Local government finance circular 7-2023: accounting for service concession arrangements, leases and similar arrangements

Part 1 - commentary and non-statutory guidance

1.    Finance Circular 7/2023 applies to all service concession arrangements (PFI/PPP etc.), leases and similar arrangements recognised by a local authority on its balance sheet, in accordance with the Accounting Code. This replaces Finance Circular 10/2022.

2.    The Local Authority (Capital Finance and Accounting) (Scotland) Regulations 2016 (the 2016 Regulations) require a local authority to determine the expenditure to be met from borrowing, to make a loans fund advance for that expenditure, and to repay that advance over future financial years as a charge to the general fund. The local authority is to determine the period over which the advance is to be repaid and the amount of repayment to the loans fund (the statutory repayment of debt) in each financial year. 

3.    Service concession arrangements and leases are credit agreements rather than borrowing and therefore no loans fund advance is made for capital expenditure which is financed by such agreements.

4.    However, to ensure consistency with the statutory framework for borrowing, as set out in the 2016 Regulations, the statutory guidance applies the principle that depreciation will not be a charge to the General Fund. The charge to the General Fund will be a ‘statutory charge for the repayment of debt’ which recognises the repayment of the principal element of the lease component of the service concession or lease liability for the year. 

5.    The temporary flexibility which permitted a local authority to recognise the principal repayments for a service concession arrangement over the asset life rather than contractual term was only available for use in either 2022-23 or 2023-24 and only for service concession arrangements in place prior to 1 April 2022.

6.    With the exception of those service concession arrangements to which the statutory flexibility was applied in either 2022-23 or 2023-24, from 1 April 2024 the annual ‘statutory charge for the repayment of debt’ to the General Fund for all existing and new service concession arrangements, leases and similar arrangements must reflect the principal element of the contractual repayments and must be charged to the General Fund over the term of the contract.

7.    For service concession arrangements entered into prior to 1 April 2022, where the temporary flexibility to permit the principal repayments to be accounted for over the asset life rather than contract term was exercised in either 2022-23 or 2023-24, the annual ‘statutory charge for the repayment of debt’ to the General Fund may continue to be calculated on the basis of the asset life rather than the contract term, as set out in Finance Circular 10/2022.

8.    The statutory guidance (Part 2) retains the option to disapply the statutory adjustments and recognise service concession arrangements, leases and similar arrangements in accordance with the Accounting Code.

9.    The statutory guidance applies to all service concession arrangements, leases and similar arrangements where the local authority recognises an asset on their balance sheet in accordance with proper accounting practice.

Service concession arrangements - proper accounting practice

Unitary Payments to the Operator

10.    Unitary payments to the operator for a relevant service concession arrangement or lease are to be charged to the Comprehensive Income and Expenditure Statement in accordance with the Accounting Code. 

11.    Paragraphs 4.3.2.25 and 4.3.2.26 of the Accounting Code require unitary payments to be separated into the elements related to services, repayment of the liability (construction) and interest charges. The service element and interest charges are changes to the Comprehensive Income and Expenditure Account; the liability repayment element reduces the outstanding liability held on the balance sheet.

Depreciation, Impairment and Revaluations

12.    Depreciation, impairment and the revaluation of assets recognised by local authorities under service concession arrangements and leases shall be accounted for in accordance with proper accounting practices.  This means such assets will be accounted for in the same way as other local authority assets.  It also means that these costs are not chargeable to the General Fund and are adjusted through the Movement in Reserves Statement.

13.    Depreciation costs are to be charged to the Comprehensive Income and Expenditure Statement of a local authority in accordance with proper accounting practices.  Depreciation costs are to be excluded when determining the movement on the General Fund balance for the financial year and are adjusted through the Movement in Reserves Statement.

14.    Impairment costs are to be charged to the Comprehensive Income and Expenditure Statement of a local authority in accordance with proper accounting practices.  Impairment costs are to be excluded when determining the movement on the General Fund balance for the financial year and are adjusted through the Movement in Reserves Statement.

15.    The revaluation of assets recognised by local authorities under service concession arrangements shall be accounted for in accordance with proper accounting practices. This means such assets will be accounted for in the same way as other local authority assets. It also means that these costs are not chargeable to the General Fund and are adjusted through the Movement in Reserves Statement.

16.    On a revalued asset, a transfer between the revaluation reserve and capital adjustment account shall be carried out that represents the difference between depreciation based on the revalued carrying amount of the asset and the depreciation based on the asset’s historical cost.

Statutory changes for service concession arrangements

Statutory charge for lifecycle replacements - capital expenditure

17.    The unitary payment may include an element for lifecycle replacement costs. These costs will largely comprise the replacement of components of an asset as they wear out. The Accounting Code permits a local authority to charge lifecycle costs against the unitary payment as they are incurred or to set amounts aside as prepayments over the contract term. Lifecycle replacement costs that cannot be capitalised will be charged to the Income and Expenditure account in accordance with proper accounting practice. 

Sums set aside as prepayments over the contract term

18.    Sums set aside from the unitary payment as a prepayment for lifecycle costs planned within the contract shall not be a charge to the General Fund when set aside.  The statutory charge to the General Fund is made when the capital expenditure is actually incurred and the prepayment is used to meet that cost.

19.    Authorities may transfer sums from the General Fund to the Renewals and Repair fund should they wish to identify and set aside funds to finance the capital expenditure when it occurs.

20.    If it becomes probable during the contract that the programmed lifecycle replacement costs will not take place, or the authority believes the prepayment is too large the excess should be charged to the Comprehensive Income and Expenditure Statement.  Should this occur no statutory adjustment is required.  Local authorities would however release a matching amount from the earmarked reserves/ Renewal and Repair fund at the same time to support the charge to the Comprehensive Income and Expenditure Statement.
Charging Lifecycle costs against the unitary payments as they are incurred

21.    Where the capital expenditure is equal to the lifecycle cost identified in the contract the statutory charge to the General Fund is equal to the lifecycle cost. The charge to the General Fund will be made via Movement in Reserves Statement as ‘Capital expenditure charged to the General Fund balance’.

22.    Where the capital expenditure is less than the lifecycle costs identified in the contract the statutory charge to the General Fund is equal to the actual capital expenditure recognised as incurred. The charge to the General Fund will be made via the Movement in Reserves Statement as ‘Capital expenditure charged to the General Fund balance’. The difference between the actual capital expenditure incurred and the planned contract value is required to be charged to the Income and Expenditure account in accordance with proper accounting practice. No further statutory adjustment is therefore required. 

23.    Where the capital expenditure is greater than the lifecycle costs identified in the contract the statutory charge to the General Fund is equal to the lifecycle costs identified in the contract. The charge to the General Fund will be made via the Movement in Reserves Statement and be recognised as ‘Capital expenditure charged to the General Fund balance’. The excess of expenditure is a gain to be recognised. The asset is effectively ‘donated’ by the operator, and a grant recognised to fund that acquisition through the creation of ‘deferred income’. The deferred capital grant income is then released to the Income and Expenditure account over the life of the asset. This income is not income that may be credited to the General Fund. A statutory adjustment equal to the grant released must be charged to the General Fund via the Movement in Reserves Statement and be recognised as ‘Grants deferred amortisation matching depreciation and impairment’. 

Planned capital expenditure - not undertaken

24.    If the planned work is still expected to be undertaken later in the contract the relevant part of the unitary payment will be posted to the balance sheet as a prepayment. The prepayment will not be a statutory charge to the General Fund when the prepayment is posted to the balance sheet. The expenditure will only be charged to the General Fund when the capital expenditure is actually incurred. Paragraphs 19, 20 or 21 will then apply. 

Works undertaken earlier than planned

25.    The capital expenditure will need to be charged to the General Fund as incurred. Paragraphs 19, 20 or 21 will apply. 

26.    It is possible that lifecycle replacement costs may be substantial enough in any year to exceed the unitary payment after deducting the fair value of services. In such cases the statutory charge to the General Fund is equal to the unitary payment after deducting the fair value of services. The charge to the General Fund will be made via the Movement in Reserves Statement and be recognised as ‘Capital expenditure charged to the General Fund balance’. In the subsequent financial year the excess of lifecycle costs will be charged against the unitary payment. This cost will be charged to the General Fund via the Movement in Reserves Statement and be recognised as a ‘statutory repayment of debt’. This recognises that the excess of capital expenditure incurred in the prior year was effectively funded by borrowing in the previous year by increasing the lease liability. The charge to the General Fund in the subsequent year repays that debt.

27.    Impairments and the revaluation of assets recognised by local authorities under service concession arrangements shall be accounted for in accordance with proper accounting practices. This means such assets will be accounted for in the same way as other local authority assets. It also means that these costs are not chargeable to the General Fund and are adjusted through the Movement in Reserves Statement.

Local Authority Assets 

28.    A local authority may provide the operator with access to existing assets of the authority that are not used in the service concession arrangement but are in exchange for reduced or eliminated contractual payments. 

29.    Where the arrangement involves the permanent transfer of an asset to the operator, or the asset is provided in the form of a lease, the local authority is required to derecognise the asset. The authority is required to recognise the consideration received from the asset / operator. This may be the reduction or elimination of the service concession arrangement outstanding liability. The statutory guidance permits the capital receipt to be applied to the outstanding liability to reflect the reduced liability and hence reduced contractual payments. 

30.    In such cases no further statutory intervention is required, and the annual charge to the General Fund follows the statutory guidance. 

31.    Where the arrangement does not involve the permanent transfer of the assets to the operator but is provided as an operating lease no revised balance sheet entries are required to reflect the asset used by the operator. This remains the local authority asset. In such cases the local authority is required to recognise the service concession arrangement infrastructure asset (fair value) and the associated long-term liability. Over the period of the operating lease the authority will recognise income from the operating lease in the Income and Expenditure Account. At the point the income is recognised, there shall be a corresponding reduction in the long-term liability, reflecting the offset arrangements. 

32.    The statutory charge to the General Fund is unaffected by the operating lease arrangements. 
Scottish Government support for Service Concession Arrangements 

33.    The statutory guidance for service concession arrangements will not impact the accounting treatment of Scottish Government support for such arrangements. This forms part of the General Revenue Grant. As such there is no requirement to apportion the grant and then to match the grant with the new elements of the expenditure and the equivalent service lines. 

Debt restructuring 

34.    Service concession arrangements may include clauses that transfer a proportion of any savings arising from a restructuring of the operator’s debt to the local authority. The revised accounting arrangements will require any debt restructuring to be accounted for as a renegotiation of the lease. The existing liability shall not be altered but the revised financing terms reflected as a reprofiling of repayments and finance charge. 

35.    Where the authority receives a share of the benefit from the refinancing as a lump sum this will either be included in deferred income and released to the income and expenditure account over the life of the arrangement if the gain is conditional on the continuation of the arrangement, or as an immediate gain in finance income if unconditional on the continuation of the arrangement. Where the refinancing gain is accounted as deferred income and released to the income and expenditure account over the life of the arrangement no statutory adjustment is required. The statutory charge for the repayment of the outstanding liability for the service concession arrangement will continue to be charged in accordance with the statutory guidance. 

36.    However, where the authority recognises an immediate gain, a statutory adjustment is required. Statutory guidance permits premiums arising from the refinancing of borrowing to be deferred and charged to the General Fund over time (Finance circular 4 of 2007). The statutory adjustment to be made where the authority recognises an immediate gain from a restructuring of the operator’s debt is to credit an equivalent sum to the Financial Instruments Adjustment Account and charge the General Fund. This transfer is to be reported as part of the Movement in Reserves Statement.

37.    Where a local authority has no outstanding statutory premium balances in the Financial Instruments Adjustment Account this requirement will not apply. If the value of the outstanding statutory premiums held is less than the refinancing gain, the transfer is restricted to the value of the outstanding premiums. The refinancing gain is to be released back to the General Fund over the life of the contract. 

38.    The statutory requirement to transfer the refinancing gain to the Financial Instruments Adjustment Account is prospective only. There is no requirement to amend or restate the General Fund balance to reflect any refinancing gains which have occurred before 1 April 2010. 

Use of capital receipts

39.    For the borrowing of money, capital receipts may be used to voluntarily write down loans fund advances once made. The use of capital receipts in this way allows previous decisions to borrow to be changed and substituted with capital receipts. 

40.    This reduces the statutory charge to the General fund for subsequent years. In principle, Scottish Ministers have no difficulty in allowing capital receipts to be applied to service concession arrangements to reduce the statutory charge for future years. Unlike the borrowing of money, the debt is associated directly with the service concession assets. The difficulty therefore is how substituting capital receipts to reduce the long-term liability can be achieved when the actual liability will remain. It also complicates the statutory arrangements for the repayment of the debt as set out in this guidance. 

41.    The statutory guidance does not permit capital receipts to be used to reduce or meet the repayment of the outstanding liability associated with a service concession arrangement.
Scottish Government support for service concession arrangements

42.    The statutory guidance for service concession arrangements will not impact the accounting treatment of Scottish Government support for such arrangements. This forms part of the General Revenue Grant.  As such there is no requirement to apportion the grant and then to match the grant with the new elements of the expenditure and the equivalent service lines.

Statutory charges for leases

43.    Like service concession arrangements, leases are considered to be credit arrangements and not the borrowing of money. The statutory guidance also sets out the statutory arrangements for leases.