By David Ellis, Finance Advisory Network (FAN) advisor, CIPFA
The 2016/17 Code of Practice on Local Authority Accounting (Accounting Code) will introduce a significant change in the measurement of transport infrastructure assets, now affectionately referred to as the Highways Network Asset. Up to now such assets have been reflected in the accounts of local authorities at depreciated historical cost.
The accounting proposals for the Highways Network Asset were a major element of the 2016/17 Accounting Code consultation during the summer of 2015. And, following, the discussion at its November meeting and based on the progress ascertained by a number of feedback processes including the consultation, the CIPFA/LASAAC Local Authority Accounting Code Board (CIPFA/LASAAC) has pressed ahead with these proposals. The main headline is that the 2015/16 accounts will not require restatement and that there is an expectation for the changes to not apply to district authorities.
Increasing local authorities' balance sheets
However, although the proposed accounting treatment is relatively straight-forward to handle in the financial statements, the bigger challenges are likely to relate to assurance. For the first time, the valuation of these assets will not be measured from what has historically been spent in the ledger. Instead it will be provided each year from the detailed toolkits that are maintained by the highways engineers.
The reliance on any system outside of the ledger for the financial statements raises obvious assurance issues, not just for the auditor, but of course for the Responsible Financial Officer, who will sign their name to the financial statements to confirm they represent a true and fair view of the financial position at the year-end and the transactions for the year. However this is no minor change, and if the estimated under-statement from the Whole of Government Accounts (WGA) process is anything to go by, the change to a DRC-based measurement could increase the size of local authority balance sheets by figures in the £ billions.
Crucial assurance areas
So what are the key assurance areas? The most material factor in the valuation of the Highways Network Asset is of course the inventory itself. Any imperfections in the inventory data could lead to a material uncertainty in the accounts, something that will present both accountants and auditors with potential challenges in producing and approving the accounts in 2016/17.
All that inventory data is typically held on asset management systems being maintained by the engineers, which in future will be key in providing the data for the detailed calculations for the figures in the accounts. With specific systems measuring annual and accumulated depreciation for carriageways, the Gross Replacement Cost (GRC) and DRC for ‘structures’ such as bridges, underpasses and retaining walls, and the detailed calculation of GRC for carriageways and GRC and DRC of the remaining component elements of the Highways Network Asset, there will need to be assurance in the use of these key computer-based systems, which will effectively become accounting records.
The use of toolkits
CIPFA has been leading discussions with the National Audit Office and the various audit firms to try to provide central assurance around the use of the toolkits and the application of centrally provided GRC rates (i.e. the cost of replacing the various highways asset components with their Modern Equivalent Asset).
There will clearly though be a need to obtain assurance on how the toolkits are actually used. The initial focus of this work is likely to be on providing independent assurance to responsible finance officers that centrally provided toolkits are consistent with the Code and so providing a foundation to enable them to demonstrate that the valuation estimates are reasonable.
Perhaps there is a role for internal audit here, looking at how use of the toolkits is controlled, how updates to the data are recorded, etc? The computing phrase ‘Garbage In, Garbage Out’ very much applies here.
Other key areas of assurance will include any local adjustments made to the toolkits to take into account authority-specific factors influencing asset deterioration and, for example, the time before a road begins to display signs of wear, such as the nature of the sub-soil or the typical traffic mix, as well as the assumptions made and evidence supporting the use of local replacement rates and the data on estimated age and lifespan of the various highways component assets.
Key questions to answer
In terms of the robustness of inventory data, have your engineers identified any concerns through their WGA submissions? To what extent are there assumed values in the toolkits which may require further review and evidencing before the 2016/17 accounts are prepared? To use a specific example, is the authority using its own street furniture data or modelling their dimension data on one of the three benchmark authorities in the toolkit?
Ultimately the Responsible Financial Officer will need to be briefed on any risks in relation to the data so to obtain sufficient assurance when signing off the accounts in 2016/17 as true and fair.
Early discussions with the auditor are recommended, to consider their expectations, especially given the complexity of the data and the judgements required around materiality. Whilst the decision made not to restate 2015/16 will be a welcome relief to authorities under continuing pressure to meet austerity challenges, there remains a journey ahead that needs some careful planning – to reach your destination of a successful 2016/17 closedown it is necessary to start the preparations in good time, so the road to assurance is a smooth one.
- Attendees at CIPFA Finance Advisory Network's events discussed many of the accounting and assurance issues for the Highways Network Asset as part of its Accounts Closedown series with Grant Thornton and also through a number of full-day events. The event slides from which can be accessed by FAN subscribers on the website.