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David Watkins, HM Treasury’s Head of Financial Reporting Policy was in Northern Ireland recently to brief top government accountants on how the introduction of IFRS could impact Northern Ireland’s Public Sector.

Northern Ireland government departments and agencies are about to embark on the biggest change to government financial reporting in a decade. The introduction of International Financial Reporting Standards (IFRS) will allow better comparison between the finances of the public and private sectors. Addressing a seminar hosted by PricewaterhouseCoopers LLP (PwC) and the Chartered Institute of Public Finance and Accountancy (CIPFA), David Watkins, HM Treasury’s Head of Financial Reporting, told delegates not to underestimate the task ahead:

“This is the biggest accounting policy shift in a decade and there are many issues facing Northern Ireland Departments, not least of which is the treatment of assets held under Private Finance Initiative (PFI) schemes.

“Under IFRS, it is likely that many PFI assets will be recognised in Public Sector balance sheets for the first time. Every PFI scheme will need to be reassessed to judge how it should be reported.

“IFRS is a real opportunity to improve government accountability, but it may prove a threat to those not prepared for the challenges.”

In the 2007 Budget, the then Chancellor, Gordon Brown confirmed that government bodies must adopt International Financial Reporting Standards (IFRS) for their 2008/09 accounts. To provide a direct comparison, they were also required to restate their 2007/08 accounts under IFRS. In the March 2008 Budget, Alistair Darling postponed the introduction of IFRS until 2009/10. Reasons for the delay included specific difficulties around PPP/PFI accounting. In addition, some central government departments said they could not meet the 2008/09 timetable; the delay will give them time to transition smoothly. Departments will be required to produce ‘shadow’ 2008/2009 accounts.

The introduction of IFRS may have a significant impact on the financial statements of public sector entities and will bring onto departmental balance sheets at fair value, assets previously held off balance sheet. This may include underlying assets in PPP/PFI arrangements, which could substantially increase the level of government ‘debt’ brought onto departmental balance sheets Private Finance Initiative (PFI)

The accounting requirements under IFRS for PFI schemes have attracted perhaps the greatest attention, and the Treasury in the UK has only recently finalised its approach, which is to be consistent with private sector companies by applying the principles of IFRIC Interpretation 12 (IFRIC 12). In place of the present ‘risk and rewards’ approach under UK GAAP, IFRIC 12 focuses on which party controls the asset and applies the following two tests:

- Can the public sector body control what the asset is used for? - Does the public sector control any significant residual interest in the asset?

Where the answer to both these questions is ‘yes’ then the public sector body will need to recognise the PFI scheme as ‘on-balance sheet’. In most PFI schemes, the public sector will control the operation of the asset through the contract – e.g. where are the services provided, to whom and at what price. Additionally the specialised nature of most assets in sectors such as health means that they will normally transfer to the public sector body at the end of the contract. Consequently it is expected that most PFI schemes will be recognised as ‘on-balance sheet’ under IFRS.

Leases

The international requirements are quite similar to UK GAAP in that they include the concepts of finance leasesand operating leases and have similar classification criteria, although the ‘90% test’ does not appear in IFRS.

A significant difference under IFRS is that for leases of land and buildings, the two components must be considered separately. This may lead to more buildings being recognised as finance leases, particularly where they are specialised in nature.

Another difference is that leases of land are determined always to beoperating leases, due to the importance the standard attaches to the residual value risk resting with the freeholder. Thus where leased land is currently treated as a fixed asset, either on a finance lease or long leasehold with a capitalised lease premium, it will need to be converted to an operating lease. IFRIC Interpretation 4 deals with arrangements which, in substance, contain an underlying lease. These might include, for example, some IT outsourcing arrangements and energy assets such as dedicated electricity sub-stations.

In addition, public sector bodies will also need to examine their assetsharing arrangements with other public bodies. Such arrangements are often not on a formal basis and the underlying lease is not always recognised currently.

Private Sector

Since 1 January 2005, private companies listed on EU exchanges have been required to use IFRS and from 2009/10 government accounts will be produced on an IFRS basis. A 2007 PwC survey of companies that had migrated to IFRS found that around 85% experienced accounting costs, while around 20% were still running parallel systems for internal accounting and external reporting.1 In a similar survey of the Public Sector in March of this year, PwC found that, worryingly, a high level of respondents had made limited or no progress:

- 10% of public sector organisation surveyed had still made no progress in setting up an IFRS conversion project and 17% had only made limited progress; and - 14% had yet to start their IFRS conversion projects and 44% had made only limited progress

Approaching the Task

The public sector should seek to learn from the experience of parts of the private sector which have already implemented IFRS and not underestimate what is likely to be involved. A key lesson is that planning for conversion needs to start as soon as possible. IFRS is more than just a finance issue and early planning enables organisations to identify issues around systems, processes and people, to mitigate both risk and the possibility of unwelcome surprises.

Early planning also provides greater certainty for the finance function, enabling public sector bodies to haveinformed discussions on future funding and to begin planning for future projects and services. It also permits early communication of the likely impact.

The approach recommended by PricewaterhouseCoopers is to start with an impact assessment. This permits the project to be scoped accurately and the necessary resources to be identified. Obtaining buy-in from audit committee and board members is vital and an impact assessment can provide the evidence to support this.

Given the private sector experience and the progress to date within the public sector, the Northern Ireland Executive and its Departments and Agencies should not underestimate the complexity of IFRS. One of the key lessons learnt from implementing IFRS in the private sector is that it is never too early to start planning for conversion. Most conversions take between 12 and 24 months, so action is needed now.

Notes 1 Has the dust settled yet? Survey June 2007. PricewaterhouseCoopers / Ipsos MORI. 2 IFRS Rising to the Challenge Survey March 2008. PricewaterhouseCoopers.

Patrick Gallen, FCA is an Associate Partner in the Belfast office of PricewaterhouseCoopers and a member of the UK IFRS Public Sector Team.