when an asset becomes operational should its running costs hit P&L. Interest incurred on funding the construction of an asset is not a running cost; just as design staff salaries aren’t.
Identification of interest incurred to fund the construction of a specific asset would be quite easy if loans were drawn down in that manner. In reality that tends not to be the case. Local authorities operate loans pools. Everything goes in the pot. Perhaps this is why capitalisation of interest isn’t widespread because identifying the element to be capitalised may be a bit difficult? It’s certainly not impossible though. In fact crunching those sort of numbers is the sort of thing that accountants thrive on.
So in planning whether savings can be made against the 2020/21 Revenue budget one item on every Treasurer’s list for investigation should be:
You know it makes sense.