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Local authority balance sheets in the spotlight

Author: ICAEW Insights

Published: 06 Apr 2021

A recent legal battle over the transparency of Thurrock Council’s £815m debt-leveraged investments in solar power bonds highlights the importance of understanding and managing balance sheet risk in the public sector.

The Bureau of Investigative Journalism has won an appeal against a ruling by the Information Commissioner that Thurrock Council does not have to disclose details about its investments in solar power projects. Thurrock has until 12 April to provide the information requested, although it may not have to answer all of the questions asked if it can provide alternative grounds for non-disclosure under the Freedom of Information Act.

Thurrock Council spent £393m on local services in 2019-20, according to its latest report and accounts published in November 2020, with interest receivable and similar income of £50m (significantly greater than £21m in interest payable and similar charges and a £3m loss on £373m of investments carried at fair value through profit and loss) supplementing its income from local taxes and other sources.

Investments of £1,091m, comprising £815m in renewable energy related bonds and £276m in other investments, represented 46% of total assets of £2,355m at 31 March 2020. Total debt of £1,421m represented 85% of total liabilities of £1,666m, with £1,073m disclosed as being short-term and falling due for repayment within one year. Net assets of £689m include £91m in usable reserves, with the balance of unusable reserves principally relating to property revaluations.

Thurrock is not the only council where income from commercial investments is now a significant contributor to their budgets as local authorities have sought to maintain local services following a 55% fall in government funding since 2010-11. Where it is unusual is that a substantial proportion of the funding it has used to finance investment has come from other councils.

Alison Ring, Director for Public Sector at ICAEW, has previously written about concerns over central government monitoring of local authority commercial investments, a concern shared with MPs on the Public Accounts Committee.

Central government has recently sought to make it more difficult for councils to borrow to fund commercial investments. Revisions to the Prudential and Treasury Management Codes came into force in 2019-20 and loan conditions were tightened by the Public Works Loan Board, the principal source of finance for most local authorities wanting to borrow. CIPFA has also launched a consultation on how the Prudential Code can be further strengthened. However, these changes do not address the underlying issues with the current funding model for local government in England that have led a number of councils to take on more risk.

The Redmond Review into local audit and financial reporting recommended improvements in narrative reporting and the understandability of local authority financial statements, currently believed to be ‘impenetrable’ by many. Sir Tony Redmond rejected the suggestion of moving away from IFRS and back to the former near-cash accounting framework, with the increasing level of commercial investment by local authorities and more leveraged balance sheets being one reason why transparent accounting for long term assets and liabilities is needed.

Disclosures about the balance sheet risks that councils are exposed to are particularly in the spotlight given the financial strains that many local authorities are under. Recent Grant Thornton research on public interest reports issued by the external auditors of Nottingham, Northampton and Croydon councils highlights how inadequate transparency and scrutiny of the financial risks from major investments contributed to the financial losses incurred by those councils.

Oliver Simms, Manager, Public Sector Audit and Assurance for ICAEW, commented:

“A number of councils, including Thurrock, have benefited from income generated by commercial investments to supplement their budgets as well as supporting other objectives such as climate change. However, commercial investment and balance sheet leverage come with risks that must be understood and managed effectively in order to protect the interests of local taxpayers and residents. 

“Implementation of the Redmond Review recommendations to strengthen local authority financial reporting should help but local councils must consider how they can ensure their annual reports provide clear and understandable information about financial performance, financial sustainability and risk – including balance sheet risk – so that they can be accountable to councillors and to local residents. The experiences of Nottingham, Northampton and Croydon councils have highlighted how a failure to understand the risks involved in investing can lead to mistakes being made at significant cost.” 

Visit ICAEW’s Accounting for local authorities page to access a range of articles, books and online resources providing quick links to the Code of Practice, Statements of Recommended Practice, guidance and news.