by William Notton
Increasing attention being given to the use of capital in the public sector has brought with it a need to evaluate the underlying assets for reasons of capital charging, transferring to executive agency status or, simply, good management. In all cases the aim is the same — to make accounting realistic and to send the right management signals. In this article I intend to examine the current situation and some of the consequences.
It is perhaps necessary to define those assets with which I am concerned. They are the real property assets of any publicly funded body where the asset is occupied by the body and the intention is that it shall remain so. Thus, I am not concerned with the appraisal of assets currently held in the public sector but which are to pass into private ownership; with public-sector assets occupied by private persons or bodies; or assets declared surplus. In these cases perfectly adequate guidance is contained in the guidance notes on the valuation of assets issued by the RICS. What I am concerned with is the retained operational estate.
At this point it is as well to note that the public-sector estate comprises both specialised and non-specialised property assets. Specialised assets are those for which no general market exists, such as secondary schools and roads. Non-specialised assets are those identifiable with similar assets held by the private sector, such as houses or workshops.
Over recent years there has been an increasing desire on the part of Government to see the public sector account for the use of capital, not least in its property assets. This desire arose specifically in relation to the statutory undertakers and spread throughout the public sector. However, it was the preoccupation with statutory undertakers that caused — and will continue to cause — the valuation profession the greatest difficulty in respect of other public-sector bodies.
In order to understand the application of asset valuation to the public sector, it is first necessary to understand how it has been applied in the private sector.
When the private sector moved to current cost accounting (CCA), fixed assets were required to be stated in accounts at their worth to the business of which they formed part. The value of the assets could be regarded as “deprival” value, ie the loss that would be suffered if the business were deprived of the use of the assets in question. Generally, in respect of property assets, deprival value equated to the cost of acquiring in the open market a replacement asset having a similar service capacity. As the largest portion of assets by number to be valued are non-specialised, this requirement created little practical difficulty. Where a specialised asset was involved it was suggested that a depreciated replacement cost approach provided the required information.
Thus, when the Government and the accountancy profession turned to the public sector the desire was to emulate the private sector accounting treatment. Unfortunately, by looking first at the statutory undertakers — bodies which actually traded and produced a valuable product allowing a monetary test of profitability — a mould was cast with the intent of encompassing the whole of the public sector.
In any business producing either a product or a service which is actually sold, the worth of any asset to the business can be judged by real measures. Hence, although the valuation profession found difficulties inherent in the nature of the assets to be valued for statutory undertakers, the end result could nevertheless always be tested by reference to profitability. Where that test is not available, it is, therefore, doubtful that the same approach should apply, or whether better management signals might not be sent by a combination of different performance indicators.
By retracing history, we have now arrived at the present situation. Clear signals have come from both the Treasury and public-sector accountants that a similar accounting model should apply to the operational property assets of public-sector bodies other than statutory undertakers. Unfortunately, this decision was taken before regard was given to the practicality of provision of property-related information.
Where no test of profitability exists against which to measure deprival value the figures appearing in a balance sheet representing the worth of the asset to the business cannot be stated as “values”. Nevertheless non-specialised assets can generally be represented by their existing use value in the open market.
Where the asset is specialised a greater problem arises. In the private sector the concept is to envisage a depreciated replacement cost (DRC) assessment based on a modern equivalent asset. That is to say the asset can be worth no more to the business than a modern equivalent with a similar life expectancy and service capacity. This assumption presumes that modern equivalents exist but no market evidence of value is available.
In the public sector, however, there is no choice available in the use of capital: a public authority cannot opt to invest its capital assets in preference to providing a service. Thus it is questionable whether, when considering a specialised asset, a modern equivalent should be assumed in preference to an appraisal of the amount of capital invested in the actual property and that remaining to be utilised. Such an appraisal would be made by costing the provision of an identical asset and then looking at the amount of that sum remaining unconsumed by reference to the remaining life of the subject building. Such an amount I call “capital in use”.
Economists and accountants might approve my argument thus far. However, there is a further consideration adding, I believe, strength to the suggestion. When utilising a DRC based on a modern equivalent asset it is assumed that the modern equivalent will have the same life expectancy as the subject and the same service capacity. In practice such a situation is impossible to achieve. For example, one of the nation’s national museums might have a fabric life, assuming normal maintenance, of 300 years or more, but the services might only have a life of 15 years. A modern equivalent would not align. Not only would the expected life be very different but the life cycle costs of the modern equivalent would be fundamentally different. In my view, therefore, “capital in use” is to be preferred as sending the right management signal in the public sector.
Having identified what I consider to be the correct approach it is appropriate to look at what is actually happening.
No valuation guidance has been promulgated by HM Treasury or any other body, and to date assessments of major departmental estates have been made only by the Valuation Office. Thus the local authority valuers are currently busily carrying out pilot studies in response to the CIPFA initiative, and the RICS Assets Valuation Standards Committee is attempting to produce a new guidance note and background paper.
While I suspect that my idea of the measurement of “capital in use” might receive an indications of approval from those responsible for policy in the public sector, I am apprehensive that the guidance eventually issued to practitioners will not address the central problem, but will show a preoccupation with “value” as a result of using the so-called “contractors test” — a DRC by another name — for valuation purposes. (It is not my intention here to examine the use of contractors test save to say that I have the gravest doubts as to whether the results produced by it ever actually represent a true picture.)
I am therefore concerned that those responsible for preparing public-sector balance sheets may not understand what it is they are likely to receive from the property profession, and those responsible for providing the figures cannot be certain that what they propose to give is that which is required.
One might at this point be forgiven for asking whether this matter is actually of significance. I suggest it is, and would cite a single example.
In a recent rationalisation study of the NHS estate the conceptual exercise was completed without reference to the proposed capital charge. When this was injected — as an afterthought — the implication was so fundamental as to require reappraisal of the whole exercise. It is therefore quite reasonable to suppose that the amount of the capital charge is of itself significant.
What ought to be done about this situation? There can only be a single response to the question, and that is for those concerned — both users and providers — to get together as soon as possible, and make sure that each understands the other.
