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13 PPPs: Some Accounting and Reporting Issues

Author(s):
Ana Corbacho, Katja Funke, and Gerd Schwartz
Published Date:
July 2008
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Author(s)
Richard Hemming

Public-private partnerships (PPPs) refer to arrangements where the private sector supplies infrastructure assets and infrastructure-based services that traditionally have been provided by the government. PPPs can be used to build and operate both economic infrastructure, such as roads, railways and ports, and social infrastructure, such as schools and hospitals. For the private sector, PPPs present business opportunities in areas from which it was in many cases previously excluded. For the government, PPPs can offer better value for money than public investment and government service provision if private sector managers are more skillful and innovative, and PPPs are therefore more efficient than public investment and government service provision. The ability to levy user charges—which may be difficult for the government—can also add to efficiency.

A key advantage of PPPs for many governments may be that private financing can support increased infrastructure investment without immediately adding to government borrowing and debt. While this is a legitimate reason for governments to enter into PPPs, they should still offer value for money. However, there is a possibility that governments will use PPPs to move public investment off budget and debt off the government balance sheet even where this is not the case. In this way, they can formally satisfy externally or self-imposed fiscal rules or targets, even though fiscal costs have simply been shifted to the future. Moreover, governments may go about this in a non-transparent manner, in particular by offering private operators guarantees with hidden and potentially high future fiscal costs.

An internationally accepted accounting and reporting standard for PPPs would help to promote transparency about the fiscal consequences of PPPs, close loopholes that enable PPPs to be misused, and in the process make increased efficiency rather than a desire to live within fiscal constraints their main motivation. This chapter describes current approaches to PPP accounting and reporting, and discusses supplementary disclosure requirements for PPPs, problems created by government guarantees and relevant disclosure requirements for them, and PPPs and debt sustainability analysis. The chapter draws heavily on Hemming and others (2006).

Current approaches to PPP accounting and reporting

Existing government accounting and reporting standards cover payments to and from government under PPPs, the transfer of PPP assets to government, and the calling of guarantees.1

Under a standard PPP operating contract, where a PPP asset is owned by a private operator for the duration of the contract, payments for services provided to the government are recorded as an operating expense under accrual accounting. In the case of a concession, where the concession operator charges the public for services, concession fees and other payments by the concession operator to the government (for example, profit shares) are recorded as revenue. Under an operating lease, where a private operator leases an asset from the government for the purpose of supplying services to the government or the public, lease payments to the government are also recorded as revenue.

When a PPP asset is transferred to the government after an operating contract or a concession expires, this is recorded as the acquisition of a non-financial asset at its residual value, balanced by a capital transfer from the private owner. Any purchase price involved would be an operating expense, and the capital transfer is reduced by the corresponding amount. The asset would also be recorded on the balance sheet at its residual value at the time the transfer takes place, and subsequent depreciation of the asset would be recorded as an operating expense.

If loan guarantees are called, there are two possibilities: either the government assumes the liabilities concerned and there is no financial claim on the original borrower, or the government lends to the borrower on the presumption that the borrower will repay at a later stage. In the first case, the government records the full cost of called guarantees as an operating expense, and the assumption of the loan as a liability. In the second case, the government has a claim on the borrower, which is recorded as the acquisition of a financial asset. When the loan is repaid, interest is recorded as revenue, and amortization as a financial transaction.

Private operators also benefit from other guarantees, and in particular minimum revenue guarantees and exchange rate guarantees. If such guarantees are called, payments are recorded as an expense. Where a guarantee is symmetric and the government stands to gain on the upside (for example, through profit sharing), payments to the government are recorded as revenue. There is no requirement that the government recognizes and records a liability on its balance sheet in respect of guarantees unless they are more likely than not to be called and there is a reasonable basis for calculating the expense involved.

Under cash accounting, the revenue and expenditure implications of PPPs will be recorded in the government accounts only insofar as a cash receipt or payment is involved.

In addition to the PPP transactions mentioned above, considerable attention has also been paid to accounting for limited risk transfer. Risk transfer is important because it goes hand-in-hand with transfer to the private sector of responsibility for designing, financing, building, and operating infrastructure assets. If the private sector does not put its capital and future profit at risk, the efficiency benefits of PPPs are unlikely to emerge, in which case a PPP is little different from public investment and government service provision. This fact has had an influence on the approach to accounting and reporting adopted in Australia and the United Kingdom, and in the member countries of the European Union. In these countries, the guiding principle is that the accounting and reporting of PPPs should reflect economic rather than legal ownership of PPP assets, and that economic ownership can be established by reference to whether the private sector or the government bears the risks (and reaps the rewards) normally associated with ownership. If PPP projects do not transfer significant risk to the private sector, PPP assets can be viewed as government assets and should be recorded on the government balance sheet.

This approach derives from the accounting treatment of operating and financial (or capital) leases. An operating lease is one where the right to use an asset is transferred from its owner to an operator for a fixed period, with the owner retaining the obligations and rights of ownership. A financial lease is one where these obligations and rights are transferred to the operator, who is then assumed for accounting purposes to be using the lease to finance the purchase of the asset. Private sector and government accounting bodies say that an operating lease is in fact a financial lease if any of the following criteria are met: the lease period covers most of the useful life of the asset; the asset is transferred to the operator at the end of the lease; the operator can purchase the asset at a bargain price at the end of the lease; the present value of lease payments is close to the fair market value of the asset; and the asset is useful mainly to the operator. These criteria are assumed to signal where the obligations and rights of ownership rest, and most importantly which party bears ownership risk. If a lease is deemed to be a financial lease, an asset and liability are recorded on the operator’s balance sheet, interest and depreciation are recorded as operating expenses, and amortization is recorded as a transaction in financial assets.

The extension of this approach to PPPs is complicated by the fact that some PPPs take the form of operating leases where the government leases an asset it owns to a private operator. The issue is not whether this is in fact a financial lease, because the focus is on whether the government, and not the private operator, is using a PPP to finance the purchase of an asset. Instead, it is the principle that obligations and rights of ownership matter that is important. In the state of Victoria in Australia, a decision is made as to whether a PPP is a financial lease based largely on the above criteria. In the United Kingdom, ownership of PPP assets is established by specifically looking at the distribution of risks and rewards under a PPP project. The emphasis is not only on ownership risk, but also on other risks and some non-risk characteristics of a PPP project. The judgment as to whether PPP assets are recorded on or off the government balance sheet is based on a detailed assessment of all relevant factors. On balance sheet PPPs in Victoria are recorded as financial leases while in the United Kingdom there are specific accounting and reporting guidelines which are equivalent to those for financial leases.23

For the European Union, Eurostat has developed a risk-based rule for determining the balance sheet treatment of PPPs. More specifically, Eurostat issued a decision in 2004 saying that a private operator will be assumed to bear the balance of PPP risk if it takes on most construction risk, and either most availability risk or most demand risk. If this is the case, a PPP asset will be recorded on the private operator’s balance sheet. Otherwise, a PPP asset will be recorded on the government balance sheet, which is achieved by treating PPP investment as public investment.4 While focusing on a few key risk categories for the purpose of assessing risk transfer is understandable, especially with the rules-based Maastricht Treaty and Stability and Growth Pact (SGP) fiscal regime, it is notable that ownership risk is not taken into account. The more important concern, however, is that even if the private sector assumes most construction risk and availability risk and a PPP asset is recorded on the private operator’s balance sheet, the government can still be exposed to considerable demand risk.

The lack of international accounting and reporting standards for PPPs is in the process of being addressed. Specifically, the International Public Sector Accounting Standards Board (IPSASB), which is the public sector arm of the International Federation of Accountants (IFAC), has embarked upon a project to develop financial reporting guidelines for PPPs and similar “service concession arrangements.” While it remains unclear in which direction this project will develop, and options are at present being kept open, the indications are that it is likely to end up refining the approaches adopted in Victoria, the United Kingdom and the European Union. One possibility is that adoption of the degree of control of service provision and receipt of payment for services could be used as a basis for establishing asset ownership, suggesting that PPP assets would be recorded on private sector balance sheets primarily if services are sold to the public for a price that reflects the level and quality of service. This would probably result in toll road, railway, airport and port projects being recorded as private projects and most other PPP projects as government projects.

Supplementary disclosure requirements for PPPs

Whatever the precise outcome, and that described above would be a welcome improvement over the current situation, any international accounting and reporting standard for PPPs will help those countries seeking definitive guidance on their accounting and reporting treatment. That said, there is an issue as to whether attempting to classify PPP assets as either government or private assets is fundamentally the right approach to PPP accounting and reporting. More specifically, there is a concern that such a “binary approach” to accounting and reporting, where PPP assets are either recorded on or off the government balance sheet, will inevitably tempt governments to tailor PPPs to meet the requirements for off balance sheet recording. This could result in governments accepting bids from private partners prepared to accept more risk, irrespective of the cost to government of having them do so, which would defeat the objective of using PPPs to achieve value for money. By the same token, projects that offer good value for money, even though the nature of the projects means that the government has to bear the balance of risk, may be of little interest to the government given that they have to be recorded on balance sheet. In other words, bad PPPs could end up driving out good ones. A particular concern in Europe is that the Eurostat approach may lead governments to favor PPPs that transfer construction and availability risk to the private sector at the expense of demand risk, primarily to help meet the Maastricht/SGP fiscal targets.

One response to these concerns is to develop a new approach to accounting and reporting for PPPs that is more sensitive to the degree of risk sharing. However, IPSASB is already proceeding along the lines noted above and it is unlikely to significantly change direction. Moreover, one intuitively appealing solution to this problem—the partitioning of PPP assets between the government and the private sector balance sheets according to the degree of risk sharing—is known not to be favored by IPSASB. Rather than seeking to come up with something new, an alternative is to call for supplementary disclosure of information about PPPs with a view to providing a better picture of their fiscal implications. To this end, the IMF has proposed the minimum disclosure requirements for PPPs shown in Box 13.1, with the key element being reporting of the known and potential future fiscal costs of PPPs, which primarily take the form of contractual service payments and expected calls on guarantees.

Problems with government guarantees

Government guarantees provided in connection with PPPs are a source of risk for the government. A guarantee legally binds a government to take on an obligation should a clearly specified uncertain event materialize, and as such gives rise to a contingent liability. A defining characteristic of guarantees and contingent liabilities is uncertainty as to whether the government will have to pay, and if so, the timing and amount of spending. This uncertainty is the principal source of complication in determining the fiscal costs of PPPs, and the main cause of the problems that guarantees and other contingent liabilities create for fiscal management. The focus here is on explicit guarantees with a legal basis rather than implicit guarantees that are based on expectations (for example, that the government would bail out the private sector if a PPP fails).

Box 13.1Disclosure requirements for PPPs

Budget documents and end-year financial statements should include an outline of the objectives of a current or planned PPP program and a summary description of projects that have been contracted or are at an advanced stage in the contracting process (their nature, the private partner or partners, and capital value). In addition, the following more detailed information should be provided for each PPP project or group of similar projects:

  • Future service payments and receipts (such as concession and operating lease fees) by government specified in PPP contracts over the following 20–30 years.

  • Details of contract provisions that give rise to contingent payments or receipts (for example, guarantees, shadow tolls, profit-sharing arrangements, events triggering contract renegotiation), with the latter valued to the extent feasible.

  • Amount and terms of financing and other support for PPPs provided through government on-lending, or via public financial institutions and other entities (such as special purpose vehicles) owned or controlled by government.

  • How the project affects the reported fiscal balance and public debt, and whether PPP assets are recognized as assets on the government balance sheet. It should also be noted whether PPP assets are recognized as assets either on the balance sheet of any special purpose vehicle or the private sector partner.

In countries with significant PPP programs, disclosure could be in the form of a ‘Statement on PPPs’ that is part of the budget documentation and accompanies financial statements. Within-year fiscal reports should indicate any new contracts that have a significant short-term fiscal impact. PPP contracts, or summaries of their key features (preferably in standardized format), should also be made publicly available.

Guarantees may be an appropriate form of government intervention, in particular to shield the private sector from risk that it cannot anticipate and control. Thus a minimum revenue guarantee limits the private operator’s exposure to demand risk when demand is influenced by government policy, while an exchange rate guarantee provides protection against currency volatility when hedging possibilities are limited. However, guarantees are not usually subject to the same degree of scrutiny through the budget process as regular spending. This causes a number of problems:

  • It is difficult to verify that a guarantee is the appropriate fiscal policy instrument to meet a particular objective.

  • The door is open to use guarantees to bypass fiscal constraints, in which case they can have a hidden and even unintended impact on the stance of fiscal policy.

  • Allowance is not usually made in the budget to cover the costs of called guarantees, and little prior consideration is given to the best way to reorient spending or to mobilize revenue should it prove necessary to meet these costs.

  • A “guarantee culture” is created where the private sector (and in some cases international financial institutions and bilateral lenders) seek guarantees as an alternative to managing risk themselves.

  • Because guarantees are valuable to beneficiaries and provided at the discretion of government, they can undermine governance.

These problems are compounded by the fact that guarantees can often have potentially significant fiscal consequences. Governments therefore need to be in a position to manage their risk exposure from guarantees, and to this end the key step to take is full disclosure. Box 13.2 contains disclosure requirements for guarantees recommended by the IMF. However, measurement poses a significant challenge in attempting to meet these requirements, although techniques have been developed to aid with valuation.

To impose control over the use of guarantees, quantitative ceilings could be placed on guarantees and other explicit contingent liabilities where risk exposure is high. Ceilings could apply to flows or stocks. Governments should appropriate in the annual budget the expected cost of guarantees in that year, even if this is only an approximate amount. Where valuation is possible, governments should also consider budgeting for the full cost of guarantees over their lifetime. This will subject guarantees fully to the rigors of budget discipline. Budgeting for guarantees requires a multi-year appropriation, possibly in connection with the use of guarantee or contingent liability funds. However, budgeting does not require that funds be earmarked to cover the cost of called guarantees. Earmarking may help to impose discipline on the budget process, but it does so at the cost of flexibility. Charging guarantee fees may also contribute to the control of guarantees.

Box 13.2Disclosure requirements for guarantees

Irrespective of the basis of accounting, information on guarantees should be disclosed in budget documents, within-year fiscal reports, and end-year financial statements. Guarantees should ideally be reported in a fuller Statement of Contingent Liabilities which is part of the budget documentation and accompanies financial statements, with updates provided in fiscal reports.

A common core of information to be disclosed annually for each guarantee or guarantee program is as follows:

  • A brief description of its nature, intended purpose, beneficiaries, and expected duration.

  • The government’s gross financial exposure and, where feasible, an estimate of the likely fiscal cost of called guarantees.

  • Payments made, reimbursements, recoveries, financial claims established against beneficiaries, and any waivers of such claims.

  • Guarantee fees or other revenue received.

In addition, budget documents should provide:

  • An indication of the allowance made in the budget for expected calls on guarantees, and its form (for example, an appropriation, a contingency).

  • A forecast and explanation of new guarantees to be issued in the budget year.

During the year, details of new guarantees issued should be published (for example, in the Government Gazette) as they are issued. Within-year fiscal reports should indicate new guarantees issued during the period, payments made on called guarantees, and the status of claims on beneficiaries, and update the forecast of new guarantees to be issued in the budget year and the estimate of the likely fiscal cost of called guarantees.

Finally, a reconciliation of the change in the stock of public debt between the start and end of the year should be provided, showing separately that part of the change attributable to the assumption of debt arising from called guarantees.

PPPs and debt sustainability analysis

Debt sustainability analysis, reporting of which is a key fiscal transparency requirement, is usually based on a fairly narrow concept of public debt. Often this is restricted to gross debt in the form of government securities outstanding and loans to government, although sometimes the focus is on net debt, excluding government deposits, government securities held by social security funds and other government entities, and loans made by government. Yet judgments about debt sustainability are not independent of the government’s non-debt obligations.

PPPs give rise to non-debt obligations in that the government commits to purchase services from a private operator and to honor calls on guarantees. These known and potential future costs on the government can influence debt sustainability in much the same way as if the government had incurred debt to finance public investment and provide a service itself, in that more fiscal adjustment is needed to stay on a desired debt path. They should therefore be taken into account when undertaking debt sustainability analysis. There are two ways to do this:

  • PPP obligations could be added to public debt. These obligations would comprise the present value of contractual service payments, calls on guarantees, and other known and contingent expenses, less known and contingent receipts. Debt sustainability would then be judged by reference to public debt plus PPP obligations, and resort to PPPs when debt is unsustainable would require the government to target a larger primary surplus or smaller primary deficit.

  • An analytically equivalent approach is to count known and potential future PPP costs as future primary spending. In this case, debt sustainability is judged by reference to public debt alone, and resorting to PPPs when debt is unsustainable would require additional fiscal measures to meet the original primary surplus/deficit target.

On balance, the latter is probably a better approach, in that it avoids the need to treat the present value of net future payments by the government under PPP contracts as a liability, which has little immediate prospect of being accepted by accountants or statisticians. However, the implementation of this approach does require that the disclosure requirements for PPPs and guarantees referred to above are met. If there are difficulties in valuing guarantees, the emphasis should instead be on scenario analysis to stress test debt projections with respect to different assumptions about calls on guarantees. In this case, the general presumption should be that, all other things being equal, judgments about debt sustainability are more cautious in countries that have provided extensive guarantees.

While there is inevitably a fair degree of imprecision in debt sustainability analysis in the presence of PPPs, it should be noted that taking into account the present value of net future payments by the government under PPP contracts is likely to have an impact on policy advice only where debt sustainability is already a concern. Where this is the case, borrowing to finance traditional public investment would also be a concern, and it is more likely that governments will be tempted to use PPPs to circumvent fiscal targets. Under these circumstances, a conservative approach is warranted. If debt sustainability analysis points to significant risks being entailed by a proposed PPP program, a ceiling could be placed on the overall size of the program. Such a ceiling could usefully be specified in relation to the capacity of the country to service future obligations under the PPP program, proxied by its future stream of revenue.

Notes

Relevant standards are International Public Sector Accounting Standards (IPSAS) issued by the International Federation of Accountants (IFAC), the 1995 European System of Accounts (ESA 95) supplemented by the ESA 95 Manual on Government Deficit and Debt, and the IMF’s Government Finance Statistics Manual 2001 (GFSM 2001).

In South Africa, which is developing an accounting and reporting standard for PPPs, the key consideration is whether the government or the private operator owns a PPP asset when the operating contract expires. Given that government property cannot in general be transferred to a private party in South Africa, provision for such a transfer in a PPP contract carries with it a strong presumption that the PPP is a financial lease.

An appealing consequence of the financial lease approach is that, in contrast to PPP assets suddenly appearing on a government balance sheet when PPP contracts expire, the net asset value builds up on the balance sheet over time. However, there is an issue as to the basis on which the private operator then uses an asset that is presumed to be owned by the government. A solution is to assume that it is leased back to the private operator by the government, which requires additional accounting entries for an operating lease.

This is not the same as treating a PPP as a financial lease in that, while the accounting entries are the same, they have different labels.

Reference

    Hemming, R., and a Staff Team from the Fiscal Affairs Department, 2006, Public-Private Partnerships, Government Guarantees, and Fiscal Risk (Washington: International Monetary Fund).

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