A to Z of Capital – Capital Accounting

1. A to Z of Capital – Capital Accounting Paul Boden – Finance Advisor (Paul.boden@cipfa.org.uk)

2. This Session will Cover………… • Key Principles • Primary Statements contents • Accounting exploring the issues: • Basis of subsequent asset valuation • Revaluation & Impairment of assets • Accounting for capital grants anddonated assets • Capital expenditure not increasing value of asset • Intangible assets

3. Key principles - General • Two sides of the Capital Accounting coin: • Accounting for fixed assets; and • Accounting for capital financing. • An up-to-date and complete Asset Register is a prerequisite for proper fixed asset accounting.

4. Key principles – Balance Sheet (1) • All expenditure on the acquisition, creation or enhancement of fixed assets is accounted for on an accruals basis and capitalised in the Balance Sheet. • All fixed assets are included in the Balance Sheet at their fair value except for • infrastructure assets, community assets and assets under construction (excluding investment property), which are included at historical cost; and • Assets for sale which are valued at the lower of fair value & market value less costs of sale. • With the exception of Investment property and Assets held for sale, all assets included at fair valueare revalued at intervals of not more than five years.

5. Key principles – Balance Sheet (2) • Certain short-lived assets, such as vehicles, plant and equipment, may be included at historical cost as a proxy for fair value, but only on the grounds of materiality. • Impairment loss is not a revaluation; i.e. accumulated depreciation and impairment at the date of impairment are not to be eliminated against the gross carrying amount of the asset or proportionally restated.

6. Key principles – Comp I & E statement • All services, including central support services and trading accounts, are charged with depreciation, for all fixed assets used in the provision of the service. • Where a non-revalued asset suffers an impairment, then an impairment loss should be recognised in the CI&E (charged to the service that uses the asset). • Impairment losses on re-valued assets should be recognised in the Revaluation Reserve up to the balance on the reserve with any remaining impairment loss being recognised in the CI&E. • Where a Revaluation loss results in a valuation below the historic cost net book value (HCNBV), the difference between the new valuation and HC NBV should be recognised in the CI&E.

7. Key principles – CI&E and Reserves • To ensure that depreciation and impairment losses do not impact on the level of local taxation, any debits made to the CI&E are reversed out of General Fund balances by appropriations from the Capital Adjustment Account. This will be reflected in the Movement on Reserves Statement. • The statutory Minimum Revenue Provision/loans fund principal repayment plus any additional voluntary contributions are debited to the General Fund Balance (this will be shown in the Movement in Reserves Statement) as the charge against council tax for the year. • Any revenue financing of fixed assets is accounted for as a transfer to the Capital Adjustment Account from General Fund Balances in the Movement in Reserves. • Just about everything goes through the Capital Adjustment account!

8. Comprehensive I & E Statement Service Accounts (Net Cost of Service) Depreciation Charges Amortisation charges Impairment (when revaluation reserve exhausted) REFCUS Net Operating Exp Gains/loss on disposal External borrowing costs Primary Statements contents

9. Movement in Reserve Statement Removal of items in the I&E that do not impact on general fund Depreciation / Amortisation Charges Impairment & revaluation losses REFCUS Gains/loss on disposal Capital grants Donated assets fair value Movement in fair value investment property/held for sale Add back items not in I&E that impact on general fund Minimum Revenue Provision Capital exp funded by revenue Disposal costs HRA receipts to central govt pool HRA balance The General fund is therefore charged with an amount equal to the revenue finance needed in that year to cover the capital expenditure incurred. Primary Statements contents

10. Balance sheet Non Current (Fixed) Assets Gross increase in asset value due to capital expenditure Reversal of capital expenditure not adding value (impairment) Primary Statements contents

11. Balance sheet Depreciation Recognised against majority of non current assets Is not required for; land – as generally does not wear out; Investment property – as held at market value; Available for sale – as held at market Assets under construction – as only depreciated when are available for use Community assets (generally) - as held at cost because they are held in perpetuity, have an indeterminable life and restrictions on their disposal. Primary Statements contents

12. Primary Statements contents • Revaluation Reserve (1) • Unusable reserves section of the balance sheet. • As assets held on balance sheet at value in use to authority; • Not the same as the cost • Accounts for amounts where the current value net book value (NBV) of an asset is above its historic cost NBV. • Increases (gains) from cost to value in use to Revaluation Reserve • Revaluations at least every 5 years, some more frequently where held at market value

13. Revaluation Reserve (2) Should represent the accumulated amount of valuation gains less amounts written off owing to depreciation and revaluation losses and impairment losses. The total balance on the revaluation reserve must always be the sum of individual balances of the revaluation reserve for each asset – this includes components from 01.04.10. Represents the balancing item that enables assets to be held on the Balance Sheet at current value. Gain (credit) on revaluation Reduced by depreciation applied to gain Reduced by impairment/revaluation loss Reduced by disposal Primary Statements contents

14. Balance at 1st April Upward revaluation of assets Downward revaluation of assets Impairment /revaluation loss charged Surplus/deficit on revaluation posted to Comprehensive I&E Statement Depreciation on revaluation Write out gains on assets sold or scrapped Amount written off to Capital Adjustment A/C Balance at 31st March Primary Statements contents Revaluation Reserve - note 2010-11 £000 X X X X X X X X X X X X X X 2011-12 £000 X X X X

15. Capital Adjustment Account Provides a balancing mechanism between the different rates at which assets are consumed (depreciated) and capital financing set aside to pay for them. It reflects statutory related departures from IFRS – acts as contra entry to general fund adjustments to get back to statutory based accounts rather than IFRS based accounts. Where CAA is in credit this means That capital financing has been set aside at a rate faster than the consumption of the fixed asset the financing was used to purchase. Where CAA is a debit this means That assets are being consumed in advance of the financing. The CAA is not available to the authority to support new investment but effectively represent advance provision against the depreciation of fixed assets. Primary Statements contents

16. Debits Write down of historic cost of asset (via depreciation/amortisation) Impairment of asset Disposal of asset carrying values REFCUS Not resulting in creation of asset Write down of debtor for finance leases Credits Resources set aside to financing capital expenditure Capital Receipts Revenue contributions Minimum Revenue Provision Reduction of revaluation reserve Depreciation/impairment Disposal of asset Reversal of previous impairment loss – where applied to I&E Disposals from revaluation reserve Primary Statements contents Capital Adjustment Account – typical entries

17. Balance at 1st April Reversal of items relating to capital expenditure charged to the Comp I & E statement Charges for depreciation / amortisation Impairment and Revaluation loss on assets REFCUS Write out of balances for assets sold or scrapped Net written out amount of the cost of non current assets consumed in the year Primary Statements contents Capital Adjustment Account – note (1) 2011-12 £000 X X 2010-11 £000 X X X X X X X X X X

18. Capital financing applied in year Use of capital receipts reserve Use of major repairs reserve Capital grants/contributions applied from I&E Capital grants/contributions applied from CG unapplied account Minimum revenue provision Movements in market value of investment properties Movement in the donated asset account Balance at 31st March Primary Statements contents Capital Adjustment Account – note (2) 2010-11 £000 X X X X X X X X X X X X X 2011-12 £000 X X X X

19. Primary Statements contents Capital Reserves - Useable Capital Receipts Reserve (UCRR) • Useable reserve. • Consists of balance of unapplied capital receipts (i.e. realised capital receipts that have not yet been applied to fund capital expenditure). • When capital receipts are realised, after being recognised as income in the Income and Expenditure Account the proceeds posted to a Capital Receipts Reserve in the Balance Sheet via the Statement of Movements in Reserves.

20. Primary Statements contents Capital Reserves - Deferred Capital Receipts Reserve • Useable reserve. • In most authorities these credits will represent the capital income still to be received when disposals have taken place and deferred payments have been agreed. • Normally these will consist of: • principal outstanding from sales of council houses • principal outstanding from advances to housing associations.

21. Primary Statements contents Capital Reserves – Major Repairs Reserve (MRR) • Useable reserve. • Records the unspent balance of HRA subsidy paid to English housing authorities in the form of the Major Repairs Allowance (MRA). • Resources available to meet capital investment in council housing.

22. Basis of Valuation (1) Further detail provided in handout:

23. Basis of Valuation (2)

24. Fair Value (1) In general, unless a more specific definition applies: The amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s-length transaction. Further detail provided in handout:

25. Fair Value (2)

26. Revaluation / Impairment loss • Revaluation / Impairment Assessment under IFRS Fall in prices? Consumption of economic benefit? Across the board ? Specific asset? Impairment IAS36 Revaluation loss IAS16

27. Revaluation Gains • IAS 16 Property, Plant and Equipment (PPE) • Gains are recognised in the asset’s Revaluation Reserve (unless there is a previous revaluation loss or impairment loss on the same asset that has been recognised in the CI&E*1): CR/DR Gross Carrying Amount DR Accumulated Depreciation DR Accumulated Impairment CR Revaluation Reserve The increase in the carrying amount NBV to reflect a revaluation gain *1 Implicit in Code that revaluation gains will be used to reverse any previous revaluation loss on the same asset charged to the CI&E (adjusted for depreciation that would have been charged if the revaluation loss had not occurred).

28. Revaluation Losses • IAS 16 Property, Plant and Equipment (PPE) • A revaluation loss is treated as a revaluation and as a consequence any accumulated depreciation and impairment should be written off against the gross carrying amount: CR/DR Gross Carrying Amount DR Accumulated depreciation DR Accumulated impairment DR Revaluation Reserve DR Comprehensive Income and Expenditure Statement (Direct Services/Support Services/NDC – as defined by BVACOP)* CR General Fund/HRA (via SMR))* DR Capital Adjustment Account * * Entries only required where the new valuation is below historic cost NBV

29. Revaluation Gains reversing Reval losses • Where there is a previous revaluation loss (formally under SORP impairment loss due to general fall in prices) or impairment loss on the same asset that has been recognised in the CI&E, any revaluation gain will be used to reverse this. • Use the revaluation gain to reverse the revaluation loss previously charged to the Comprehensive Income and Expenditure statement (The reversal needs to be adjusted for depreciation to take account of the depreciation that would have been charged had the loss taken place ) i.e. the previous revaluation loss is neutralised. • This reversal will go back to the point where the original revaluation loss took place. Note this can be no earlier than 1.4.2007, when the Revaluation reserve was first created.

30. Impairment Losses (1) • IAS 36 Impairment of Assets • Objective is to ensure that assets are carried at no more than their recoverable amount (i.e. the amount to be recovered through use or sale of the asset). • Examples of impairment: • a significant decline (i.e. more than expected as a result of the passage of time or normal use) in an asset’s carrying amount during the period, that is specific to the asset; • evidence of obsolescence or physical damage of an asset; • a commitment by the authority to undertake a significant reorganisation; and • a significant adverse change in the statutory or other regulatory environment in which the authority operates.

31. Impairment Losses (2) • Annual assessment for indications of impairment required: • If indication of impairment loss – need to estimate recoverable amount. • If no indication of impairment loss, no need to estimate recoverable amount (excepting intangible assets with an indefinite useful life or not yet available for use – these should be assessed annually at any time during the year, irrespective of whether there is any indication that it may be impaired). • Impairments are recognised against; • the Revaluation Reserve up to the balance in that reserve, • any remaining impairment to be charged to the Comprehensive Income and Expenditure Statement. • Ensure reasons for impairment loss are recorded, in order that any linkages with future revaluation gains can be determined and reversals actioned accordingly.

32. Impairment Losses (3) • An impairment loss is not treated as a revaluation; any accumulated depreciation and impairment should not be written off against the gross carrying amount. • Suggested accounting entries: CR Accumulated Impairment DR Revaluation Reserve DR Comprehensive Income and Expenditure Statement (Direct Services/Support Services/NDC – as defined by BVACOP)* CR General Fund/HRA (via SMR)* DR Capital Adjustment Account * The decrease in carrying amount NBV to reflect an impairment loss * Entries only required where the new valuation is below historic cost NBV

33. Reversing an Impairment loss (1) • Requirement to assess, at end of each reporting period, whether there is any indication that an impairment loss recognised in earlier periods for an asset may no longer exist or have decreased. • Indications mainly mirror (but are not limited to) the indications of a potential impairment loss. • If any such indication exists, authorities shall estimate the recoverable amount of that asset. • Reversal of an impairment loss is only permitted to be recognised if there has been a change in this estimate since the last impairment loss was recognised.

34. Reversing an Impairment (2) • Even if no impairment loss is reversed for the asset, it may be that the useful life, the depreciation method or the residual value need to be reviewed. • Reversal of an impairment loss previously recognised in Surplus or Deficit on the Provision of Services shall not exceed the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior years. • Any excess above the carrying amount that would have been determined (net of amortisation or depreciation) had no impairment loss been recognised for the asset in prior years shall be treated as a revaluation gain and charged to the Revaluation Reserve.

35. Accounting for capital grants • Where no condition attached credited to Comprehensive I&E statement below the cost of services to • Taxation and non-specific grant income • (comprising council tax income, NNDR distribution, non-ringfenced government grants, and all capital grants and contributions). • Even where grant service specific • Reversed via Movement in Reserves Statement to • Capital Grant unapplied (useable reserve) • Capital Adjustment Account (where used to finance capital) • Where Condition not to I&E but to creditor until condition met, then via I&E

36. Accounting for capital grants Capital Grant Condition? No Condition? Capital grant received in advance Creditor Recognise in I&E Yes Reverse out thru MiRS Condition met? Money spent? No No Yes Return grant Capital grant unapplied a/c Capital Adjustment a/c

37. What are donated assets? – assets transferred at nil value or acquired at less than fair value. Similar concept as for grants/ contributions. Donated assets transferred at nil consideration will be recognised immediately in the CI&E as income except where there is a condition. Where there is a condition, the asset is credited to the donated asset account (creditor) and recognised in the CI&E once the condition has been satisfied . General fund services, central support services, trading accounts and HRA (BVACOP) shall be credited with the income within CI&E. Due to statute any capital income recognised in the CI&E will need to be reversed out via movement in reserves statement to CAA. Donated Assets (1)

38. Donated assets sit on the balance sheet at fair value The measurement at fair value of an asset, acquired for no consideration or for less than fair value, does not constitute a revaluation Donated assets should be revalued, depreciated and impaired in line with all other PPE assets Donated Assets (2)

39. Accounting for donated assets Donated asset Debit PPE with fair value less consideration paid Condition? No Condition? Credit Donated Assets a/c (Creditor) Credit I&E Yes Reverse out thru SMR Condition met? Capital Adjustment a/c No Return asset

40. Ensure that the expenditure is capital Consider componentisation Revalue asset before expenditure incurred to recognised impairment cap exp will address; Cap exp is then incurred and added to the assets value; Where above doesn’t work Initially add the capital exp to the carrying value of the asset; Determine the value of the asset post expenditure; Impair the amount not increasing the overall value of the asset. Capital Exp not increasing value of asset

41. An identifiable non-monetary asset without physical substance. It must be controlled by the authority as a result of past events, and future economic or service benefits must be expected to flow from the intangible asset to the authority.E.g. computer software. Strict criteria must be met for internally generated intangible assets to be recognised. Development of Websites – an economic or service benefit must arise from the website in order for it to be recognised as an intangible asset. Initial measurement at cost – unlikely that revaluation will be applicable. An intangible asset with a finite useful life is amortised; an intangible asset with an indefinite useful life is not. Intangible Assets

42. Procured intangibles Allowable expenditure Acquisition e.g. software Directly attributable costs to bring the asset into use Professional fees Testing functionality Not allowable Advertising new service Staff training Staff relocation Admin and general overheads Intangible Assets (1)

43. Internally generated intangibles The generation of the asset is classified into a research phase and a development phase. Research phase is expensed As no intangible asset exists Development phase of the project recognised , only after it has become probable that the expected future benefits attributable to the asset will flow to the authority. Design, construction, testing Websites SIC 32 Intangible Assets – Web Site Costs a website whose primary purpose is to provide information about services and objectives does not provide an economic or service benefit and is therefore expensed Intangible Assets (2)

44. Thank you • Questions / Comments