A to Z of Capital – What is Capital Expenditure?

1. A to Z of Capital – What is Capital Expenditure?

2. This session will cover ………… • Context • Key Principle • 3 routes to qualification as capital expenditure • Overview of categories of Fixed Assets • Capitalisation Exercise.

3. Capital Expenditure - context • Capital is big business: • Assets are the second most costly resource for Councils to manage, after staff. • English Council’s own an estimated £250 billion of property. • Two-thirds of this is accounted for by council housing and schools. • This book value has nearly doubled in the last decade and its market value is probably higher. • Capital Rich, Revenue Poor • Authorities have had easier access to capital resources than revenue

4. Capital Expenditure - context • However, there are interesting times ahead… • Sources of capital sources are reducing • Capital investment is being reduced by half over the lifetime of this Parliament (from spend of £49bn in 10/11 to £20.6bn projected spend in 14/15). • Capital receipts are reducing • But opportunities are opening • Government to introduce Tax Incremental Financing

5. Capital – Key Principle Everything is revenue unless you can prove it’s capital • Unless expenditure qualifies as capital it must be charged to revenue in the year it is incurred. • 3 ‘routes’ for qualification as capital. • Just because it costs a lot doesn’t mean it’s capital!

6. Capital – 3 routes for qualification • Spending which results in the acquisition, construction or enhancement of fixed assets (tangible or intangible) in accordance with ‘proper accounting practices’. • Spending which meets one of the definitions specified in regulations made under the Local Government Act 2003. • The Secretary of State makes a directions that the spending can be treated as capital expenditure.

7. Route 1: Proper Accounting practices • Generally (there are exceptions) assets are items held for use in the production or supply of goods and services, for rental to others, or for administrative purposes, and expected to be used during more than one period. • Expenditure on newassets orsubsequent expenditure on an existing asset can only be recognised as capital if: • It is probable that future economic benefits or service potential associated with the item will flow to the entity; and • The cost of the item can be measured reliably. • For expenditure on qualifying assets to be capitalised, it must be directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.

8. Route 1: Proper Accounting practices • Costs (acquisition and/or construction) which can be capitalised include: • purchase price / cost of materials; • other directly attributable costs such as: • employee costs arising directly from the construction /acquisition of the asset; • site preparation; • initial delivery and handling costs; • installation and assembly costs; • costs of testing whether the asset is functioning properly; • professional fees; and • Finance (borrowing) costs (optional). • The initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located

9. Route 1: Proper Accounting practices • Subsequent expenditure • must meet the same requirements as initial spend in order to be capitalised, i.e.: • it is probable that the future economic benefits associated with the spend will flow to the entity; and • the cost can be measured reliably. • Examples include; • replacement of components (component accounting), enhancement costs, major inspection or overhaul. • Subsequent costs arising from day-to-day servicing of an asset (‘repairs and maintenance’), cannot be capitalised because such expenditure maintains the asset’s potential to deliver future economic benefits or service potential rather than adding to it.

10. Route 2: Capital expenditure defined by regulation • Capital Finance Regulations extend the definition of capital expenditure for either: • to recognise that expenditure incurred by an authority has a wider, lasting public benefit than is reflected in the accounting rules for fixed assets or • to provide a disincentive for authorities to enter into certain transactions that would not otherwise have expenditure implications per the accounting rules. • Revenue Expenditure Funded from Capital Under Statue (REFCUS)

11. Route 2: Capital expenditure defined by regulation - REFCUS • These include; • Expenditure incurred on works to any land or building in which the authority does not have an interest, • which would be capital expenditure if the authority had an interest in that land or building. • Expenditure incurred on the acquisition or production of assets for use by a person other than the authority • which would be capital expenditure if those assets were acquired or, as the case may be, produced for use by the authority. • The giving of a loan, grant or other financial assistance to any person, whether for use by that person or by a third party, towards expenditure which would, if incurred by the authority, be capital expenditure • (except for advances made to officers as part of their terms or conditions of employment or in connection with their appointment).

12. Route 3: Capitalisation Direction (1) • Section 16(2)(b) of the Local Government Act 2003 • A capitalisation direction is a relaxation of the normal accounting requirement that long term borrowing or capital receipts should only be used to finance capital expenditure • Enables authorities to apply for specified revenue expenditure to be treated as capital expenditure and funded from capital sources (e.g. borrowing or capital receipts), rather than revenue. • Applications are considered against strict criteria issued annually by the CLG.

13. Route 3: Capitalisation Direction (2) • General criteria includes • Authorities in unavoidable situations incurring costs which are due largely to factors beyond an authority’s control, not for investment to secure future savings. • Generally only appropriate for one-off payments (such as statutory redundancy). • Separate process for equal pay back-pay. • 2010/11 deadline for applications to be submitted for 2010-11 non-equal pay capitalisation is 29 October 2010. • Even if successful, no guarantee that the direction will be for 100% of amount requested.

14. Categories of Fixed Assets under IFRS • Property, plant and equipment (PPE) • Investment property • Intangible assets • Assets held for sale • All of the above must, as a minimum, meet the two asset recognition criteria; • It is probable that future economic benefits or service potential associated with the item will flow to the entity; and • The cost of the item can be measured reliably

15. Categories of Fixed Assets

16. Property,Plant and Equipment – IAS 16 • PPE asset classes include but are not limited to; Infrastructure assets, Community assets, Land, Buildings, Machinery, Office equipment, Assets under construction, Vehicles, aircraft. • Including PFI assets and Finance Lease assets. • Expectation that the asset will be used for more than 1 year.

17. Investment Property – IAS 40 & IPSAS 16 • An investment property is one that is used solely to earn rentals or for capital appreciation or both. • Property that is used to facilitate the delivery of services or production of goods as well as to earn rentals or for capital appreciation does not meet the definition of an investment property and is accounted for as property, plant and equipment (PPE). For example: • If earning rentals were an outcome of a regeneration policy, the properties concerned would be accounted for as PPE rather than investment property. • Social housing is delivering a service and shall be accounted for as PPE.

18. Intangible Assets – IAS 38 • 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.

19. Assets held for sale - IFRS 5 Criteria (all four must be met): • The asset must be available for immediate sale in its present condition subject to terms that are usual and customary for sales of such assets (or disposal groups). • The sale must be highlyprobable; the appropriate level of management must be committed to a plan to sell the asset and an active programme to locate a buyer and complete the plan must have been initiated. • The asset must be actively marketed for a sale at a price that is reasonable in relation to its current fair value. • The sale should be expected to qualify for recognition as a completed sale within one year from the date of classification and action required to complete the plan should indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.

20. Capital – Allowable or not? Exercise.