CFWG Paper 56
To:
Capital Finance Working Group (CFWG)
From:
Scottish Government
Date:
22 August 2012
Subject:
Non-current asset insurance events and compensation
Background
1.
The Local Authority (Scotland) Accounts Advisory Committee (LASAAC)
considered a paper dealing with non-current insurance events and compensation.
The LASAAC paper was previously provided with CFWG Paper 47 as Annex A.
2.
LASAAC considered that before agreeing accounting practices for the
operation of the insurance fund there was a need for a review to consider the
insurance fund and its relationship to the capital control framework. In particular
LASAAC wished the CFWG to consider when an insurance receipt should be treated
as a capital receipt. An extract from the LASAAC draft minutes of the meeting
15 August 2011 have be reproduced at Annex A.
3.
The CFWG agreed at its meeting in September 2011 to consider the
treatment of insurance receipts from a policy perspective.
Capital receipts - definition
4.
In Scotland there is no legislative definition of a capital receipt.
5.
In England, Section 9(1) of the Local Government Act 2003 provides a basic
definition of a capital receipt:
“…a sum received by the authority in respect of the disposal by it of an interest in a
capital asset.” A capital asset is defined by section 9(2) as “An asset is a capital
asset…if, at the time of the disposal, expenditure on the acquisition of the asset
would be capital expenditure.”
6.
CIPFA’s publication, a “Practitioners’ Guide to Capital Finance in Local
Government” (2008) identifies that this definition is based on a mirror principle. If an
authority enters into a transaction where it will receive income for a disposal, it has to
imagine that it is the other party to the transaction. If the acquisition of the interest
would meet the statutory definition of capital expenditure it is a capital receipt.
7.
The CIPFA Guidance, in considering the legislation, notes that the definition is
a precise one and no matter how big the sum received, it will not be a capital receipt
unless it satisfies the terms of section 9. The guidance uses insurance as an
example, and advises that insurance proceeds would only be a capital receipt if the
settlement related specifically to the insurer purchasing the damaged asset from the
authority.
8.
Applying this approach, an insurer may be considered to have purchased a
vehicle but it is not so likely that an insurer would be considered to have purchase a
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damaged or destroyed building. It is probably more likely that the insurer is
considered to have compensated the authority rather than have purchased the
asset. The conclusion is that, applying this approach, the insurance receipt is not
considered to be a capital receipt.
Statutory accounting adjustments
9.
However, losses arising from impairments, or arising from the de-recognition
of an asset, is not a charge to the General Fund. If the insurance receipt is a
revenue receipt, a question arises as to whether the impairment, or loss arising,
which is the subject of compensation income, should be the subject of a statutory
adjustment.
Intended use of the insurance receipt
10.
Rather than focus on definitions or statutory adjustments, an alternate
approach is to consider the intended use of the insurance receipt to develop policy.
11.
If the local authority intends to use the insurance receipt to fund the
expenditure which replaces, rebuilds or repairs a non-current asset then the
classification of the insurance monies does not raise any policy concerns. The
authority, if it were to treat the receipt as a capital receipt, could then use the receipt
to fund capital expenditure. If the authority chooses to treat the insurance monies as
a revenue receipt, this would give rise to an increase in the General Fund balance
(applying the statutory adjustment re impairments and losses), allowing a revenue
contribution to capital. In both cases this is cost neutral to the local authority.
12.
However, it is possible for a local authority to take advantage of the statutory
adjustment and use the insurance receipt to increase General Fund reserves, and,
rather than use the insurance monies to finance the capital replacement, borrow to
rebuild or replace the asset.
13.
From a policy perspective, rather than classifying an insurance receipt as
capital or revenue, it would seem appropriate to consider what would be considered
a prudent application of that receipt.
Policy proposal
14.
An insurance receipt is not a capital receipt. A local authority is expected to
act prudently in the use and application of an insurance receipt.
15.
Where a non-current asset is damaged or destroyed and the local authority
replaces or rebuilds the non-current asset it is considered prudent that the insurance
receipt is used to fund any capital expenditure. Prudence in this regard extends
beyond the strict application of an exact replacement or rebuild of an asset, and
encompasses any capital expenditure to restore or continue service provision the
subject of the insurance claim.
16.
Where a non-current asset is damaged or destroyed and the local authority
does not replace or rebuild the non-current asset, it is for the local authority to
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determine what is prudent. In making this determination a local authority is expected
to consider whether there is any outstanding borrowing on the non-current asset and
the long term capital investment plans of the local authority. The materiality of the
insurance receipt should also be taken into account.
Comments on the proposal
17.
The proposal could be that an insurance receipt does not need to be treated
as a capital receipt, rather than “is not” a capital receipt. However, from the LASAAC
comments (Annex A) for accounting purposes, it may be simpler to require all
insurance receipts to be treated as revenue receipts.
18.
Where the non-current asset is damaged or destroyed and the local authority
does not replace or rebuild the non-current asset is it considered prudent to place
the monies in the Insurance Fund?
19.
If this approach is adopted Finance Circular 7/2011 will need to be amended
as this currently requires an insurance receipt to be treated as a capital receipt.
Recommendation
20.
The group considers the policy proposal and provides feedback.
Scottish Government
22 August 2012
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Annex A
Extract from LASAAC draft minutes from meeting 15 Aug 2011
Non-Current Asset Insurance Events and Compensation
Gareth briefly reviewed the paper. Lynn queried why the issue had arisen. Gareth
indicated that a technical query had arisen on treatment and also that the Scottish
Government finance circular (FC 7/2011) on Investment Properties had specified
treatment of compensation as capital income for legislative purposes. The matter had
also been discussed with Audit Scotland (Tim Bridle).
Hazel queried what private sector treatment would normally be. Gareth noted that IFRS
viewed the original impairment as distinct from any right of compensation. As such the
loss would be recognised when it occurred but the income from the claim would only be
recognised when there was a right established and this could be reliably estimated.
Gareth noted that taking compensation received for non-current assets to the Insurance
Account /Insurance Fund could be regarded as another form of ‘leakage’ or resource
transfer from capital to revenue.
Lynn requested views on the initial issue of whether any loss should be presented as an
impairment or as de-recognition. Derek commented that the situation could be
complicated by the use of an Insurance Account, although this is really just an ‘interim
account’.
Grant suggested that in reality the organisation would establish in principle very quickly
whether it would receive compensation, but that estimating the amount might be more
problematic. This was most likely to be the situation when a building is ‘part damaged’
rather than completely destroyed.
Derek noted that the Insurance Account covered more than just property and other noncurrent assets.
Ian R and Derek noted that the impact of impairment on non-current assets was
reversed out to the Capital Adjustment Account, so did not affect the General Fund.
On the subject of presentation of compensation Russell indicated the view that the
insurance income should offset the impairment since this was the substance of the
situation. Nick agreed adding that compensation might also be received for additional
revenue costs or loss of income.
Gareth noted that this could run contrary to the presentation of compensation as capital
income in ‘Taxation & Non-Specific Grants’ (if this was the legally determined position).
A consequence however of excluding compensation from the Service Revenue Account is
the potential volatility of trend analysis on benchmarking / performance indicator costs.
Tom suggested that this was not necessarily a problem since it reflected the actual event
taking place.
Marjory and Derek both commented that, from their recollection, previous non-current
asset insurance compensation received by their authorities had been regarded as capital
receipts, although the exact mechanism used to channel the funds was uncertain.
Lynn commented that it seemed unlikely that there would be a clear determination of
treatment at the meeting.
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Hazel stated that there was a policy issue regarding the use of non-current asset
receipts for revenue. Derek concurred.
Hazel suggested that the Capital Finance Working Group should consider the treatment
of receipts under various scenarios. Gareth suggested that this would be helpful since
the extant LASAAC guidance did not clearly state that non-current asset compensation
was a capital receipt.
Lynn queried the timescale for this. Hazel suggested it would be added to the work plan
but would probably be considered at the CFWG meeting in February.
It was suggested that the accounting requirements would then be developed, potentially
by LASAAC, to reflect the policy decisions.
Gareth noted that liaison with ALARM (Risk Management association) (Scotland) would
be advisable since they had been involved with the original LASAAC guidance.
Action: Capital Finance Working Group to consider treatment of non-current
asset compensation receipts
Action:
LASAAC secretary to liaise with the CFWG and others on the
development of accounting guidance once policy direction is established.
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