Most of the accounting issues have been thrashed out in the literature (our own contribution is Grimsey and Lewis, 2002b), and we do not want to go through them here in part because matters have moved on. It is true that the pivotal issue with respect to the accounting treatment revolves around where the risks lie, and judgements about the relative importance of different kinds of risk are likely to be paramount, for example, the balance between construc- tion risk, design risk, demand risk and residual value risk (Heald, 2003).
However, the real issue is not so much one of whether or not the PPP under- taking is off-balance sheet, and thus whether the arrangement constitutes borrowing in another name, but whether it represents good value for money.
This is the real prerequisite for evaluating the PPP route. The UK Treasury Taskforce guidance on PFI accounting specifically countenanced against sacrificing value for money in the search to obtain off-balance sheet account- ing treatment:
The objective of PFI procurement is to provide high quality public services that represent value for money for the taxpayer. It is therefore value for money, and not the accounting treatment, which is the key determinant of whether a project should go ahead or not. Purchasers should focus on how procurement can achieve risk transfer in a way that optimizes value for money and must not transfer risks to the operator at the expense of value for money. (Treasury Taskforce, 1999, para 1.8) The current position is summarized by the UK Treasury in its July 2003 review of PFI:
The decision to undertake PFI investment is taken on value for money grounds alone, and whether it is on or off balance sheet is a subsequent decision taken by indepen- dent auditors and is not relevant to the choice of procurement route. Almost 60 per cent of PFI projects by value are on balance sheet. (HM Treasury, 2003b, p. 1) This last quotation brings out the point that value-for-money considerations are ex ante. The accounting decision is made ex post, looking at matters after the event.
A major reason why accounting has proven to be such a controversial aspect of PPPs is because the scope of these arrangements strains design boundaries and commercial concepts envisaged by the existing leasing stan- dards. Leasing standards pre-date the emergence of PPP models for involving the private sector in the delivery of services (dependent on infrastructure assets). When the leasing standards were drafted they did not contemplate the more complex and interwoven risk transfers that characterize many PPP service delivery models. Development of an international standard on PPPs still appears some way off, and in the meantime there seems to be a recogni- tion in the industry that the UK approach, in particular Financial Report Standard 5 (FRS 5), constitutes the best available.15
Accounting principles distinguish property, an asset, from services, accounted for as current expenditure. In the case of a PPP, the issue is whether to regard the resulting property as an asset of the government or to record the stream of unitary charge payments as expenditure in the year in which they occur. Whether a party has ‘an asset of the structure or property’ will depend on whether it has access to the benefits, and exposure to the risks, normally associated with ownership of that property. FRS 5 methods seek to resolve this fundamental question by employing a standard set of tests to measure the quantum of key risks for the type of property (assets) involved, and then esti- mate which party bears the overall majority of the risks. An example might be where a building or other facility is needed to fulfil a contract for services, and there is a need to determine which party has an asset of that property, and recognize the identified assets and corresponding liabilities.
A starting point of the accounting analysis under FRS 5 is to determine if the contract is separable; that is, whether the commercial effect is that indi- vidual elements of the contract payments operate independently from each other. ‘Operate independently’ means that the elements behave differently and can therefore be separately identified. The more integral the asset is to the provision of the service, the more likely the asset will not be separable. If the contract is not separable down to any underlying amounts, FRS 5 methods will directly apply. Should the contract be separable, and can be reduced down to the supply of an asset, leasing rules can be used to determine whether the arrangement is a finance lease (on balance sheet) or an operating lease (off balance sheet) by reference to the payment stream for the asset.
Once separability has been assessed, the essential principles of FRS 5 as applied to PPPs can be summarized as follows:
• if property is necessary to fulfil a serviced contract, the party which has an asset of the property must be determined;
• a party will have an asset of the property when they have access to the benefits and exposure to the risks inherent in the benefits;
• the purchaser should recognize an asset and a liability to pay for the asset where the commercial effect of the contract is that the purchaser bears a greater percentage of the risks associated with the potential vari- ations in property profits/losses;
• where the components of the contract payments are separable, those components relating entirely to services are not relevant to determining who has the asset of the property; and
• once separable service elements have been excluded, any remaining elements are either payments for the property, in which case lease accounting applies, or other contracts where FRS 5 applies directly.
In determining who bears most of the risk of the property for the overall contract, it is necessary to weigh up the risks, and determine their relative importance. The UK experience is that it is very rare that one party will clearly show that they hold all the risks and benefits associated with a property. At a minimum, a qualitative assessment of the risks, plus an assessment of non- quantifiable risks, is required before drawing a preliminary conclusion as to who bears the risks associated with the property. For example, in the majority of cases for social infrastructure projects, demand risk and residual value risk will remain with the concession provider. However, if this division is not straightforward, it will be necessary to quantify, to the extent possible, the importance of each risk and the relative allocation of risks between the conces- sion provider and the concession operator.