Private standards in public places

Rapid change, business re-engineering and strong commercial values are three concepts rarely associated with the public sector. Yet all have taken their place in town halls, hospitals, schools and housing associations across the country over recent years as public bodies become more like private sector organisations. And, while this change is obviously having a major impact on senior finance executives within the public sector, the private-side FD whose company is keen to win lucrative contracts from the state sector is also having to adapt.

Public sector accountancy is a key element in this. The council treasurer has always been a powerful figure in local government, but since the early 1990s their peers in the NHS, and later in central government, higher education and housing associations, have taken on more significant roles. Not only that, but since the 1980s government initiatives aimed at improving the efficiency of the public sector, such as compulsory competitive tendering, and outsourcing of non-core services, have seen public bodies acting more like commercial organisations and entering into partnerships with private businesses.

This trend has been continued in the 1990s with the introduction of the Private Finance Initiative (PFI), while, at the same time, the implementation of an internal market served to hasten the adoption of private sector-style accountancy practices in the NHS. And now, while their commercial peers debate the relative merits of global, European and national accounting standards, there are moves to create a worldwide set of accounting standards for the public sector, too.

The Tory years

‘Successive Conservative governments made the public sector more commercially orientated and this made quite an impact,’ says Vernon Sore, policy and technical director at the public sector accountancy institute CIPFA. ‘The public sector was expected not to be returning a profit, but to be using assets in an efficient way. Public sector bodies had to move to an accounting base that demonstrated that. For example, one of the tests of a successful hospital is that it makes a 6% return on its asset base. In local government, as part of compulsory competitive tendering, councils had to keep trading accounts which demonstrated the return on assets.’

So the roles of public sector accountants have changed significantly, mirroring much of the experience of their private sector colleagues. This was highlighted in a 1998 report from public spending watchdog the Audit Commission on the function of the finance director in local government.

It found that some councils viewed the role of finance directors purely as one of financial administration and accounting, but that the best councils had handed their finance directors a pivotal role in maintaining their financial health, allowed them to act as custodians of the public purse and enabled them to play a major part in delivering corporate objectives. This greater strategic role will be familiar to many private sector accountants, although it is still some way behind the job of FDs of most publicly-quoted companies.

Public/private divide

Steve Freer, former treasurer at Warwickshire County Council, and now chief executive of public sector accountancy institute CIPFA, says the public-private divide is closing. ‘The gap continues to narrow to the extent that it is now quite difficult to think of a change or a strong theme distinctive of the public sector that is not mirrored in the private sector,’ he says. ‘What we call modernisation is an emphasis on performance, outcomes and encouraging organisations not simply to do things because they have always done them. We are looking at step changes in organisation and performance through the use of technology. These are as relevant to the private sector as the public sector.’

Freer believes that much of this change is due to policy changes made by central government. ‘The drivers are from a demanding government that has a clear agenda about how it wants public services to change. This government has put the public sector back at the top of the political agenda.’

New way of thinking

To deliver the government’s programme, the public sector has to adopt a commercial mindset. ‘We have got to think of the customer. People who use public services have increasingly demanding expectations. From the moment people go into their town hall and go up to reception they expect to be treated in the same way as they would be treated by a reputable private organisation,’ he says. ‘The best public sector accountants are at the heart of these changes and are impacting on the role of accountants in terms of being financial managers and advisors.’

Vernon Sore points out that the public sector, like business, is not monolithic. ‘Historically, accounting has tended to develop in different ways in different parts of the public sector. I don’t think public sector accounting practice is behind that in the commercial sector, or that the commercial sector is behind the public sector. They operate in very different environments.’

But while accounting standards are increasingly common to both sectors, they will never be totally the same. ‘Commercial accounting has developed on the basis of safeguarding equity invested by shareholders, hence there is a lot of emphasis on profit and loss and earnings per share. In the public sector, the emphasis has been on stewardship; on demonstrating to the taxpayer how public money has been spent.’

So public sector accountancy means accountability, but it also has a key role to play in helping governments maintain a tight hold of the purse strings – an essential consideration with so much interaction with the more commercially-savvy private sector. ‘Central government accounting has been about making sure departments stay within the budgets voted to them by Parliament. If you are coming at accounts from the controlling cash point of view, looking at profit and loss is a quite different approach,’ Sore says.

Of course, public spending is a political football, but not only do accountants in the sector hear constant calls for better use of taxpayers’ money, politicians also prescribe how the accounts should be prepared. ‘Commercial accountants, and increasingly public sector accountants, are being asked to move towards the financial reporting standards set by the ASB because of the growing importance of capital markets. But because they have a standard framework for accounts laid down by law, it is not as easy for local authorities and others in the public sector to move towards a GAAP approach,’ says Sore.

UK GAAPUK GAAP could hold other perils, too. ‘At the moment, if local authority accounts were prepared to the letter of UK GAAP, their resourcing requirement would go up considerably,’ Sore claims. For example, councils would be charged twice for capital assets – once in the form of depreciation, and secondly in charges set by central government to ensure councils use assets efficiently. This could lead local authorities into the red – but, by law, they are not permitted to set a deficit budget.

‘This would mean that council tax would have to go up – but it is highly unlikely that a government would raise the levels of public expenditure in order to comply with accounting principles,’ Sore says. Many commercial FDs will see parallels in their own problems with accounting standards – on pensions, for example, through FRED 20, which promises to fundamentally alter the appearance of the balance sheet and p&l.

Revolution in the NHS

The NHS has perhaps seen the most movement towards private-sector standards. Recently, health secretary Alan Milburn urged the NHS to become a ’21st century service industry’, but significant changes occurred ten years ago. In 1991, the health service introduced an internal market which divided health bodies into purchasers (health authorities and some GPs) and providers (NHS trust hospitals). Even the language used betrays a commercially-oriented service, and, under the new system, providers agreed annual contracts with purchasers, including, for example, a certain number of hip replacements and cataract removals.

Judy Finn, project manager in the technical services department at management accountants’ institute CIMA, says the internal market triggered a revolution in the NHS. ‘Accountants are being urged to think beyond the numbers and it has become clear that they must look at a lot of non-financial information so they can get to grips with the whole picture,’ she says.

She also believes the change has led the health service to become more rigorous. ‘I worked in the NHS for six years and was there right at the start of the contracting process, and there was very little management information about what went on. Over time, we became much more rigorous at collecting the information, analysing it and making sure the quality was good.’

Kieran Lappin, director of finance at Hereford Hospitals NHS Trust, agrees that the 1990s was a significant decade in health service accounting. ‘One of the key things is that the NHS accounts on a proper accruals accounting basis, unlike many other parts of government service, which account on a cash basis,’ he explains. ‘In the health service during the 1990s we took that on significantly. At the beginning of the 1990s capital charges were introduced. This is comparable to industry because we were recognising the costs of the capital resources we consume.’

Under the NHS capital charges regime, health service trusts pay a 6% return on the assets they employ, plus a depreciation charge, to the Department of Health each year. Health authorities are then given funds reflecting the level of capital charges. This money is paid to trusts as part of the fees negotiated with purchasers. Another key development in the 1990s was the introduction of balance sheets. ‘If you look in particular at the trust reporting and financial monitoring regime, to a degree it is similar to that in commercial organisations,’ says Lappin.

Although the government has now abolished the internal market, the accounting elements that were built up around it are still in place. And, as with their private sector colleagues, NHS finance directors are having to adapt to ASB financial reporting standards. ‘Throughout the 1990s the ASB has brought forward a number of standards that are having a significant impact,’ says Lappin. ‘FRS 5 on the substance of transactions is impacting particularly on PFI.’ FRS 11 on the impairment of assets and FRS 12 on provision for contingent liabilities are also important in the NHS. ‘In the past, few finance directors in the NHS would have seen intangible assets but we have to account for these now,’ he says.

With Treasury agreement, the implementation of FRS 11 was postponed for a year in the English NHS. The National Audit Office says that, had it been introduced in 1998/99 as planned, an extra £419m would have been charged to the health service’s income and expenditure account because of a downward revaluation of fixed assets. From 1999/2000, the Department of Health has increased NHS budgets to cover this shortfall.

Contingent liabilities are also a big issue in the NHS, particularly with regard to claims for clinical negligence. The NAO says total potential liabilities in the English health service accounts for 1998/99 amount to £2.4bn – up £600m from the previous year. The audit office also believes that liability for incidents that have occurred but have not been reported could reach £1bn.

Implementation of FRS 12 was also postponed until 1999/2000. But Lappin says its introduction is another step on the road to rigorous accounting practice. ‘Up until about four or five years ago we only recognised negligence claims as a cost when we paid out a settlement,’ he says. ‘Now there is no difference between the NHS and any commercial organisation in dealing with such issues.’

Commercial ventures

He points out that, in addition to accounting in a similar way to the private sector, many hospitals have commercial ventures of their own. ‘The NHS is the second biggest landlord in the country, with maybe 100,000 tenants,’ he says. ‘Most trusts run substantial catering organisations. Services incomes at this trust come to about £4.5m a year. Many hospitals have private patients – here we earn about £300,000 a year, about 1% of total income – and most have charities to administer. At somewhere like Guy’s hospital in London you could be dealing with millions.’

This more commercial and standardised public financial administration will certainly change the way private sector companies deal with the state sector. Understanding that the FD at a health or education authority is now operating in much the same way, and under the same – or more pressing – financial strictures as their private-side colleagues ought to make the relationship between public and private easier to manage.

But the ultimate test of convergence must be whether an accountant from the private sector could join a hospital trust and hit the ground running. Lappin believes this to be the case. ‘We have our own system geared to the NHS, but I would say that, if we took someone from the private sector, they would be an asset to us and experience shows us that they would probably fit in quite quickly. Up until the beginning of the 1990s that simply would not have been the case.’

This article first appeared in Financial Director magazine.

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