Prudential Code for Capital Finance in Local Authorities
Comments from ACCA
May 2003
Executive Summary
The Association of Chartered Certified Accountants (ACCA) is pleased to have this opportunity to comment on the proposed Prudential Code for Capital Finance in Local Authorities (the draft Code). These comments have been prepared in consultation with members of ACCA's Public Sector Technical Issues Committee, a group of experienced accountants working in the public sector.
In ACCA's view, the Code should place greater emphasis on the need for capital investment plans to be sustainable. Thus, for example, further consideration should be given to probable impacts over a longer time frame than just the following three years. In addition, changes to the Government's system of funding capital spending by local authorities may have negative effects on the sustainability of these plans.
We welcome the inclusion in the draft Code of an illustrative report which uses the prudential indicators. We believe, however, that this report would be improved by the inclusion of the following aspects:
- explicit consideration of the effects on the Council Tax of differing levels of capital investment
- a comparison of net external borrowing with the capital financing
requirement of the Council's investment programme
and - further comparative details of the Council's total debt.
We recognise that the draft Code has been written as part of a strategy of securing greater freedom for local authorities to control their own capital expenditure. We make the point, however, that it is not advisable to under-invest in capital infrastructure as this places an undue burden on future generations. Thus, for example, we believe that local authorities are now suffering from past under-investment in their housing stocks. This has resulted in a back-log in maintenance of Council houses totalling approximately £19 billion. As result, authorities are being forced to transfer their stock to housing associations.
General Matters
Reference to Sustainability
The executive summary of the draft Code states that the key objectives of the
Code are to ensure that "the capital investment plans of local authorities are
affordable, prudent and sustainable". Although the draft Code includes sections
on "affordability" and "prudence", we note that there is limited reference to
"sustainability" in the main body of the Code.
To be sustainable, a capital programme must be planned over a much longer
time period than just three years. The draft Code, however, makes limited
reference to a time frame beyond three years although the time frame for capital
investment and the associated borrowing requirement will be measured in decades
rather than years.
At the same time, as a result of the proposed changes to the Government's grant regime, Councils may lose the current integration of borrowing approvals and additional grant which has provided a sustainable underpinning for their borrowing for many years. In the absence of a Government commitment to recognise its obligations for long-term support to local government capital investment, there can be no long-term certainty about the overall resources and commitments of a local authority or the sustainability of its capital resource base.
Reporting prudential indicators
We are pleased that the current draft Code has taken on board our
recommendation that performance indicators should not be reported or used in
isolation. Thus, the draft Code includes (as Appendix C) an illustrative example
of a report on prudential indicators to be included in a Council's budget and
rent setting report. We believe, however, that this illustration needs
considerable improvement if it is to be an example of good practice. For
example, the illustration should include the following aspects:
- explicit consideration of the effects on the Council Tax of differing levels of capital investment
- a comparison of net external borrowing with the capital financing
requirement of the Council's investment programme
and - further comparative details of the Council's total debt.
Paragraph 28 of the draft Code recommends that an authority considers the impact of its proposed capital investment programme on the level of its Council Tax. In addition, at paragraph C16 of the illustration, it is suggested that an authority "could consider different options for its capital investment programme in relation to their differential impact on the Council Tax". No details of this impact are however, provided. It would be helpful and informative if the illustration included an assessment of the effect of the proposed investment programme on the level of Council Tax for at least the next three years. Thus, additional figures for the level of Council Tax over the next three years should also be provided under the following scenarios:
- a capital investment programme of zero
- a capita investment programme of 10% higher than proposed
and - a capital investment programme of 10% less than proposed.
In addition, it would be informative if historical figures were provided for
the relationship between the level of Council Tax and the authorities investment
programme over at least the last five years.
Paragraph 45 of the draft Code states "over the medium term net borrowing
[should] only be for a capital purpose". It goes on to suggest that a comparison
of net external borrowing of a Council with the capital financing requirement of
its investment programme is "a key indicator".
In paragraph C5 of the illustration, however, the Director of Finance only provides the assertion that the authority's net external borrowing was less than the capital financing requirement of the Council's investment programme during the last full financial year. No figures are provided to substantiate this assertion. It would be substantially more informative if the Director of Finance's assertion were to be accompanied by figures showing a comparison of net external borrowing of the Council with the capital financing requirement of the Council's investment programme. These figures should cover at least the last year and also include the projected figures for current and the next three financial years.
Paragraph 64 of the draft code recommends actual external debt as a prudential indicator. Paragraph C9 of the illustration, however, only provides the figure for the authority at the end of the last full financial year. This figure will be largely meaningless unless comparative figures are provided for other authorities (for example the Council's position on the graph provide at page 10 of Appendix B of the first draft of the Code) or in comparison with historical figures for the Council over at least the previous five full financial years. The benefits of such information are emphasised by paragraph 4 of the draft Code which acknowledges that "local authorities will have widely different debt positions� and the differences are likely to increase over time".
We recognise, however, that whilst comparative figures from other authorities
may be useful in putting an authority's debt position in context, it would not
be appropriate for such comparisons to be published. This is because of the
widely different levels of external debt held by individual authorities based on
their individual circumstances and priorities.
In addition, it may be helpful to put the total net debt of the authority in context by providing a comparison with the value of its capital assets and/or its annual revenue over at least the last five years with projections for the current and next three financial years.
We also believe that the performance indicators should be used to assist in the development of local strategic capital expenditure plans and suitable schemes for asset management. All performance indicators should be set in the context of the authority's strategic plans and need to be explained with a suitable narrative.
Maintaining appropriate investment levels
The draft Code is written in a language which suggests that upper limits
should be set on local authority capital investment, but not lower limits. For
capital investment to be sustainable, the associated assets will have to be
adequately maintained over their useful lives. Inter-generational equity also
requires that suitable levels of investment are maintained, at least to maintain
the fabric of local authority properties. Thus, for example, the level of
back-log maintenance on local authority housing, currently estimated at £19
billion, is a burden on present day authorities which limits their policy
options.
It is stated, in paragraph 1(f), that the proposed Code should be consistent with, and support, local asset management planning. Mechanisms to support this objective, however, are not developed. We believe that there should be a further performance indicator to measure any back-log maintenance which may arise from the management of an authority's capital assets.
This suggested performance indicator should be developed within the context of a cyclical condition survey of an authority's capital stock. This should ensure that complete coverage of the authority's capital estate is achieved at least once every ten years and lead to the development of a cyclical and planned maintenance scheme covering at least five years.
The context of performance indicators
The illustration at Appendix C of the draft Code shows the use of the suggested performance indicators in the context of budget and rent setting reports. We believe, however, that they should also be used to assist in the development of local strategic capital expenditure plans and suitable schemes for asset management.
The distinction between indicators and targets
The proposed Code does not make a clear distinction between performance indicators and targets. We believe that, as part of their capital expenditure strategies and plans, authorities should establish clear objectives and measurable targets. Performance indicators may then be used to assist in the assessment of the extent to which these targets are being achieved.
Detailed Points
Setting the Council's budget
At paragraph 9, the draft Code suggests that the full Council is only
"usually" the body that sets the budget for the authority. The exceptions to
this practice should be provided to explain this exceptional practice. These
will include police, fire and other authorities which are not governed by a
Council.
Balance between borrowing and other long term liabilities
The first sentence of paragraph 11 of the draft Code is not clear. Consideration should be given to re-phrasing this sentence to make the recommendation more explicit.
Meaning of the words 'sustained' and 'regular'
The second sub-paragraph of paragraph 21 of the draft Code refers to a 'sustained or regular trend' without explaining what time scale this may cover. The Code should include an explanation of these terms with an appropriate example.
Monitoring Capital Expenditure
In the section of the Code on monitoring against prudential indicators
(paragraphs 20 to 23), no mention is made of monitoring for under-expenditure or
to identify levels of borrowing below the expected figures. We believe that
levels of investment or borrowing below planned levels may also indicate
problems which could result, for example, in a failure to implement an
authority's development strategy. For this reason, we believe that this section
of the Code should be written to indicate that investigations should be
undertaken if the actual figures are significantly above or below the expected
or planned figures.
Stewardship of assets
At paragraph 24, the draft Code states that local authorities are required to
have regard to asset management planning. This section of the Code does not,
however, develop any guidance on this important aspect of the capital financing
of local authority activity. We believe that this section of the Code should
include additional guidance on asset management planning and capital
maintenance.
Three year revenue forcasts
Paragraph 33, which is an explanatory statement, indicates that paragraphs 28 and 29 of the draft Code require the development of 'three year revenue forecasts and three year forward estimates of Council Tax'. These requirements are not explicitly included within the relevant paragraphs and Appendix C does not include the figures for three year revenue forecasts.
Financing decisions
The last sentence in paragraph 56 appears unduly prescriptive. The financing of capital expenditure may be determined at any stage during the financial year.
Other long term liabilities
Commitments to Private Finance Initiative (PFI) contracts are an increasingly significant aspect of local authority finances. For this reason, we believe that, whether or not such commitments are included on an authority's balance sheet, PFI and similar commitments should be included within the definition of 'other long term liabilities'. This requirement should be included explicitly within the definition of other long term liabilities at paragraph 91 of the draft Code.