Service Concession Flexibility David Green

The Scottish Government has introduced flexible accounting arrangements for local authorities that are the grantor in service concession arrangements, including private finance initiative and similar schemes.

This flexibility is around the statutory charge for the capital expenditure on the service concession asset, similar to loans fund repayments for assets funded by borrowing. Previously, local authorities had to make the statutory charge equal to the principal repayment element of the unitary charge payment. That meant they were paying for the asset over the life of the contract.

Now that may be sensible for a leased asset that may be returned at the end of the lease contract, but service concession assets are never returned and are owned by the local authority at the end of the contract. The accounting flexibility allows authorities to pay for these assets over their full useful life, which is usually longer than the contract, and in doing so to make substantial revenue savings over the contract period.

For example, if you are halfway through a 30-year contract for 50-year asset, and the implicit interest rate was 5%, you will have charged 32% of the capital expenditure to revenue under the previous rules, but need only have charged 10% under the new rules. On a £100m scheme that could mean a backdated credit of £22m for the General Fund.

These calculations are based on the annuity method, whereby the combined principal plus interest remain a constant figure, although principal increases and interest reduces over the term, just like with a repayment mortgage.

However, when evaluating the impact of adopting the new flexibility, local authorities must bear in mind that they will shortly adopt a new accounting standard, IFRS 16, for service concession arrangements. This will alter the mix of principal and interest on these and other contracts where the price rises by inflation. Interest is always charged to revenue, but if you adopt the flexible policy and the statutory charge is no longer equal to the principal, IFRS 16 and inflation will alter the overall revenue effect.

Arlingclose is working with a number of Scottish local authorities to evaluate the impact of the various options listed in the government’s circular, all in the context of IFRS 16. Please get in touch if we can be of assistance to you in this complex area.

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