The New F&HE SORP and colleges

Transcription

1 The New F&HE SORP and colleges 23 May 2014

2 Introduction and Background 1 In 2015, colleges will be adopting international accounting standards when presenting their accounts. They will be doing this at the same time as universities, charities and smaller companies, all of whom will be revising their accounts in line with new Financial Reporting Standards (FRS 100, 101 and 102). The university and college sector in the UK has developed a new Further and Higher Education Statement of Recommended Practice (F&HE SORP) which makes these standards meaningful for education organisation. The new F&HE SORP is effective from the 2015/16 financial year. College 2015/16 accounts will include comparative data for 2014/15 so it is necessary to start work now. 2 The College Finance Directors Group (CFDG) and Association of Colleges (AoC) would like all colleges to be sufficiently prepared for implementation of the revised F&HE SORP. Although full implementation will not start until 1 August 2015, being prepared is important and that colleges will need to commence gathering the necessary information for the comparatives from 1 August In order to prepare the sector for the change, Darwen Financial Management Limited (DFM) was appointed to consider the implications. A working group of college representatives was created to support DFM in this task (see Annex 1). 4 The initial view of this group is that many of the changes resulting from the revised F&HE SORP may not be significant for some colleges but that time is needed to fully evaluate them and to consult with the key audit firms and other interested parties active in the further education sector. 5 The report provides: An overview of the change. An assessment of the impact of the change on the annual Accounts Direction and related guidance. The impact of Financial Health Automatic Score Calculations. The impact on bank covenants. Actions the funding bodies and colleges need to take from now to implementation of the revised F&HE SORP.

3 This change is important 6 The change is important because it also means colleges moving from Generally Accepted Accounting Practice in the United Kingdom (UK GAAP) to international accounting standards. For colleges, all the applicable international standards are consolidated within the new concise Financial Reporting Standard (FRS) 102 The Financial Reporting Standard Applicable in the UK and Republic of Ireland. For many finance directors and managers, this will mean a change away from the framework of accounting standards that may have underpinned their initial professional training. 7 It has taken two years to develop the new F&HE SORP and this has been a process which has involved college finance directors and AoC. The college sector responded robustly to the draft F&HE SORP proposals issued for consultation in July Changes were approved by the F&HE SORP Board in December 2013 and the Financial Reporting Council approved the whole document in March The working group 8 It is only possible to understanding the impact of the new F&HE SORP by looking at existing college data. The working group therefore agreed to collect more information from colleges 2012/13 financial statements so that the effects of could be modeled. The request was made via the Finance Directors JISC mailbase and by AoC. By 24 April 2014, 51 responses from colleges had been received. 9 In April 2014, the Skills Funding Agency published College Accounts 2012/13. This is a consolidation of all colleges 2012/13 finance records. The extra data supplied by the respondent colleges has been added to the information provided in the College Accounts 2012/13 publication. Accordingly, three new tabs have been added to the data: Comprehensive Income Statement (previously called the I&E account). Balance Sheet. Financial ratios. 10 The new tabs display, for each college, the existing Income and Expenditure Account, Balance Sheet and Financial Ratios (from the 2012/13 accounts) and set out the likely effects of the new F&HE SORP on these figures. In order to ensure that colleges could quickly provide the extra information, only four areas were chosen: Deferred capital grant. Holiday pay.

4 Academies, free schools, studio schools accounts for 2012/13 (where not already consolidated). Pooled pension schemes where the college has agreed a deficit recovery programme. 11 On closer analysis of the 51 returns from colleges, the group decided to restrict modelling the effects of the revised F&HE SORP for deferred capital grant and holiday pay. The issues related to academy consolidation are critical for some colleges but will need to be addressed on a case-by-case basis. 12 The model can be downloaded from AoC s website at 13 To operate the model, users will need to choose their college short code at cell D4 of the Comprehensive Income Statement. 14 Where a college has supplied the data, the key changes will be evident at: The Total Net Assets/(Liabilities) line of the Balance Sheet. Columns E and F of the Comprehensive Income Statement. 15 If a college has not provided any of the extra information requested, they can still see the effect of implementing the new F&HE SORP. However, there will not be any breakdown of, say, the deferred capital grant. For these colleges, in order to ensure everything balances, the deferred capital balance has been released fully to the Comprehensive Income Statement. To complete this in line with actual data, non-respondent colleges will need to know and fill in the split between what is due to be released within 12 months and after 12 months. The key changes 16 The F&HE SORP is being revised because of the mandatory implementation of FRS 102. FRS 102 brings about the long anticipated convergence with international accounting standards. FRS 102 replaces all previously issued extant Statements of Standard Accounting Practice, and Financial Reporting Standards up to and including FRS 30 Heritage Assets. 17 FRS 102 would appear to be broadly similar in many aspects with current UK GAAP. The key differences to the primary statements are summarised in the table below:

5 Subject Primary Statements Notes to the Financial Statements Old F&HE SORP Income & Expenditure Account Statement of Total Recognised Gains and Losses New F&HE SORP Statement of Comprehensive Income Consolidated Statement of Changes in Reserves Changes Donations and other grant income moved to separate section Disclosure of comprehensive income for year Balance Sheet Balance Sheet Deferred Capital Grant split between creditors due within the next year and after more than one year Cashflow Statement Not Applicable Statement of Cashflows Key Management Personnel Requires cash and cash equivalents Requirement to disclose total salaries and benefits of key management personnel. Issue for colleges is who meets the definition of key management personnel 18 However, FRS 102 and the revised F&HE SORP do not provide as much supporting detail as there was in earlier Financial Reporting Standards. It may become even more critical for the annual Accounts Direction to continue to provide clarification and guidance where FRS 102 or the revised F&HE SORP are silent. 19 The schedules at the end of this report provide: A comparison between the existing and the revised F&HE SORP, where clarification is required from the financial statement auditors. Changes in accounting but where there is no noticeable change in presentation in either Primary Statements or Notes to Accounts.

6 Specific guidance in the Accounts Direction Handbook 20 The funding bodies publish an annual Accounts Direction to colleges in the form of the Accounts Direction Handbook. The handbook has been a onestop shop which relates solely to further education colleges and sixth form colleges and which helps finance directors deal with specific issues, for example Train to Gain accounting or land and buildings owned by a third party (for example a trust or church). 21 All references to existing UK GAAP and the old F&HE SORP in the current handbook will need to be checked against the relevant paragraph of FRS 102 and/or the revised F&HE SORP. 22 Consultation should take place with colleges regarding the applicability of certain sections of Chapter 6 Detailed Guidance on Specific Topics. For example, the chapter provides several pages on discontinued activities, but these are rare. Is this guidance still required? It would be sensible to create a working group to review the handbook to ensure only relevant and up to date information is published. 23 Chapter 5 of the handbook covers guidance on the preparation of the annual report and notes to the financial statements. This chapter will need to be revised to reflect the new layout of the primary statements and the extra disclosures notes, such as the requirement to disclose total salaries and benefits of key management personnel. 24 The Enhanced Pension spreadsheet will need to be checked to ensure that its methodology is still applicable under FRS 102. Financial Planning 25 Apart from detailing any necessary changes to the automatic financial health calculation, the detailed guidance notes of the Financial Planning Publication issued by the funding bodies does not need to be changed to reflect the revised F&HE SORP. 26 The financial planning template will need to be up-dated to reflect: Changes to the primary statements. Changes to the automatic financial health score (see below). A need to update the help facility in some cells (shown by a red cap in the right hand side of a cell).

7 Transitional arrangements. For example, should the figures for the 2014/15 forecast outturn reflect the old or revised F&HE SORP; how will prior year adjustments be shown? Deferred capital grants in schedule 2e being moved to the creditors schedule 2d. Finance Record 27 Although the Finance Record for 2014/15 should reflect the old F&HE SORP, additional schedules will need to be added to the spreadsheet for the revised F&HE SORP. This will enable both the funding bodies and the college to see the impact of the revised F&HE SORP. It would be sensible for funding bodies request the financial statements auditors to review these figures when auditing the 2014/15 accounts. This will provide the college with certainty that their auditors are content with the opening balance figures at 1 August College Accounts Publication 28 The College Accounts publication is issued annually by the funding bodies to provide a snapshot of the health of the FE sector as at 31 July. It is produced through collating all colleges finance records into one return. Various stakeholders, ranging from banks, trade unions, newspapers, competitors and the public use it. It will be necessary to explain the figures because the changes resulting from the new capital grant accounting may be large. If a particular college had net assets of 45m using the old F&HE SORP, and now has net liabilities of 5m using the revised F&HE SORP, clarification is required. Funding agencies will need to provide clarification when the spreadsheet is published. Financial Health Automatic Score Calculations 29 The funding bodies approach to grading the financial health of colleges is incorporated into the college financial returns. It results in one of four assessment grades: outstanding, good, satisfactory or inadequate. 30 In calculating the automatic financial health score, the following criteria are used: Cash-based operating surplus/ (deficit) as a % of income. Adjusted current ratio. Borrowing as a % of net assets. 31 The effect of the revised F&HE SORP on the above three criteria is overleaf:

8 Financial Health Criteria Cash-based operating surplus/ (deficit) as a % of income Adjusted current ratio Borrowing as a % of net assets Measured by Operating surplus plus depreciation less associated capital grant releases, exceptional support and pension finance income plus FRS 17 (staff costs) adjustment. Total current assets less fixed assets held for resale less restricted cash from disposal of fixed assets and held for future fixed asset acquisition divided by total current liabilities. Bank overdraft plus long and short term loans plus long & short term finance leases divided by net assets (excluding net pension asset / liability). FRS102 Implications Overall no major change. However, there will be a few adjustments for holiday pay, the possible consolidation of academies, etc. Deferred capital grants due within one year will be shown as a current liability. The holiday pay adjustment will increase accrued expenditure. If academies, free schools and studio schools have to be consolidated, this could have a major effect on the ratio. As deferred capital grants will now be part of the net assets figure, the criterion will need to be changed to exclude the figures. Bank Covenants 32 Banks can specify a wide range of ratios in their terms and conditions and this is an area where it is important for each college to take stock of its own particular circumstances. A summary of the effects of implementing FRS 102 on colleges bank covenants using typical terms and conditions provided by banks is detailed in the table below.

9 Bank Covenant FRS102 Implications Outstanding Issues Total external debt shall not exceed XX% for DD/MM/201Y of total reserves (excluding exceptional items). Total borrowing costs not to exceed A% of total consolidated income (incl. grant income) (Interest Paid +Capital Repayments divided by Total Income). Revenue reserves shall not be less than XX% of the total consolidated income for DD/MM/201Y Historical Cost Deficits permitted in 2 out of any 3 years Historical Cost Deficit shall not be above 500k in any one year. Please refer to the revenue reserves comment below. Total consolidated income subject to annual fluctuations due to releases of non Government Deferred Capital Grants. Borrowing could increase due to the removal of the 90% rule for assessing whether a transaction should be treated as a finance lease. Revenue reserves could change due to a greater emphasis on component accounting (leading to higher depreciation); holiday pay accruals; treatment of non Government deferred capital grants. Historical cost surplus/(deficit) figure does not appear in Statement of Comprehensive Income. Historical cost surplus/(deficit) figure does not appear in Statement of Comprehensive Income. Treatment of inherited revaluation reserves and their possible release to the Income and Expenditure Account reserve. The possible consolidation of academies, free schools and studio schools into colleges' accounts, will inflate income. Clarification is sought from banks whether they will continue to exclude from their calculations academies, free schools and studio schools because these organisations cannot borrow without the permission of the Secretary of State for Education. Treatment of inherited revaluation reserves and their possible release to the Income and Expenditure Account reserve. As per comment above regarding total borrowing costs not exceeding A% of total consolidated income. Clarification is sought from the banks whether they will continue to ask colleges for the historical cost figure or will request an equivalent figure.clarification is also sought on their reaction to the impact of a release of a nongovernment grant in a single year in accordance with FRS102.

10 Action from now to implementation of the revised F&HE SORP Funding agencies 33 The two funding agencies will issue clear and timely guidance on the implementation of the revised F&HE SORP before the 2015/16 financial statements need to be prepared. As colleges will need to prepare 2014/15 comparatives in the 2015/16 financial statements, it is essential that the funding agencies provide this guidance by March 2015 at the latest. 34 The financial plan template completed by colleges between May and July 2015 will include a forecast outturn for 2014/15 based upon the old F&HE SORP and figures after 1 August 2015 based upon the revised F&HE SORP. A decision will need to be made on whether this is acceptable or should be changed to use the same basis, such as the revised F&HE SORP. 35 The finance record for 2014/15 will be the last year for colleges using the old F&HE SORP. Additional schedules should be added to the spreadsheet so that the figures are also displayed using the revised F&HE SORP. This will have the advantage for the college, in that they would have already calculated the 2014/15 comparator figures for the following year s financial statements. 36 While the 2013/14 finance record has been published without any additional schedules, the funding bodies may consider publishing an amended version in late summer, after clarification has been sought from the audit firms on the issues detailed below. As such, it would provide colleges with opening balances for 1 August 2014 and institutions could at least give an indication of the impact in their own discussions with banks, etc. Colleges 37 Colleges need to model the effect of the revised F&HE SORP on their accounts. Although a template has been provided with this report, each college will have unique characteristics, which may not be reflected in the template. 38 If the college has borrowing, then it needs to discuss with its lender the implications of the implementation of the revised F&HE SORP on its existing covenants. 39 Colleges need to inform senior management and the Board of the implications of the revised F&HE SORP. 40 There could be a training need for both governors and staff.

11 Acknowledgements 41 AoC and CFDG would like to thank Darwen Financial Management Limited for preparing this report, the college Finance Directors who volunteered to be members of the steering group, and BUFDG for allowing extracts of the Pilot Conversion Summary Report to be used.

12 Subject Old SORP New SORP Clarification required Government Grants (for non-land transactions). Charged to Deferred Capital Grants and released over life of asset. Split between Creditors due within one year and those due after one year and treated as income over the life of the asset. Schedule 1 to SI 2008/410 of Companies Act (CA) lists two alternative balance sheet formats. The F&HE SORP appears to follow format 1. Format 1 in the CAs, however states that Accruals and Deferred Income can be shown as a separate heading after the Provisions figure. This seems to mirror the position of Deferred Capital Grants before the F&HE SORP was published in Although this is not shown as an alternative disclosure in the new F&HE SORP, further clarification will need to be sought whether colleges can show their balance of deferred capital grants as a separate line rather than split the balance between creditors due and after one year. In the meantime colleges should plan on Deferred Capital Grant being treated as per the New SORP. Unspent Government Grants. Shown as a payment on account. Shown under restricted reserves (see Note 26 of SORP). If colleges are allowed to use the matching concept for deferred capital grants, in what circumstances should a restricted reserve for unspent Government Grants be disclosed? Capital Grant from private sector in response to S106 agreement with a local Authority. No specific mention of this type of example. No specific mention of this type of example. Probable treatment would be to recognise grant as revenue income, with any unspent balance held in a restricted reserve.

13 Subject Old SORP New SORP Clarification required Retirement Benefits Pooled Schemes. Treated as defined contributio n schemes. As per old SORP, but if pension scheme has written to college outlining its share of a deficit recovery plan, then this deficit must be reported in the Balance Sheet. The F&HE SORP discloses pension scheme provisions under FRS102 in the Provisions for Liabilities note. Clarification from audit firms on the disclosure requirements. Buildings that colleges own but no teaching undertaken in them (e.g. a conference center, small business units). Treated as any other building. Buildings may be defined as investment properties and subject to annual revaluation with gain or loss reflected in the Comprehensive Income Statement. What will be the approach from the financial statements auditors? It is important that there is consistency between them. Service Concessions. Approach based on risk and reward. Approach based on Control. Examples in SORP cover student residences, where previously they might have been treated off balance sheet, but now need to be shown on balance sheet. The F&HE SORP Boards FE Steering Group (which supports and advises the F&HE SORP Board on technical accounting matters) has indicated that there might be other cases of off balance sheet transactions which will have to now be re-assessed to see if in essence the control is with the college and so should be on balance sheet. Rather than the Accounts Direction providing specific guidance just for say, one college, the emphasis must be with colleges to discuss and seek clarification with their auditors when the opening balance figures are being prepared, that is the 2014/15 financial statements.

14 Subject Old SORP New SORP Changes Consolidation of subsidiaries. Question of control and risk and reward. Question of control. If academies have to be consolidated, clarification is required over their financial year. FRS102 indicates that the consolidation of the subsidiary can be based on financial statements made up to its last reporting date, providing that the subsidiary s accounting period ends no more than three months before that of its parent. If not, the subsidiary must prepare interim financial statements to coincide with the end of the parent s financial year. Academies have a 31 August financial year end, which is 11 months before the college year end date of 31 July. Interim financial statements may be required. Academies must show any EFA/DfE income as restricted income in their accounts. Colleges will also receive funding from the EFA/DfE via the SFA. If academies accounts are consolidated, how should this income and associated expenditure be treated? If it is left as restricted, then shouldn t all Government funding be treated as restricted as well? BUFDG 1 commissioned a consultant to oversee a number of pilotsat universities to consider in the main university based issues. In one of the conclusions 2, the consultant indicates that on transition all historic revaluation reserves will be released to retained earnings, which is taken to mean the Income and Expenditure Account Reserve. However, there is no other reference to this in either the F&HE SORP or FRS102. Therefore, clarification is required to be sought from audit firms. Treatment of EFA income if academies are consolidated. No mention. No mention. Revaluation Reserves. Covered in old SORP. No change. 1 British Universities Finance Directors Group 2 BUFDG The Pilot Conversion Summary Report, published October 2013, Page 28 Revaluation Reserves

15 Subject Old SORP New SORP Changes Revaluation of Tangible Fixed Assets. Retirement Benefits. The changes in the net defined benefit asset or liability are analysed into the following components: Periodic costs: Current service cost. Interest cost. Expected return of asset. Actuarial gain and losses. Non periodic costs: Past service costs. Gains and losses on curtailments and settlements. (FRS 17 para. 50) College can continue to revalue its assets or as a one off, freeze its 31 July 2015 value and stop revaluing Seems similar to current UK GAAP. However, instead of applying the discount rate to the liability and an expected return to the asset, the net interest cost is derived by multiplying the net defined benefit obligation (surplus) by the discount rate (both determined at the start of the period) and taking account of any changes in the net defined benefit obligation (surplus) during the period. (FRS 102 para ) Colleges will need to decide in advance of its 2015/16 accounts - whether a revaluation policy might increase the net assets figure but lead to higher depreciation. This may reduce the surplus in the Income Statement. This may need further attention.

16 Subject Old SORP New SORP Changes Retirement Benefits. Full actuarial valuations by a professionally qualified actuary are required at least every three years (FRS 17 para. 35). No specific requirement for component accounting. Residual values are based upon prices prevailing at the date of acquisition (or revaluation) and do not take into account future price changes. (FRS 15 para 2) Involvement of an independent actuary is not required when performing a comprehensive actuarial valuation. Valuations are not required annually. (FRS 102 paras ) If the college can prove that the principal actuarial assumptions have not changed significantly, the defined benefit obligation can be measured by adjusting the prior period measurement for changes in employee demographics, such as employees and salary levels. What is the audit firms interpretation of FRS 102 paras ? Would this be acceptable to them, or would they still seek to insist on annual valuations? The fixed asset register should be reviewed to identify any large assets which should have been divided into components. This could lead to large depreciation adjustments. Tangible Fixed Assets. A greater emphasis on component accounting. Residual values are based on prices prevailing at the balance sheet date. (FRS 102 Glossary) Might the audit firms seek to require colleges to annually review the residual values of each fixed asset?

17 Subject Old SORP New SORP Changes Finance Leases. Guidance more detailed. Not applicable. Removal of 90% rule 3. This could lead to more transactions being designated as finance leases. This could lead to both prepayments (if an employee has taken more holiday than the proportion that should been taken at year end) and accrued expenditure. There is an issue of materiality of this adjustment and also a concern that the audit firms might look for an automated system to support any accrual. Under FRS 102 (although not mentioned in the new SORP) there appears to be a new drive to look for embedded leases, for example, a telephone contract might include equipment hire. Clarification is sought from audit firms whether a subsidiary company which uses the FRSSE exemptions to produce its financial statements, still needs to apply this requirement. Holiday pay and sabbatical leave. A requirement to calculate the amount of outstanding holiday pay at financial year end. Operating leases. Off balance sheet with rent expense. No change. Management charges to subsidiary companies. No specific guidance. The proportion of the management charge that relates to staff costs should be disclosed in the subsidiary s financial statements as staff costs. The employees concerned should be included in the calculation of average number of employees. The notes to the financial statements should explain that the employees do not have contracts of service with the college, and they should also explain why their costs and average number are disclosed in the financial statements. 3 90%rule: A lease is presumed to be a finance lease if at the inception of the lease the present value of the minimum lease payments including any initial payment, amounts to substantially all (normally 90% or more) of the fair value of the leased asset.

18 Appendix Members of the Steering Group Name Alan Searle Brian Godbold Brian Page Chris Knight David McIntyre Evelyn Dixon Jennifer Eastham John Foster Kevin Hodge Marc Webb Margaret Playle Mark Albrighton Mike Hobbs Peter Darwen Rav Garcha Sarah Horan Tracy Waite Organisation Skills Funding Agency Godbold Consultancy Epping Forest College North Warwickshire and Hinckley College City Liverpool College Highbury College Myerscough College Wakefield College City of Islington College Richard Huish College Bridgwater College West Nottinghamshire College Education Funding Agency Darwen Financial Management Limited Walsall Adult Community College Loreto College Leeds City College

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