One of the principal benefits of accruals accounting is a balance sheet that records assets and liabilities in one place, providing essential information on the financial position of an organisation, enabling insights into how well it is being run.
As a pioneer in adopting accruals accounting in the public sector, the UK government is unique internationally in preparing consolidated financial statements that encompass almost the entire public sector – the Whole of Government Accounts (WGA). The Balance Sheet Review was launched by HM Treasury (HMT) in 2017 “to identify opportunities to dispose of assets that no longer serve a policy purpose, improve returns on retained assets and reduce the risk and cost of liabilities”. The ‘Balance Sheet Review Report: Improving public sector balance sheet management’ was published in November 2020 and can be found here.
ICAEW strongly supports HMT’s initiative to carry out a thorough review of how the government balance sheet is being managed, taking advantage of the information provided in the WGA and in the data collected from the over 8,000 entities in the public sector in the UK that it consolidates. The report demonstrates that active management of the balance sheet can lead to tangible benefits for taxpayers and society. A number of benefits have long been associated with a well-managed balance sheet such as better planning, lower interest costs and better deployment of assets earning greater returns.
The report starts by discussing the background to the review and the public sector balance sheet framework, followed by three broad chapters looking at different aspects of what the balance sheet has to offer:
- Transparency – long-term impacts of policies on the balance sheet.
- Asset management – delivering better value for money from assets.
- Risk management – strengthening control of long-term risks and the costs of liabilities.
The public sector balance sheet framework is a critical component to the longevity of the Balance Sheet Review as it provides a basis for assessing the impact of changing policies, how different assets can be evaluated, and how risks and opportunities can be weighed against government objectives.
Public sector balance sheet framework
The development of a principles-based framework for the public sector balance sheet is an important step that goes beyond how public bodies can actively manage their existing assets and liabilities to improve outcomes.
The framework is intended to guide HMT’s fiscal and public spending decisions by allocating assets and liabilities between policy, financial and commercial portfolios. The framework establishes criteria for the composition of each portfolio and sets out broad management objectives, governance arrangements and exit strategies, with the aim of optimising how public assets and liabilities are managed, based on their different characteristics. For example, the principal objectives for assets and liabilities in the policy portfolio are to ensure they are delivering on government policy aims and providing value for money, while in the commercial portfolio a key management objective is to maximise returns while limiting risk for taxpayers.
The government plans to use the framework as a basis for updating more detailed guidance to create a sound basis for managing risk and optimising returns. This includes “identifying management economies of scale within each asset portfolio to optimise performance” and “informing the mandates of future institutional vehicles tasked with delivering specific policy priorities”.
The report comments that as a first step the framework has been applied to inform the management of the assets of the government's Future Fund and to guide the objectives and operational management of legacy assets and liabilities from Covid-19 interventions.
Query 1: The relatively high-level nature of the public sector balance sheet framework set out in the review raises a number of questions, the first of which is how the framework will be developed and embedded into the workings of government at all levels?
The Balance Sheet Review highlights how fiscal decision-making can be better informed by considering the impact of policies on balance sheet metrics. For example by:
- strengthening assessments of fiscal sustainability by taking into account the health of the entire public sector balance sheet beyond public debt;
- better informing decisions to buy or sell assets and settle or incur liabilities by considering the impacts not only on the balance sheet but also on income flows over the longer term; and
- assessing value for money and the rationale for asset disposals.
This will be helped by enhancing fiscal transparency through rules requiring departments to systematically disclose the impacts of asset sales across a range of balance sheet metrics to Parliament.
Two new balance sheet metrics (Public Sector Financial Liabilities and Public Sector Net Worth) have been developed in conjunction with the Office for Budget Responsibility (OBR) and the Office for National Statistics (ONS) for use in statistical reporting and forecasting to support a more comprehensive appraisal of the financial implication of policies. Although not perfect, combining audited accruals-based financial data with these unaudited statistical and forecast metrics should provide a significantly improved view of the public finances and allow for better policy evaluation.
The Balance Sheet Review states that improving the coverage, quality, frequency and timeliness of balance sheet information is key to understanding the long-term impacts of policies on the public finances and to unlocking the gains from taking a more active approach to the management of the public sector balance sheet.
This will require action to significantly speed up the production of the WGA each year (the latest took around 15 months to produce, compared with the two to three months more common in the private sector), while a more systematic approach to evaluating and critically appraising policies will also be required if these benefits are to be achieved.
The quality of narrative reporting in the WGA and in departmental and local authority annual reports will need improvement too, addressing criticism from the Public Accounts Committee that they often do not allow sufficient scrutiny of key policies. Transparency over how much key policies are costing the taxpayer and what the outcomes have been will not only assist Parliament and other stakeholders in holding public bodies to account, but will also help public bodies by making them demonstrate how they have discharged their responsibilities as stewards and managers of public resources.
Query 2: How can public sector annual reports and accounts be improved to enable more effective evaluation of policies, linking the achievement of objectives, outputs and KPIs (for example) to the balance sheet resources used and not just to the cash cost incurred?
The effective management of assets to achieve value for money is central to the Balance Sheet Review and the asset management chapter is the longest part of the report.
The chapter starts out with the need to recognise the long-term balance sheet implications of spending decisions and how Spending Reviews from 2020 onwards will take a long-term approach to spending decision-making. It says this also offers the benefit of allowing the Government to take into account opportunities to improve the management of existing assets and liabilities before providing new money.
Departments were asked during the 2020 Spending Review to look at how they could improve returns and/or utilisation of core assets, reduce the costs and risks of core liabilities and improve compensation for bearing risks.
The chapter provides a series of examples of how applying the framework has helped or can help improve outcomes, ranging from strengthening asset maintenance to extending the useful life of the public sector asset base, improving returns and utilisation of assets in the NHS estate and maximising the value of knowledge assets in the public sector.
The chapter seems a little disjointed with various initiatives listed one after the other, but it does identify both immediate and longer-lasting opportunities to improve balance sheet management. However, there is little sense of priority and at times it is difficult to understand whether initiatives have already commenced or are still being contemplated.
Some of the key points discussed include:
- The 2020 Spending Review did not impose any asset sales targets, in contrast with the 2015 Spending Review target of raising £5 billion a year from selling assets; the report says that departments should not proceed with asset sales that do not achieve value for money.
- The need to maximise the value of intangibles in the public sector, including intellectual property rights, research & development, technology and data, with the report estimating that these assets could be worth as much as £150bn. These assets remain largely underexploited and the government plans to set up a unit to look for and develop opportunities for managing intangibles more effectively.
- A new digital national asset register is to be created to enable better management of property across the public sector. A trial version has already been tested for feasibility, with more than 330,000 properties with an estimated value of £443bn included. The new register should help identify opportunities for the disposal, re-location and co-location of these assets by providing information on vacant, surplus and available estate within the public sector.
- Another example was in how receivables can be better managed through better data sharing between HMRC and local councils. One pilot initiative sought to help councils avoid the use of expensive enforcement agents by enabling them to recover more unpaid amounts through Attachments of Earnings (taking money owed directly from wages).
Query 3: Many of the initiatives described in the report rely on good data – to what extent is the Balance Sheet Review able to interact effectively with the National Data Strategy?
The risk management chapter of the Balance Sheet Review looks at how to improve the identification and mitigation of balance sheet risk, improving the capability to understand and manage risk and improve compensation for risk to protect the taxpayer.
Examples discussed in the chapter include how the government decided to reduce its exposure to inflation risk by issuing fewer index-linked gilts, how placing controls on commercial property investments by local authorities reduces the potential exposure of central government, and how to improve management of clinical negligence liabilities in the NHS. Other examples include developing a risk sharing framework for financial guarantees provided to support private sector house building and reducing insurance costs by allowing local-authority schools to participate in risk pooling arrangements, replacing commercial insurance with a government contingent liability.
Improved understanding of risk is identified as critical to managing it better, and HMT is establishing a ‘contingent liability central capability’ unit in 2021 to strengthen the management of contingent liabilities. This unit will help stress-test the portfolio of contingent liabilities to determine the economic conditions to which the government is especially vulnerable too, as well as advising on premiums to charge where appropriate. According to the most recent WGA, there were £80.1bn contingent liabilities and £297.4bn in remote contingent liabilities as at 31 March 2019, in addition to contingent liabilities that were not quantifiable.
The report highlights how the government can be more commercial in the premiums it charges the private sector for the risk borne by the taxpayer while still achieving its policy objectives of encouraging exports.
The report does not analyse the principal risks facing the government beyond the illustrative examples it provides, with no mention of climate risk nor of many of the other key risks identified in the government’s risk register. While the report is primarily focused on the risks inherent in the existing balance sheet, it does not analyse the wider risk landscape, including how risks may evolve over time or potential risks arising from factors such as an ageing population, a reducing tax base and rapid technological advances.
Query 4: How do key risks facing the UK not explored in this report, such as climate and demographic risks, fit into the public sector balance sheet framework?
The Balance Sheet Review Report concludes by setting out eleven next steps to be taken to improve balance sheet management across government, including actions stemming from the examples referred to in the report.
Wider actions identified include using the balance sheet framework that has been developed to assess performance, further work by the ONS and the OBR on balance sheet metrics and embedding consideration of balance sheet impacts into spending decisions, processes and guidance across government, as well as feeding into a wider review of the fiscal framework.
The conclusion of the Balance Sheet Review does not complete this process as the recommendations at the end of the report makes clear. There is a lot still to do to improve the coverage, quality, frequency and timeliness of balance sheet information and to improve the capability of the UK government to assess and manage risk. There are also gaps that still need to be addressed, such as its acknowledgment that a further review is needed on the public sector balance sheet and risk exposures in the context of climate change and the shift to a greener economy.
Despite that, the report provides a range of examples of how the use of accruals-accounting, including an integrated balance sheet, can help the government to improve the way it manages the public finances and improve both outcomes and value for money for taxpayers and citizens. Governments around the world considering whether to adopt accruals-accounting should find it useful in understanding some of the potential benefits that may be achievable.
Query 5: How can the UK government convert the conclusions of the Balance Sheet Review from a set of examples into an embedded way of working across the whole of the public sector?