Module 3

Budgeting and financial reporting

introduction

Budgeting and financial planning have never been more important in councils as expenditure cuts bite even more deeply and service and organisational transformation becomes the key to long-term survival. This module looks at the budget process and the importance of setting the annual budget in the context of more long-term financial planning.

Setting the budget is only the first part of effective financial management and this module also looks at budget management and financial reporting, finishing with a look at how the statement of accounts under IFRS can be tied back to the original budget set by the council.

SETTING AND MANAGING BUDGETS

Setting and managing budgets has come into sharp focus in the last few years, with the severe cuts in public sector expenditure. This section considers the requirements for authorities to set and manage budgets. It covers financial planning and the financial cycle; the annual budget, including reserves and balances; setting the council tax; budgetary control and devolved budgets; and virement.

Statutory context

Budget setting is at the core of the financial processes within a council. It is complex, with many aspects, and must be fully integrated with the authority’s strategic planning, service planning and best value planning processes.

CIPFA’s Standards of Professional Practice set out the key principles that should underpin each aspect of the budget planning and control process and provide guidance on each of them. The key principles and guidance cover:

• ■the relationship between the budgets and the organisation of the authority
• ■the consistency, transparency, prudence and accuracy of the council’s budgets
• ■the effective control and implementation of the council’s budgets
• ■the measurement and monitoring of performance against the council’s budgets and objectives.

The principles remain unchanged, but Part 2 of the Local Government Act 2003 provides a legislative framework for the process:

• ■Sections 25 to 29 places new duties on local authorities – and their chief finance officers – in relation to the setting and monitoring their budgets.
• ■Section 25 requires each local authority’s chief finance officer to make a report to the authority when it is considering its budget and council tax. The report must deal with:
• – the robustness of the estimates
• – the adequacy (or otherwise) of the council’s reserves.
• ■Sections 26 and 27:
• – enable the secretary of state, or the National Assembly for Wales, to specify, by regulation, the minimum levels of reserves to be held by local authorities
• – require each local authority’s chief finance officer to report to the authority if it appears likely that the authority’s reserves will fall below the prescribed minimum level, and to explain why this is likely to happen and what action should be taken.
• ■Sections 28 and 29 require local authorities to monitor their budgets during the financial year, and to take remedial action if this is necessary because of potential overspendings and/or potential shortfalls in income.

Financial planning

A council must have a sound financial planning system. This has always been the case, but:

• ■the changes in the age structure and lifestyle of the population – and in particular the ageing of the population in many parts of the country and the increase in the number and proportion of single adult households – mean that councils need to plan for the effects of these changes on council services and spending levels
• ■the capital finance system means that each council must – at least – produce robust, medium-term financial plans.

Each council’s plans must be monitored and reviewed regularly if they are to be of real value.

Financial planning is a part of the corporate planning process and is not just a matter for the chief finance officer. CIPFA’s Standards of Professional Practice make it clear that the chief finance officer ‘should take all reasonable steps to ensure that budgets are planned as an integral part of the strategic and operational management of the organisation and are aligned with its structure of managerial responsibilities’. The objectives of the financial planning system are:

• ■to help elected members to determine priorities and their timing
• ■to forecast the changes in demand for services
• ■to show the likely implications of changes in legislation on spending
• ■to show the future costs of alternative policies
• ■to match demand with likely resources
• ■to provide a framework for programming activities by individual services.

The most important short-term planning activity is the preparation of the annual budget, but the annual budget is of limited value as a policy document if it looks only one year ahead. The implementation of significant policy initiatives often takes longer than one financial year. This is most obvious where the policy involves major capital works. Longer-term forecasting is therefore essential. It is particularly important to plan over a longer timescale – at least three to five years ahead – for the likely effects of demographic and/or economic change, and the medium-term consequences of legislative changes. This is made clear in the CIPFA Standards of Professional Practice.

The financial cycle

No two councils have precisely the same financial arrangements, but they usually follow a similar pattern. The following table sets out a typical budget cycle – spread over about 30 months – that could apply to many councils. A county council’s budget cycle would need to run slightly ahead of that shown because of the legal requirement to set precepts before 1 March for the financial year beginning one month later. The financial year runs from 1 April to 31 March for all authorities.

In the table, year 0 is taken up with policy planning and finalising the budget. Year 1 is the year in which money is spent to implement the agreed policies. During year 1, the implementation of policy decisions should be reviewed regularly and there should be a procedure for monitoring actual expenditure and income against the budget. The preparation of final accounts for year 1 must be completed and approved by committee within six months of that year-end, ie during the first half of year 2.

In practice, the tasks of planning the budget for the following year, monitoring the budget for the current year and closing the accounts for the previous year must all take place simultaneously. It is the responsibility of the chief finance officer to ensure that sufficient attention is given to each of these tasks.

The provisional details of the local government finance settlement are usually announced about three months before councils take their final decisions on the budget and local tax level for the next financial year – that is, in the November or December of the preceding financial year. The final decisions on the local government finance settlement are usually taken in January or February for the year beginning on the following 1 April.

Financial planning and control timetable

Improving the budgeting, monitoring and reporting cycle

In many public sector organisations, setting the budget can consume significant board and senior management time and energy. There is also a danger that the budget can dominate as the financial target for managers to hit for in-year monitoring, rather than being the expression of the organisation’s delivery plan.

At the end of the financial year actual financial results, and the operational performance that they reflect, often receive scant scrutiny and examination other than at headline level.

In recent years, CIPFA has taken a long and hard look at the budgeting, forecasting, monitoring and reporting cycle arrangements in place in most public bodies to assess whether they are working well. The evidence suggests that improvements are needed. All financial processes need to be fundamentally reviewed from time to time and the budget cycle is no exception.

The financial environment has now moved towards medium-term three-year settlements for public services, with pressure for faster accounts closure, and a greater emphasis on efficiency, performance outcomes and value for money. The budget and reporting cycle needs to adapt as a tool to support these developments.

Improving Budgeting: Modernising the Cycle, published in February 2008, describes practical ways to improve this process. Existing good practice and fresh approaches to budgeting are explained along with sensible steps that organisations can take. The CIPFA website says of the publication:

Rolling forecasts that are formally reviewed and updated each quarter are potentially a powerful tool. Looking ahead 18 months and integrating known financial outcomes with performance metrics, taken together with frequent re-forecasts and the analysis of underlying performance and financial trends … allows organisations to see into the future as a rounded whole. Resources can be redirected at frequent intervals. Because known financial results are prepared each quarter the closure of the accounts for the current financial year is streamlined.

Among the potential benefits of this approach are better skilled managers who remain engaged with planning what the future will look like. They can gain a deeper understanding of the prime cost drivers and variables for their business area. For the organisation’s leaders, the forecasts act as a tool for relating funds with the outcomes they purchase and the organisation is much better able to assess value for money.

Preparing the annual budget

The annual budget is the financial representation of the council’s policies. Its preparation is one of the most extensive and visible products of the authority’s financial management system. The annual budget process is one part of the medium- and longer-term planning process.

This section outlines the way in which the annual budget is typically completed.

Stage 1 (April to October)

The first step is for the chief finance officer to issue detailed guidelines to the various spending departments explaining the basis on which they, rather than the chief finance officer, should compile the basic budget figures and the date by which they should return these figures to the chief finance officer. The objective is to ensure that the underlying pressures to spend on each service are assessed by the appropriate managers. The chief finance officer’s task is to provide advice and assistance to spending departments, to draw together the departmental estimates, to test out the assumptions lying behind them, and to ensure that the established principles have been followed.

The chief finance officer’s setting of the detailed guidelines is an important part of the exercise. The guidelines must take account of the council’s service delivery policies as well as prevailing economic conditions. For example, they should indicate the council’s policies for expansion or contraction in relation to individual services as well as the likely effects of inflation, for example on energy costs and other goods and services. With the move to three-year capital and revenue settlements, consideration needs to be given to the provision of figures for years 2 and 3 as well as the first year of each spending review period.

CIPFA’s Standards of Professional Practice list the factors that should be taken into account in the framing of the budget.

Stage 2 (October to November)

After the chief finance officer has collected and scrutinised the various budget returns from spending departments, the budget for each service will be submitted to the appropriate elected members of the council for consideration. The chief finance officer may report at the same time to the finance or policy committee, setting out the initial trends and outlining the possible effects on services and local tax levels of changes to spending levels.

Stage 3 (December to January)

Elected members usually carry out their final scrutiny of budgets at this stage. Each authority should receive the final notification of its grant entitlement for the forthcoming year, with indicative figures for years 2 and 3, by late January (or early February).

Stage 4 (February to March)

The final stage in the process is the collection of the service figures with any final adjustments for contingencies, planned use of reserves, etc, by the chief finance officer for presentation to council, which then agrees and publishes the precept or council tax for its own services. If the authority is a billing authority, it will add precepting authorities’ precepts to its own budgetary requirement before determining the council tax level for the coming year, with indicative figures for years 2 and 3. Only the full council can make a precept or set the council tax.

In recent years, councils have had to take account of expenditure limitation – or capping – when framing their budgets. The government decided to abandon the universal capping of councils’ budgets from 1999/2000. Accordingly, councils no longer needed to test their budget plans against the government’s capping criteria. However, the secretary of state retained reserve capping powers – and the minister for local government made it clear that the government would continue to use those powers, and did so.

Since the 2012/13 budget round, the council tax referendum arrangements require council tax increases above a pre-announced level to be subject to a local referendum, so councils still need to be satisfied that their budget increases will not be considered excessive and fall foul of the referendum criteria.

The budget in detail

The lowest level of detail at which budgets are usually produced by officers is the individual line item (also known as the detail head or vote). For example:

• ■planning department – printing and stationery
• ■social services department – caretakers’ wages.

However, working papers should contain more detail, showing exactly how the figures have been compiled. Budgets presented to elected members for approval, certainly at council level, will show less detail than this. Exactly how much detail is shown depends upon the traditions of the authority and the wishes of its members. Too much detail can divert the attention of members from their policy-making role and prevent officers from giving attention to critical areas where decisions are required; too little may prevent members from exercising adequate scrutiny.

The figure below illustrates the components of a typical council budget. The paragraphs that follow explain the key terms used.

Local authority budget building

Base budget

The previous year’s budget is often the starting point for the budget exercise, but this does not mean that the base budget cannot be changed. Too ready an acceptance of the previous year’s budget as the base, ie incremental budgeting, could mean that the current level of service and the means of providing it, such as the staffing structure, are accepted by default. Elected members need to re-examine the policies that are implicit in the existing budget, as well as focusing attention on new initiatives.

An alternative approach to the budget process is to start from zero and build up the figures for each year from scratch; this is called zero-based budgeting (ZBB). This approach does not take existing policies and service levels for granted; instead, it examines them afresh and rebuilds the budget each year. It demands greater input to the budget process from officers and members, so it is often used where substantial changes in service provision are envisaged, or where expenditure or income is of an ad hoc nature. In addition, it may be used to carry out a zero-based review of each budget, from time to time, perhaps on a rolling programme, to make sure that spending plans remain consistent with agreed priorities and reflect:

• ■service levels
• ■volume changes
• ■price changes.

CIPFA issued a briefing paper on ZBB in January 2006. There was renewed interest in ZBB, springing partly from the fact that the 2007 comprehensive spending review included a set of zero-based reviews of baseline expenditure in government departments, aimed at assessing their effectiveness in delivering the government’s long-term objectives, and contributing further to the efficiency programme.

ZBB aligns closely to current initiatives, including the efficiency agenda, and to performance measurement. Successful use of ZBB relies upon the effective involvement of all executive managers. Like all good budgeting processes, it requires that the organisation’s objectives are determined and clearly stated. Where it differs from the traditional route and adds value to the budget process is in the next stage, where different ways of achieving those objectives are explored and assessed, so that the resources associated with the preferred option can be actively justified.

Committed growth and savings

It is necessary to add to the base budget existing (and generally inescapable) commitments and to deduct known reductions or savings. There is no universally agreed definition of what constitutes a commitment, although it is generally taken to mean a contractual or statutory obligation. Elected members should satisfy themselves that what is claimed as committed expenditure is confirmed by their own judgement. Some authorities may regard increasing or decreasing numbers of clients as committed growth or savings respectively; others will not. Commitments will normally include the following:

• ■full-year impact of previous policy decisions not wholly included in the previous budget, often known as the full-year effect (for example, additional costs where new buildings were opened during the course of the previous year or savings arising where buildings were closed down part-way through a year)
• ■full-year effect of financing the current year’s capital spending as well as savings in debt charges resulting from debt repayment
• ■annual salary increments for those staff continuing in post, although this can be offset by an allowance for new staff replacing staff leaving with the new staff on a lower incremental point
• ■full-year effects of pay awards
• ■changes in prices or charges (such as national insurance contributions)
• ■superannuation fund deficiency payments.

Inflation

Most authorities incorporate a provision for inflation in each budget head. Detailed budgets are therefore prepared at outturn prices, ie those expected to occur during the forthcoming year. The inclusion of the inflation allowance in the detailed budget heads gives service managers a clear cash budget within which to work. However, the actual effect of inflation may be different from the budgeted amount. If it is higher than budgeted, the purchasing power of the cash budget will be less than intended in real terms. If this happens, departments may well have to reduce the volume of goods and services they consume – and the volume of service they provide to clients – in order to keep within budget, or renegotiate prices.

Apart from the desire to reduce bureaucracy, many councils have moved towards setting budgets at outturn prices because housing rents and trading account charges need to be fixed in advance, after taking into account likely levels of inflation.

Councils need to take account of inflation when setting fees and charges for the year ahead in order to maintain the level of income in real terms.

Councils may choose to set charges for some services by reference to what the market will bear rather than the cost of provision in order to hold down the council tax or pay for the development of other services.

The chief finance officer should include information on the inflation factors to be used in the preparation of the budget in the budget guidelines. In calculating the inflation factors, the chief finance officer will usually take a view on the likely level of:

• ■pay awards for different categories of employee
• ■price increases for supplies and services
• ■trends in interest rates.

Councils need to make adequate provision for the effects of inflation, particularly when inflation rates are high. If an authority seriously underestimates inflation when setting its budget, it might have to make unplanned cuts in services during the year. In extreme circumstances, the chief finance officer might have to issue a report under section 114 of the Local Government Finance Act 1988.

Non-domestic rates and central government support

A factor in preparing an acceptable authority-wide budget is the level of the authority’s non-domestic rates and revenue support grant. With the localisation of business rates, the level of resources available to the general fund is set by the finalisation of the NNDR1 form by the end of January preceding the start of the financial year. NNDR1 is a statutory form that has to be completed by billing authorities and submitted to the Department for Communities and Local Government which sets out the projections for the amount of non-domestic rates to be collected the following year. The estimate will take into account any projected increases in the tax base along with any projected losses due to appeals and collection rates.

Final decisions on the level of RSG are usually taken late in the January or early in the February preceding the start of the new financial year as part of the final local government finance settlement following the provisional settlement in December.

More details about the funding of local government can be found in module one.

Other policy decisions for the authority

Councils have to make a number of major policy decisions on the financing of the authority as a whole. These are dealt with differently by individual authorities, but are likely to involve the leader or the appropriate members of the council’s cabinet. Sometimes these decisions are preceded by informal discussions within the council’s majority political group.

The capital programme

The CIPFA Prudential Code requires each council to produce a three-year forecast of its capital expenditure, and have regard to, inter alia:

• ■the affordability of its plans, including the implications for the council tax
• ■the prudence and sustainability of the plans and their implications for external borrowing
• ■the council’s service objectives; for example, the capital spending plans should be consistent with the council’s strategic plan for the authority
• ■the practicality of the capital expenditure plan, and that the forward plan is capable of being achieved.

Put simply, each council must consider the consequences of its capital programme, and the way in which that capital programme is to be financed, as part of its financial planning process.

Contingency provisions

Councils may choose to make a central contingency provision for inflation in excess of the budget provision and/or for unforeseen events, such as for increased expenditure on highways maintenance due to an exceptionally severe winter. Alternatively, these risks could be covered by the retention of general reserves, in which case no contingency provision would appear in the budget.

Deficit or surplus on trading undertakings

Councils must decide how far deficits or surpluses should be allowed to develop on trading undertakings and, in the case of surpluses, how these should be used.

Reserves and balances

A council must decide the level of general reserves it wishes to maintain before it can decide the level of the council tax – and has a statutory duty to do so.

CIPFA takes the view that there is no theoretically right level of reserves because the factors that affect the need for reserves – such as inflation rates and the certainty about councils’ spending plans – vary over time. But, CIPFA believes that elected members should agree on the appropriate level of reserves in the light of the advice given by the chief finance officer.

The chief finance officer has a fiduciary duty to local taxpayers, and must be satisfied that the decisions taken on balances and reserves represent proper stewardship of public funds.

CIPFA’s views on reserves and balances are set out in LAAP Bulletin 99 Local Authority Reserves and Balances, published in July 2014. The bulletin:

• ■describes the different types of reserves held
• ■makes it clear that it was the responsibility of the finance director to advise councils about the appropriate levels of reserves and to ensure that clear protocols were in place, setting out the purpose of the reserves, how and when they could be used, how they should be managed, and how – and when – they should be reviewed
• ■sets out the factors, in addition to the authority’s cash flow requirements, that should be taken into account in determining the appropriate level of reserves.

The bulletin makes it clear that the factors to be taken into account in setting reserves can only be properly assessed at local level, and stressed that decisions on the level of reserves should be set in the context of each council’s medium-term financial plan, not based on short-term considerations.

Authorities will need to consider various factors when an assessing an appropriate level of reserves. The bulletin reflects the lessons learned from recent events, including the collapse of Icelandic banks and the ensuing threat to council deposits with the banks. External factors such as the flooding in 2007 and 2008, and the problems experienced by the global financial markets in 2008, have highlighted the importance for authorities of maintaining appropriate levels of reserves. LAAP Bulletin 99 provides guidance to council chief finance officers in England, Northern Ireland, Scotland and Wales. The general principles set out in the guidance apply to an authority’s general fund and, where appropriate, to the housing revenue account. The advice relates to reserves, not provisions. Definitions of provisions and reserves are given below.

Reserves and provisions in the balance sheet

A council’s balance sheet summarises its financial position at 31 March each year. The top half of the balance sheet contains the assets that it holds and liabilities (including provisions) that it has accrued with other parties. As councils do not have equity, the bottom half is comprised of reserves that show the disposition of a council’s net worth falling into two categories, usable and unusable. In order for the balance sheet to balance, the sum of the reserves must equal the council’s total assets less liabilities.

Reserves

Amounts set aside for purposes falling outside the definition of provisions should be considered as reserves, and transfers to and from them should be distinguished from expenditure disclosed in the income and expenditure account. Expenditure should not be charged directly to any reserve. For each reserve established, the purpose, usage and the basis of transactions should be clearly identified. Reserves include earmarked reserves set aside for specific policy purposes and balances which represent resources set aside for purposes such as general contingencies and cash flow management.

Provisions

Provisions are required for any liabilities of uncertain timing or amount that have been incurred. Provisions are required to be recognised when:

• ■the council has a present obligation (legal or constructive) as a result of a past event
• ■it is probable that a transfer of economic benefits will be required to settle the obligation
• ■a reliable estimate can be made of the amount of the obligation.

A transfer of economic benefits or other event is regarded as probable if the event is more likely than not to occur. If these conditions are not met, no provision should be recognised.

A provision should be recognised when the council has a contract that is onerous, ie the unavoidable costs of meeting the obligations under the contract exceed the economic benefit or service potential expected to be received under it.

The costs of internal and external restructuring should only be recognised as a provision when the council has a constructive obligation to restructure, ie there is an approved and detailed formal plan and the authority has raised a valid expectation in those affected that it will carry out the restructuring either by starting to implement the plan or by announcing its main features to those affected by it. A restructuring provision should include only the direct expenditures arising from the restructuring, which are those that are both:

• ■necessarily entailed by the restructuring, and
• ■not associated with the ongoing activities of the entity, for example retraining or relocating continuing staff.

Provisions should not be recognised for future operating losses.

Provisions should be charged to the appropriate revenue account; when payments for expenditure are incurred to which the provision relates they should be charged directly to the provision. The amount recognised as a provision should be the best estimate, taking into account the risks and uncertainties surrounding the events.

Provisions should be reviewed at each balance sheet date and adjusted to reflect the current best estimate. If it is no longer probable that a transfer of economic benefits will be required to settle the obligation, the provision should be reversed.

Where some or all of the expenditure required to settle a provision is expected to be reimbursed by another party, the reimbursement should be recognised only when it is virtually certain that reimbursement will be received if the entity settles the obligation. The reimbursement should be treated as a separate asset. The amount recognised for the reimbursement should not exceed the amount of the provision.

In the appropriate revenue account the expense relating to a provision may be presented net of the amount recognised for a reimbursement.

Types of reserve

When reviewing their medium-term financial plans and preparing their annual budgets, councils should consider the establishment and maintenance of reserves. These can be held for three main purposes:

• ■a working balance to help cushion the impact of uneven cash flows and avoid unnecessary temporary borrowing – this forms part of general reserves
• ■a contingency to cushion the impact of unexpected events or emergencies – this also forms part of general reserves
• ■a means of building up funds, often referred to as earmarked reserves (or earmarked portion of the general fund in Scotland – see below), to meet known or predicted requirements; earmarked reserves are accounted for separately but remain legally part of the general fund.

Reserves can be established in Scotland only where there are explicit statutory powers. Schedule 3 of the Local Government (Scotland) Act 1973 (as amended) permits certain Scottish local authorities to establish a renewal and repair fund, an insurance fund and a capital fund (including capital receipts). Scottish local authorities may earmark specific parts of the general fund reserve. Some common examples of established earmarked reserves (earmarked portions of the general fund in Scotland) are listed in the table below (the list is not exhaustive).

Common types of reserve

Councils also hold other reserves that arise out of the interaction of legislation and proper accounting practice. These reserves, which are not resource-backed and cannot be used for any other purpose, are described below.

The pensions reserve is a specific accounting mechanism used to reconcile the payments made for the year to various statutory pension schemes in accordance with those schemes’ requirements and the net change in the authority’s recognised liability under the Code’s adoption of IAS 19 Employee Benefits for the same period. A transfer is made to or from the pensions reserve to ensure that the charge to the general fund reflects the amount to be raised in taxation.

The revaluation reserve records unrealised gains in the value of property, plant and equipment. The reserve increases when assets are revalued upwards, and decreases as assets are depreciated or when assets are revalued downwards or disposed of. The capital adjustment account is a specific accounting mechanism used to reconcile the different rates at which assets are depreciated under proper accounting practice and are financed through the capital controls system. Statute requires that the charge to the general fund is determined by the capital controls system. The available-for-sale financial instruments reserve records unrealised revaluation gains arising from holding available-for-sale investments, plus any unrealised losses that have not arisen from impairment of the assets. The financial instruments adjustment account is a specific accounting mechanism used to reconcile the different rates at which gains and losses (such as premiums on the early repayment of debt) are recognised under proper accounting practice and are required by statute to be met from the general fund. The unequal pay back pay account is a specific accounting mechanism used to reconcile the different rates at which payments in relation to compensation for previous unequal pay are recognised under proper accounting practice and are required by statute to be met from the general fund. This account is not applicable to Scotland.

The collection fund adjustment account is a specific accounting mechanism used to reconcile the differences arising from the recognition of council tax and non-domestic rates income under proper accounting practice to those amounts required to be charged by statute to the general fund.

The major repairs reserve records the unspent amount of HRA balances for capital financing purposes in accordance with statutory requirements for the reserve. In Wales, this represents the amounts unspent from the major repairs allowance capital grant.

Other such reserves may be created in future where developments in local authority accounting result in timing differences between the recognition of income and expenditure under proper accounting practice and under statute or regulation.

In addition, authorities will hold a capital receipts reserve. This reserve holds the proceeds from the sale of assets, and can only be used for capital purposes in accordance with regulations.

For each earmarked reserve (earmarked portion of the general fund in Scotland) held by a council, there should be a clear protocol setting out:

• ■the reason for/purpose of the reserve (required by the Code)
• ■how and when the reserve can be used (required by the Code)
• ■procedures for the reserve’s management and control
• ■a process and timescale for review of the reserve to ensure continuing relevance and adequacy.

When establishing reserves, councils need to ensure that they are complying with the Code of Practice on Local Authority Accounting in the United Kingdom (the Code) and in particular the need to distinguish between reserves and provisions.

In LAAP Bulletin 99, CIPFA and the Local Authority Accounting Panel make it clear that they do not accept that there is a case for introducing a generally applicable minimum level of reserves. Councils, on the advice of their chief finance officers, should make their own judgements on such matters taking into account all the relevant local circumstances. Such circumstances vary. A well-managed authority, for example, with a prudent approach to budgeting, should be able to operate with a level of general reserves appropriate for the risks (both internal and external) to which it is exposed. In assessing the appropriate level of reserves, a well-managed authority will ensure that the reserves are not only adequate but also necessary. There is a broad range within which authorities might reasonably operate depending on their particular circumstances.

Imposing a generally applicable minimum level would also run counter to the promotion of local autonomy and would conflict with the financial freedoms introduced for English and Welsh local authorities in the Local Government Act 2003 and for Scottish authorities in the Local Government in Scotland Act 2003. Nor is it considered appropriate or practical for CIPFA, or other external agencies, to give prescriptive guidance on the minimum (or maximum) level of reserves required, either as an absolute amount or as a percentage of budget.

Section 26 of the Local Government Act 2003 gives ministers in England and Wales a general power to set a minimum level of reserves for local authorities. However, the government has undertaken to apply this only to individual authorities in circumstances where an authority does not act prudently, disregards the advice of its chief finance officer and is heading for serious financial difficulty. This accords with CIPFA’s view that a generally applicable minimum level is inappropriate, as a minimum level of reserve will only be imposed where an authority is not following best financial practice (including the guidance in LAAP Bulletin 99).

Principles to assess the adequacy of reserves

In order to assess the adequacy of unallocated general reserves when setting the budget, a chief finance officer should take account of the strategic, operational and financial risks facing the authority. Where authorities are being reorganised, this assessment should be conducted on the basis that the services will continue to be provided, and adequate reserves will therefore be required by successor authorities. The assessment of risks should include external risks, such as flooding, as well as internal risks.

In England and Wales, statutory provisions require an authority to conduct a review at least once in a year of the effectiveness of its system of internal control, which will include risk management. The CIPFA/SOLACE framework Delivering Good Governance in Local Government details an approach to giving assurance that risk, control and governance matters are being addressed in accordance with best practice.

The Codes of Audit Practice in England, Wales, Scotland and Northern Ireland make it clear that it is the responsibility of the audited body to identify and address its operational and financial risks, and to develop and implement proper arrangements to manage them, including adequate and effective systems of internal control. The financial risks should be assessed in the context of the authority’s overall approach to risk management.

Setting the level of general reserves is just one of several related decisions in the formulation of the medium-term financial strategy and the budget for a particular year. Account should be taken of the key financial assumptions underpinning the budget and financial strategy alongside a consideration of the authority’s financial management arrangements. In addition to the cash flow requirements of the authority, the following factors should be considered:

• ■The treatment of inflation and interest rates – the overall financial standing of the authority (level of borrowing, debt outstanding, council tax collection rates, etc). The significant increases in the prices of some commodities, such as fuel, highlighted the relevance of using a number of inflation rates in the budget and financial strategy, and considering whether general reserves are adequate to deal with unexpected increases. Recent volatility in the financial markets also points to the need to consider investment and borrowing risks and their impact on income.
• ■Estimates of the level and timing of capital receipts – the authority’s track record in budget and financial management, including the robustness of the medium-term plans. Authorities will also need to take into account changes in the property market and adjust estimates and assumptions for reserves accordingly.
• ■The treatment of demand-led pressures – the authority’s capacity to manage in-year budget pressures, and its strategy for managing both demand and service delivery in the longer term.
• ■The treatment of planned efficiency savings and productivity gains – the strength of the financial information and reporting arrangements. The authority should also be in a position to activate contingency plans should the reporting arrangements identify that planned savings or gains will either not be achieved or be delayed.
• ■The financial risks inherent in any significant new funding partnerships, major outsourcing arrangements or major capital developments – the authority’s virement and end-of-year procedures in relation to budget under/overspends at authority and departmental level. Risk management measures in relation to partnerships, including consideration of risk allocation. Contract provisions designed to safeguard the authority’s position in the event of problems arising from outsourcing arrangements.
• ■The availability of reserves, government grants and other funds to deal with major contingencies and the adequacy of provisions – the adequacy of the authority’s insurance arrangements to cover major unforeseen risks. When considering insurance cover, the structure of the cover as well as the overall level of risk should be taken into account. Risk assessments should be used when balancing the levels of insurance premiums and reserves.
• ■The general financial climate to which the authority is subject – external factors, such as future funding levels expected to be included in national spending reviews and expected capping criteria, will influence an authority’s ability to replenish reserves once they have been used. Any plans for using reserves will need to consider the need and ability of the authority to replenish the reserves, and the risks to which the authority will be exposed while doing so.

While many of these factors relate to setting the annual budget, the level of risk and uncertainty associated with them will be relevant in determining an appropriate level of reserves.

Events such as large-scale flooding have emphasised the need for authorities to be prepared for major unforeseen events. Adequate insurance cover combined with appropriate levels of reserves will enable authorities to manage the demands placed on them in such circumstances. However, these arrangements need to take account of all possible scenarios. An example quoted in the Audit Commission report Staying Afloat is that the total cost of the flooding was reduced where authorities had specifically considered the impact of a wide-scale, serious event affecting many assets, and had taken appropriate action, such as negotiating insurance policies that capped the total excesses linked to one event.

Emergency financial assistance from central government may be available to assist authorities in dealing with the immediate consequences of major unforeseen events, normally under the ‘emergency financial assistance to local authorities’ scheme (commonly known as the Bellwin scheme). However, there is no automatic entitlement to financial assistance, and where financial assistance is given, it will not cover all of the costs even in exceptional circumstances.

Authorities should plan to have access to sufficient resources (through reserves, insurance or a combination) to cover the costs of recovering from events that are likely to be unavoidable. Alternative arrangements, such as mutual aid agreements, may help to reduce the reliance on reserves or insurance.

Part of the risk management process involves taking appropriate action to mitigate or remove risks, where this is possible. This in turn may lead to a lower level of reserves being required, and it would be appropriate to consider reducing the level of balances held where appropriate action to mitigate or remove risks has been successfully undertaken. A balance will need to be found between maintaining adequate levels of reserves and investing in risk reduction measures. This balance should form part of the risk management process and be considered as part of the annual budget process.

The many factors involved when considering appropriate levels of reserves can only be assessed properly at a local level. A considerable degree of professional judgement is required. The chief finance officer may choose to express advice on the level of balances in cash and/or as percentage of budget (to aid understanding) so long as that advice is tailored to the circumstances of the authority.

The advice should be set in the context of the authority’s risk register and medium-term plans and should not focus exclusively on short-term considerations. Balancing the annual budget by drawing on general reserves may be viewed as a legitimate short-term option. However, it is not normally prudent for reserves to be deployed to finance recurrent expenditure. Where such action is to be taken, this should be made explicit, and an explanation given as to how such expenditure will be funded in the medium to long term. Advice should be given on the adequacy of reserves over the lifetime of the medium-term financial plan, and should also take account of the expected need for reserves in the longer term.

The Code of Practice on Local Authority Accounting in the United Kingdom requires the purpose, usage and basis of transactions of earmarked reserves to be identified clearly. It is recommended that a review of the level of earmarked reserves be undertaken as part of annual budget preparation.

It is worth stressing that it is illegal for an authority to budget for a deficit.

The external auditor can and does comment on the level of reserves, in the context of good financial management practice. The auditor is likely to comment if, in his or her opinion, an authority’s reserves are considered too high or too low. However, it is not the responsibility of auditors to prescribe the optimum or minimum level of reserves for individual authorities or authorities in general.

Reserves can only be used once. If they are used to keep the council tax down in the current year, that will put pressure on the next year’s tax. The council tax or budget will be even greater if the authority has to raise additional money in order to restore reserves to a reasonable level.

Setting the council tax

The council tax is set by billing authorities – London boroughs, metropolitan districts, non-metropolitan districts, unitary authorities and the City of London Corporation. Each billing authority adds the amounts required by major precepting authorities (including county councils, police authorities and joint authorities) to its own tax requirement. It translates the required tax yield into the tax rate for band D properties; other bands can be calculated on the basis set out in the Local Government Finance Act 1992.

The precepts for local precepting authorities, such as parish councils, must be calculated separately for each local precepting authority area.

Precepting authorities must issue precepts before 1 March and billing authorities must set the council tax by 11 March for the financial year starting on the following 1 April.

Budgetary control

The responsibility for budgetary control usually lies with service chief officers, and through them with their line managers. These line managers should monitor actual expenditure and income against the budget provisions regularly, usually monthly.

Elected members will consider budget monitoring reports regularly throughout the year. These reports should provide comparisons of actual and estimated income and expenditure, usually at the same level of detail as the budget approved by the committee. If the monitoring process reveals adverse trends, ie if expenditure is too high or income is too low, councillors may need to reconsider their policies at some level, for example:

• ■at detailed budget level if, say, income is considerably below the estimated level, or
• ■at authority level if, say, events occur that cannot be covered by the contingency provision or general reserves.

Devolved budgets

Councils usually devolve responsibilities for operational decision-making and budgeting to individual service managers. Responsibility has been devolved first from central departments, like the finance department, to service departments and then within departments down to area offices, divisions and some sections within divisions.

In many councils, managers have been given more flexibility to make changes within their budgets. The flexibility can extend to allowing managers to fund improvements in the services they manage from the income raised by new initiatives. In other cases, managers have been given the flexibility to negotiate the cost of support services provided by central departments, often through service level agreements. In some cases managers purchase support services from outside the authority, if this alternative is cheaper or more convenient.

One advantage of devolution is that service managers may feel more responsible for their budgets than they did when large elements were beyond their control. However, with greater devolution there is greater risk if staff are inadequately trained. It remains the responsibility of the chief finance officer to ensure proper financial control is maintained. This could include providing detailed guidelines to departments on budget setting, budget monitoring and internal controls and ensuring that managers in service departments receive appropriate financial training.

Elected members are ultimately responsible for determining a scheme of delegation to enable the authority to operate effectively. Not all decisions can be taken by members and chief officers, so the scheme of delegation needs to specify the responsibilities delegated to different levels of management within the authority. The scheme of delegation should cover the delegation of budgetary responsibility. Financial limits should be set on the financial decisions that can be taken by the various committees and post holders.

Strategic partnerships

There has been an increasing emphasis in recent years on authorities working in partnership with other authorities and organisations. This may well have budget implications, especially where funding streams or budgets are pooled, and concerns have been expressed, for example by the Audit Commission, about financial management in relation to partnerships.

Virement

Under virement, a service manager may spend more than originally planned on one budget head provided that this is matched by a corresponding reduction on some other budget head, ie a switch of resources between budget heads. Practice varies: a few authorities allow no virement at all; some allow almost unlimited virement; many prohibit transfers that would give rise to a continuing commitment, such as a transfer of resources from the equipment budget to the salaries budget in order to finance the cost of a new permanent member of staff. Virement should be encouraged where it allows managers to obtain better value for money, provided that it does not result in poor financial management.

Performance indicators

In the past, budget information tended to relate solely to financial information. This was unsatisfactory. If value for money is to be obtained, then money spent has to be related, as far as possible, to the outputs it achieves. The use of performance indicators to establish the relationship between financial and non-financial data leads to better management of council services – provided that the number of indicators is not excessive and the indicators are not contradictory.

CIPFA guidance

Balance sheet management

Balance Sheet Management in the Public Services: A Framework for Good Practice (2006) looks at balance sheet management in the context of an authority’s overall financial management framework.

The message from the publication is that the finance function is increasingly involved in supporting operational service delivery and performance. Balance sheet management has a key role to play in generating real savings and delivering assets where they are needed, to enable effective front-line service delivery.

The framework provides an assessment tool that organisations can use to develop a much closer knowledge of their balance sheets. It also includes a powerful analysis tool to identify the areas where greatest focus is required for improvement. Finally, the framework provides practical ideas on how organisations can improve and supplies links to other sources of guidance.

Integrated planning

Public sector organisations are expected to have corporate and business plans – sometimes several different plans, each with a different focus, meeting the needs of a range of stakeholders, including central government and regulatory authorities. Yet, in many public sector bodies, the annual financial planning process is often only loosely connected to the strategic and service planning process.

Planning is an important activity, but is not an end in itself. Plans must join up and have both an operational and a financial dimension. Despite this, the gulf between financial and operational plans is familiar to many organisations.

Integrated Planning: An Overview of Approaches (2006) recommends practical steps that can be taken to bridge the gap, covering people, processes and tools – starting with strategy and planning, working through performance management, and feedback through the review process.

This guide is intended to provide an overview of how an integrated planning process can be approached and made to work more effectively for planners, finance and operational staff who play a part in it.

The first section examines the overall process and includes a summary for senior management and board members about their part in setting the direction and deciding on alternative options when finalising the overall plan.

The second section looks at elements of the cycle and suggests techniques and approaches for better planning outcomes.

The guide also offers brief summaries of the techniques and approaches involved in planning and links to further sources of details and advice.

Developing a financial strategy

The annual budget secures the stewardship of public money and is an important source of information with which to build more ambitious strategies. In the medium-term view, attention switches to the management of performance against demanding efficiency targets that can only be realised over a period of several years. Within this medium-term planning horizon, most public service organisations have become adept at financial forecasting – often with the appropriate sensitivity testing against a range of assumptions.

The distinctive feature of Thinking Ahead: Developing a Financial Strategy (2012) is its emphasis on longer-term planning and on the limitations of using forecasting for such strategies. It advocates instead the more widespread use of scenario planning. Scenarios are plausible and coherent possible states of the future world that may become a reality. Some methodologies for developing credible scenarios are sketched out, as well as some techniques for developing a reasonable response to the challenges they pose. Such approaches force organisations to consider the distinctly different futures that they may face and as a consequence become more agile in developing their responses.

Public financial management

The CIPFA FM Model: Assessment of Financial Management in Public Service Organisations (2010) was launched in 2004 and is now in its third version. The principles of good financial management are unchanged, namely that it is the business of the whole organisation, that it requires a tone set from the top, sound processes, competent and motivated people and attention to the needs of stakeholders.

The model is structured around three styles of financial management:

• ■Securing stewardship – an emphasis on control, probity, meeting regulatory requirements and accountability.
• ■Supporting performance – responsive to customers, efficient and effective, and with a commitment to improving performance.
• ■Enabling transformation – strategic and customer led, future orientated, proactive in managing change and risk, outcome focused and receptive to new ideas.

The styles of financial management are intended to be progressive and it is expected that all three styles will be present in an organisation exhibiting best practice financial management characteristics. For example, stewardship alone is not sufficient to enable an organisation to drive performance and to develop its transformational capacity and, conversely, performance or transformation programmes that are not founded in a robust approach to controlling and accounting for resources are unlikely to succeed.

The model is also organised by four management dimensions. These cover both hard-edge attributes that can be costed and measured and softer features such as communications, motivation, behaviour and cultural change. The dimensions are:

• ■Leadership – focuses on strategic direction and business management, and the impact on financial management of the vision and involvement of the organisation’s board members and management team. The tone set from the top will be critical.
• ■People – includes both the competencies and the engagement of staff, within and throughout the organisation.
• ■Processes – examines the organisation’s ability to design, manage, control and improve its financial processes to support its policy and strategy.
• ■Stakeholders – acknowledges the relationships between the organisation and those with an interest in its financial health. Public service organisations interact with a web of stakeholders from government, inspectors, taxpayers, partners, suppliers, customers and clients. External stakeholders have legitimate expectations about the finances of the organisations. This is enveloped by the public interest.

A matrix approach is used in the model, combining the styles of financial management and the management dimensions. The assessment matrix that is formed shows the high-level issues that an organisation faces. The evidence that underpins the scores enables organisations to identify the key issues that need to be addressed in order to raise scores and most importantly improve financial management.

Audit Commission guidance

In Financial Management in a Glacial Age (2009), the Audit Commission comments on the uncertain financial future facing authorities, with increasing demand for services and decreasing income. The publication aims to help councils learn lessons from past financial failure and secure their financial stability. It is based on real-life examples of:

• ■possible causes of financial failure to watch out for
• ■key changes to take to help with recovery
• ■steps management can take to improve financial standing.

It highlights that the financial management arrangements in failing bodies often included:

• ■a reliance on short-term fixes, such as asset sales to raise cash
• ■the use of reserves and investment income to balance budgets
• ■a reluctance to commit to key financial decisions, such as budget setting
• ■insufficient budget monitoring, especially at the start of the year
• ■misleading budget information, particularly information to audit committees
• ■a disconnect between financial planning and other key functions, such as human resources
• ■a lack of understanding of costs and their relationship with activities.

In addition, the Audit Commission carried out detailed fieldwork into strategic financial management between July and November 2009. It defines strategic financial management as councils’ abilities to allocate resources to achieve their objectives, choose between competing priorities, and manage and monitor implementation of their plans. The study should help councils assess the advantages of a strategic approach to financial management and prepare for, and respond to, the challenges of the current financial and fiscal climate.

The Commission commented that:

There are still situations where the board assumes it’s the finance director’s responsibility to sort out problems: this attitude has contributed to wider corporate failures. Substitute ‘council’ for ‘board’ and we have a real risk. Financial planning must link to corporate and business planning and embrace not just income and expenditure, but also balance sheet items including cash flow and asset management.

The Audit Commission continued its work on how councils were affected by and responding to recession and public expenditure cuts in Tough Times (2011, 2012 and 2013).

LOCAL AUTHORITY ACCOUNTING AND REPORTING

This section of the guide outlines some of the key accounting principles and looks at the annual statement of accounts that all councils are required to produce. This is a simplified overview that is aimed at giving the reader a general understanding of councils’ accounts.

Local authority accounting differs from private sector accounting in a number of important ways. Although local authority accounting is based on the same accounting standards, these are mainly designed for the private sector and so need to be adapted for councils. In addition, the government makes specific rules known as statutory requirements that local councils must follow when they prepare their financial statements limiting the amount that can be charged to council taxpayers and avoiding significant changes in expenditure from one year to the next. As a result, local authority accounting is a combination of the accounting standards that dictate how all organisations should account and legislation.

Accounting standards are set by the International Federation of Accountants (IFAC) and are known as International Financial Reporting Standards (IFRS). These set out how accountants should present items in the annual statement of accounts. Legislation is set out through a mixture of regulations and accounting directions that are issued by the Department for Communities and Local Government, requiring councils to treat certain items in the accounts differently to the way specified in the accounting standards.

All the accounting requirements for councils are brought together in CIPFA’s Code of Practice on Local Authority Accounting in the United Kingdom.

International Financial Reporting Standards

International Financial Reporting Standards (IFRS) are a suite of accounting standards used across the world. IFRS is the international equivalent of the Financial Reporting Standards (FRSs) that were previously used in the UK, and are still used for smaller companies.

In the 2007 budget, the then chancellor announced that the UK public sector would adopt IFRS, as this was seen as best practice and allowed for international comparisons to be made. It was also a question of timing. The UK Accounting Standards Board (ASB) has been reviewing the future of UK GAAP and in the short to medium term all but the smallest organisations will be producing accounts based on IFRS.

As a result, CIPFA/LASAAC now produces the IFRS-based Code of Practice on Local Authority Accounting in the United Kingdom (the Code), overseen by the Financial Reporting Advisory Board (FRAB), the independent body that advises the government on accounting issues, rather than the Statement of Recommended Practice (the SORP), which was overseen by the Accounting Standards Board.

IFRS were developed for the private sector, but the impact of the vast majority of transactions is the same whatever sector you are in. In developing proper accounting practices, the Code is based on European Union adopted IFRS. Therefore, where appropriate, the Code adapts IFRS and sets out the required accounting treatment based on the approach in the Memorandum of Understanding (MoU) between Relevant Authorities.1. In the unusual event that a local authority enters into a transaction not covered by the Code but which is covered by an extant IAS, IFRS, SIC Interpretation or IFRIC Interpretation, IPSAS or other reporting standards relevant to the public sector, the requirements of the relevant standard or interpretation should be followed. It is not stated explicitly, but authorities would be expected to search for an appropriate standard or interpretation.

International Public Sector Accounting Standards (IPSAS) are accounting standards developed specifically for the public sector by the International Public Sector Accounting Standards Board (IPSASB). The ‘rules of the road’ followed by the IPSASB when developing IFRS-based standards mean that the requirements of IPSAS will be the same as those under IFRS, except where there is a pressing public sector reason to adopt a different treatment. This makes them the natural first port of call for CIPFA/LASAAC when IFRS is not appropriate. There are also some IPSAS that deal with exclusively public sector issues, and for which there is no IFRS equivalent, such as taxation. When HM Treasury took the decision to follow IFRS, IPSAS were not as up to date as IFRS and were still under development in key areas. So the decision was taken to adopt IFRS rather than IPSAS. That has now changed and governments around the world are increasingly adopting IPSAS directly.

There are arguments that IFRS make the accounts too long and complex. Councils have a complex story to tell and IFRS introduce more disclosures, but notes only need to be produced if they are material. For example, the accounts need to reflect the pensions deficit which, although it does not have to be funded from this year’s budget, is still a true cost – it represents the amount that will need to be found from future budgets to pay for pension entitlements already incurred in delivering services. So it is a real call on future funding. Not showing this would hide the liability that the authority has incurred.

This also applies to other reserves. Like the pension reserve, the capital adjustment account, the unequal pay back pay account and similar reserves all do one thing: they hold expenditure that the authority has incurred but not yet financed.

Annual statement of accounts

Each local council is required to produce an annual statement of accounts by the 30 June immediately following the end of the financial year. The accounts contain detailed information on the financial position of the council. They show not just the income and expenditure of the council, but also the assets and liabilities it holds. The statement of accounts is a key way that local councils are able demonstrate that they are using public money properly, known as financial stewardship. The format of the statement of accounts is set out in the Code of Practice on Local Authority Accounting in the United Kingdom and contains the following key statements:

Accruals

The principle of accruals is a key one for accounting and it describes when income and expenditure is recognised (included) in the accounts. The simplest form of accounting is cash basis, where transactions are recognised in the accounts when the actual cash is received or paid out. This would not, however, accurately reflect the true position of the council as it would not show how much the council owes or was owed.

Under the accruals basis of accounting, revenues and expenses are recorded when earned and incurred, regardless of when cash is exchanged (ie received or paid). Revenue is recognised either when it is earned (ie services are provided) and realised (ie cash is received) or realisable (ie it is reasonable to expect that cash will be collected in the future). Expenses are recognised when costs have been incurred (ie goods or services are provided) and payment is made or becomes payable (ie it is reasonable to expect that payment will have to be made in the future).

Taking a simple example, if a council is providing home care that it charges for, it would recognise the costs of the home care as it was provided, even if it has yet to be invoiced or paid for. It would then recognise the income due from the client as soon as the service is provided and cash is received or it was reasonable to expect that payment would be received (for example, if payment was due following receipt of an invoice by the client). Revenue and expenses included in a council’s accounts that has not yet been settled (ie cash has not been received or paid) will give rise to debtor and creditor balances in the council’s balance sheet.

Debtors come into existence where income has been recognised but consideration has not yet been received by the council. Put simply, debtors are individuals or organisations that owe the council money.

Creditors come into existence where expenditure has been recognised but payment has yet to be made by the council. Put simply, creditors are individuals or organisations to whom the council owes money.

Taking the home care example, the debtor would be created and the income recognised even where the income is payable many years in the future following the eventual sale of the client’s home.

Capital accounting

Capital accounting is the term used to describe the entries in a council’s accounts that are made in relation to its fixed assets; mainly buildings, infrastructure and expensive pieces of equipment. There are two key elements to capital accounting:

• ■To ensure that the value of the council’s assets are correctly reflected in its balance sheet so that the balance sheet gives an accurate view of the council’s overall financial position.
• ■To reflect the cost of using assets as an expense of the council so that the cost of service provision shows the total cost.

Asset valuation

When the council invests in new assets it includes these in the balance sheet at the cost of the investment plus any directly related expenses. In order to ensure that the balance sheet is kept up to date, assets need to be regularly revalued – every five years, or yearly for the most valuable assets. If council assets are not regularly updated, the balance sheet will very soon become out of date. For example, if a Victorian school building were left on the balance sheet at the amount it cost to build, it may be undervalued by several hundred thousand pounds. The table below sets out the main categories of assets and how they are valued.*

* This table is only relevant to the 2014/15 year (and previous years) as the 2015/16 Code adopts IFRS 13 Fair Value Measurement, which will apply prospectively from 1 April 2015. However, the 2015/16 Code adapts the measurement requirements for property, plant and equipment and has introduced the concept of current value. This new definition of current value means that the measurement requirements for property, plant and equipment providing service potential for an authority has not changed from the 2014/15 Code, ie they are measured for their service potential either at existing use value, existing use value – social housing or depreciated replacement cost, and not at fair value. The 2015/16 Code has, however, changed the measurement requirements for assets classified as surplus assets. These assets are now to be measured at fair value (as a current value measurement base) in accordance with the definition in IFRS 13 and without any adaptations to that definition. Where applicable, all other assets are measured at fair value.

** As part of its Code of Practice on Transport Infrastructure Assets, CIPFA has produced guidance for valuing infrastructure assets on a depreciated replacement cost basis (which is the estimated cost of replacing the asset in current value terms). The Code of Practice on Local Authority Accounting in the United Kingdom has confirmed that this measurement basis will be introduced in 2016/17. Further information in this area is provided in appendix D to the 2014/15 Code. This is a substantial change to measurement practice and CIPFA is considering the guidance necessary to support authorities in their implementation of these requirements. See CIPFA’s Code of Practice on Transport Infrastructure Assets: Guidance Notes. LAAP Bulletin 100 Project Plan for Implementation of the Measurement Requirements for Transport Infrastructure Assets by 2016/17 provides useful guidance to help authorities identify the key areas and milestones they should take into consideration in developing their implementation plans.

Where a council is in the process of selling an asset or has made the decision to sell an asset, it is classified as an asset held for sale (if it meets certain criteria in the Code) and included in current assets on the council’s balance sheet. This reflects the fact that the council does not intend to hold the asset for the long term. Where the criteria are not met the asset is classified as a surplus asset.

When an asset is revalued, this creates a difference between its previous value and its current value. A change in valuation is generally reflected in the revaluation reserve. When an asset’s value falls (ie a revaluation loss or it is impaired), the revaluation reserve can be reduced by this fall in value provided that the value of the asset in question has previously increased by at least as much (accumulated revaluation). If the accumulated revaluation figure for an asset is not enough, any balance between the fall in value and the accumulated depreciation has to be charged to the comprehensive income and expenditure statement.

Depreciation

Depreciation is the term used to describe the charge that is made to the comprehensive income and expenditure statement to reflect the council’s use of its assets. The argument is that, in using an asset to provide services, its value is diminished. This is most simply illustrated by taking a vehicle as an example. Suppose a council buys a new minibus for £20,000 which it intends to use for 10 years, at which point it expects to sell it for £10,000. If it included just the cash value in its comprehensive income and expenditure statement, it would have expenditure of £20,000 in the first year and income of £10,000 in year 11. In years 2 to 10 it would still be using the minibus but would show no cost in its comprehensive income and expenditure statement of doing so. If, instead, it includes the £20,000 in the balance sheet (in property, plant and equipment) and spread the £10,000 cost of owning the asset (the purchase cost of £20,000 less its final value of £10,000) over the 10 years of expected use, it would charge £1,000 per year to its comprehensive income and expenditure statement.

The actual calculation of depreciation is slightly more complicated in practice but the principle remains the same, with an asset’s value, less any final value on disposal, being spread over the expected life of the asset. Because the value of land, provided it is not being used for landfill or mineral extraction, does not change as a result of using it, land is not depreciated – only the buildings upon it.

Capital accounting in the movement in reserves statement

The comprehensive income and expenditure statement for a council will include the costs of depreciation, charges for impairment and revaluation losses and gains and losses on the disposal of fixed assets. Depreciation, impairment and revaluation losses have been described above. Gains and losses on the disposal of fixed assets reflect the difference between the balance sheet value of an asset and the amount it is sold for. Because of the way councils are financed and the fact that money received for the sale of fixed assets is tied up in capital receipts, the government does not want these items to hit the bottom line, and so has made regulations to take these items out in the Movement in Reserves Statement. Depreciation is replaced with a minimum revenue provision, which makes a charge to the accounts for the repayment of borrowing associated with capital expenditure. These adjustments are made against the capital adjustment account, which is an unusable reserve and is one of the reserves that are specific to councils.

Reserves and provisions

Reserves

Reserves are split into usable reserves and unusable reserves on the balance sheet. Usable reserves include general and earmarked reserves, ie those reserves that can be spent on future services. Unusable reserves include all those accounting reserves that cannot be used for expenditure on services.

General and earmarked reserves

When reviewing their medium-term financial plans and preparing their annual budgets, councils should consider the establishment and maintenance of reserves. These can be held for three main purposes:

• ■a working balance to help cushion the impact of uneven cash flows and avoid unnecessary temporary borrowing – this forms part of general reserves
• ■a contingency to cushion the impact of unexpected events or emergencies – this also forms part of general reserves
• ■a means of building up funds, often referred to as earmarked reserves, to meet known or predicted requirements, but where the requirements or amounts are not certain enough to create a provision.

Earmarked reserves formally remain part of the general fund of the council. The general fund of a council represents the money available to local taxpayers that can be used for expenditure on services. Key categories of earmarked reserves are as follows.

Unusable reserves

Councils also include a number of unusable reserves on the balance sheet. These are not backed by cash so cannot be spent on council services but arise because of entries in the accounts specific to councils. Examples of these accounts are as follows.

Other reserves

Councils will hold the following two usable reserves:

• ■Capital receipts reserve – this reserve holds the proceeds from the sale of assets, and can only be used to fund capital expenditure or to repay debt.
• ■Major repairs reserve (housing authorities in England and Wales) – in England, this reserve records the unspent amount of HRA balances for capital financing purposes in accordance with statutory requirements for the reserve. In Wales, this represents the amounts unspent from the major repairs allowance capital grant.

Provisions

A council may set up a provision when it knows that it is highly likely that it will have to pay out money or transfer assets in the future; for example, the council may be involved in a court case that could eventually result in the payment of compensation. Provisions are charged to the appropriate service line in the comprehensive income and expenditure statement when the council becomes aware of the need for them. When payments are eventually made, they are charged to the provision carried in the balance sheet. Provisions should be regularly reviewed to ensure they reflect the most accurate estimate of future cost.

Pensions

IAS 19 Employee Benefits is probably one of the best-known financial reporting standards as it has been frequently mentioned in news items about final salary pension schemes. The standard requires the balance sheet to give a snapshot of a pension fund’s assets and liabilities at the end of the financial year and the associated costs to be reflected in the comprehensive income and expenditure statement.

The standard applies to all employee benefits but has a particular impact on defined benefit schemes where the pension paid is based on the salary of the recipient, not the amount they have paid into their pension pot. Police and fire schemes are excluded from the accounting standard as they are ‘unfunded’ schemes where contributions are used to pay existing pensions with the difference underwritten by government.

The difference between the cost of pensions under accounting rules (IAS 19) and the actual payments made is reversed out of the accounts in the movement in reserves statement against the pension reserve.

Other accounts

Councils may use other accounts, formally known as memorandum accounts, to record income and expenditure relating to certain services they provide or functions they carry out. Key accounts include the following.

Local authority reporting

The statement of accounts is a key way that councils are able show they are using public money properly and forms the core of local authority reporting. In addition, councils have to comply with some other key aspects of financial reporting.

Narrative reporting

The financial statements on their own can be difficult for a lay person to understand and interpret, so explanations and commentary are needed to help the reader make sense of the financial statements and to help demonstrate the extent to which the objectives of the council have been achieved.

In 2009, CIPFA published Narrative Reporting: A Public Services Perspective. The report provides a guide to narrative reporting in theory and in practice and applies to public services in England, Wales, Scotland and Northern Ireland. The report highlights the need to improve reporting to ensure that it is open and honest, clear and understandable, and sufficiently relevant to stakeholders to be interesting and worth reading.

Remuneration of senior officials

Since 31 March 2010, councils have been required to include detailed remuneration information for their senior employees in their annual statement of accounts. Remuneration includes all monetary and non-monetary payments made to an employee as part of their employment. It does not include employer pension contributions. However, for the purposes of disclosing senior officer remuneration in England and Wales, employers’ pension contributions must be reported in addition to the remuneration.

The transparency agenda

Councils are required to publish all expenditure over £500 to encourage ‘armchair auditors’, members of the public with an interest in council finances who are prepared to question councils over what they spend. In February 2015, DCLG published its latest version of The Local Government Transparency Code, which councils are required to follow.

The code requires councils to publish the following data:

• ■expenditure over £500
• ■government procurement card transactions
• ■procurement information about tenders for contracts; and contracts, commissioned activity, purchase orders, framework agreements and any other legally enforceable agreement in relation to the provision of goods and/or services with a value that exceeds £5,000
• ■information on public land and buildings
• ■information on social housing asset value (details on the value of social housing assets within local authorities’ Housing Revenue Account)
• ■grants to voluntary, community and social enterprise organisations
• ■an organisational chart of the staff structure of the council including salary bands and details of currently vacant posts
• ■information on trade union facility time including the number of staff who are union representatives, the number of staff who devote at least 50% of their time to union duties and the names of the trade unions represented
• ■income and expenditure on the authority’s parking account including details of revenue collected from on-street parking, off-street parking and penalty charge notices and an analysis of how any surplus on the parking account has been spent
• ■information on parking spaces including the number of marked-out controlled on- and off-street parking spaces within their area
• ■information on senior employee salaries,
• ■information on the council’s constitution
• ■the ‘pay multiple’ – the ratio between the highest paid salary and the median average salary of the whole of the council’s workforce
• ■information about the council’s counter-fraud work and the measures in place to combat fraud.

This data should be published on the council’s website and in a format that is as widely usable as possible.

Effective reporting

There are a number of reasons why reporting should take place. They include:

• ■to explain the ambitions of the organisation for its citizens and how it is committed to their delivery
• ■to indicate how well management employs and safeguards resources in the achievement of its objectives
• ■to hold those charged with governance of the authority to account for the performance of the authority
• ■to inform stakeholders of the activities of the authority and encourage them to push for the information they require
• ■to provide sufficient comfort to regulators that authorities are acting within their boundaries.

Concerns about the increasing complexity and decreasing relevance of financial reports have been growing in recent years. Many people point to their increasing length and detail, and the regulations that govern them, as evidence that we have a problem. Others are more worried that reports no longer reflect the reality of the underlying businesses, with key messages lost in the clutter of lengthy disclosures and regulatory jargon.

These concerns have been raised by those not just within the public services but also in the corporate sector and led to the FRC’s Reducing Complexity project. This project has led to the development of eight proposed principles for reducing complexity, four for regulators in developing new standards and the following four related to effective communication.

To be effective financial reporting should be:

Focused reporting highlights important messages and transactions and avoids distracting readers with immaterial clutter. Focus is not merely about removing superfluous information; it is also about ensuring that reporting provides the information that readers need to understand both the financial figures themselves and the context within which the organisation is operating.

The level of information provided will depend on the audience and the type of report. An annual report aimed at the public will need far greater contextual information than an in-year monitoring report to the board. The key to achieving focus is to concentrate on the information that the user needs to get a proper picture of the organisation and its financial position while avoiding unnecessary clutter and superfluous information.

Open and honest reporting should provide a balanced explanation of performance – the good news and the bad. Users want a balanced commentary that provides a fair discussion of strengths and weaknesses. Where strengths and weaknesses are reported, they should be supported by an open discussion of the factors influencing them and their impact on future performance. The presentation of reports should give equal weight to both and not attempt to hide weaknesses within the text.

Clear and understandable reporting recognises that to provide an effective channel of communication, the user must be able to appreciate the message that the organisation intends to convey. While this may seem self-evident, in framing reports organisations should consider how readily their meaning will be appreciated by potential users. This will be especially relevant where they contain technical content or use terms that are not in everyday use. Clear and understandable reporting is particularly challenging for public service organisations where there is such a wide range of stakeholders and a requirement to communicate with all, both internally and externally. Public sector organisations may need to consider whether they need to provide additional education and support to users, particularly to elected representatives/boards and citizens, to help them understand financial reporting.

Interesting and engaging reporting should get the point across with a report that holds the reader’s attention. It can be easy to forget that users of reports are people too: the more interesting and engaging the report, the better it will communicate important messages to users. There is currently a significant debate under way about the future of electronic-based reporting (such as via the internet). There is a distinct argument that, in looking to the future, public service organisations should be moving to an environment when reporting can provide a snapshot in time at whatever point the user requires it and in a format and level of detail geared to their needs. However, regular key published reports (whether paper-based or electronic) still have an important role in providing a comprehensive summary of all activity and a prompt to stakeholders to consider the information they require and how that can be sourced. In effect, the published reports can be a gateway into the new forms of continuous reporting as these develop.

Comparisons with budgets

For councillors and members of the public, probably the most important issue will be whether the authority has a surplus or a deficit compared to its budget (and council tax) for the year. Because the financial statements follow accounting standards rather than local government legislation, prior to the introduction of IFRS, this was not easy to identify. However, the movement in reserves statement under IFRS gives this information.

The table below shows how this can be done for the general fund. For housing authorities, there is a separate column in the movement in reserves statement showing the equivalent HRA figures; other columns show earmarked reserves, etc.

A loss shown in the comprehensive income and expenditure statement is an indication that the costs of providing this year’s services have not been covered by income, which will need to be funded by taxpayers in future years. An overall increase in usable reserves despite a loss being shown in the comprehensive income and expenditure statement normally means that there is a corresponding change in unusable reserves as, for example, statutory charges to revenue expenditure for use of capital assets replace depreciation and impairment charges with the difference reflected in the capital adjustment account. Unusable reserves such as the capital adjustment account and the pensions reserve will need to be funded in the future, even if it is over a long period, so increases in these balances show an increasing burden on future taxpayers.

Further Reading

Balance Sheet Management in the Public Services: A Framework for Good Practice, CIPFA/PwC, 2006

The CIPFA FM Model: Assessment of Financial Management in Public Service Organisations – Statements of Good Practice, CIPFA, 2010

Code of Practice on Local Authority Accounting in the United Kingdom, CIPFA, annual

Code of Practice on Local Authority Accounting in the United Kingdom: Guidance Notes, CIPFA, annual

Code of Practice on Transport Infrastructure Assets (2013 Edition), CIPFA, 2013

Code of Practice on Transport Infrastructure Assets: Guidance Notes, CIPFA, 2015

Delivering Good Governance in Local Government: Framework, CIPFA, 2007 (a range of supporting and sector-specific publications are available – see the CIPFA website)

Financial Management in a Glacial Age, Audit Commission, 2009

Guide to Local Government Reform and the Collection Fund, CIPFA, 2012

Improving Budgeting: Modernising the Cycle, CIPFA, 2008

Integrated Planning: An Overview of Approaches, CIPFA, 2006

LAAP Bulletin 99: Local Authority Reserves and Balances, CIPFA, 2014

LAAP Bulletin 100: Project Plan for Implementation of the Measurement Requirements for Transport Infrastructure Assets by 2016/17, CIPFA, 2014

The Local Government Transparency Code, DCLG, 2015

Narrative Reporting: A Public Services Perspective, CIPFA, 2009

Principles of Effective Communication in Financial Performance Reporting, CIPFA, 2012

The Prudential Code for Capital Finance in Local Authorities (2011 Edition), CIPFA, 2011

Standards of Professional Practice, CIPFA, 2002

Thinking Ahead: Developing a Financial Strategy, CIPFA, 2012

Tough Times 2011, Audit Commission, 2011

Tough Times 2012, Audit Commission, 2012

Tough Times 2013, Audit Commission, 2013